Exhibit 13
(Form 10-K/A-1)
CITIZENS BANKING CORPORATION
2002 Annual Report Information
And
Financial Statements
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS CITIZENS BANKING CORPORATION AND SUBSIDIARIES
CITIZENS BANKING CORPORATION
2002 ANNUAL REPORT INFORMATION
This report contains information required to be included in an annual report
pursuant to the rules of the Securities and Exchange Commission, including
audited financial statements, management's discussion and analysis of financial
condition, and results of operations and five year selected financial data. Upon
request, Citizens Banking Corporation will provide without charge a copy of its
annual report on Form 10-K.
TABLE OF CONTENTS
I. Financial Review including Management's Discussion and Analysis
Five Year Summary of Selected Financial Data..................................................... 26
Management's Discussion and Analysis............................................................. 27
Critical Accounting Policies................................................................. 27
Recent Accounting Pronouncements and Developments............................................ 28
Strategic Initiatives and Other Key Actions in 2002.......................................... 28
Special Charges, Acquisitions, Divestiture and Other Initiatives............................. 29
Results of Operations........................................................................ 31
Earnings Performance..................................................................... 31
Net Interest Income...................................................................... 31
Noninterest Income....................................................................... 35
Noninterest Expense...................................................................... 37
Federal Income Taxes..................................................................... 39
Line of Business Results................................................................. 39
Financial Condition.......................................................................... 41
Liquidity and Debt Capacity.................................................................. 53
Interest Rate Risk........................................................................... 54
Interest Rate Sensitivity.................................................................... 56
Selected Quarterly Information............................................................... 57
II. Consolidated Financial Statements
Consolidated Balance Sheets...................................................................... 58
Consolidated Statements of Income................................................................ 59
Consolidated Statements of Changes in Shareholders' Equity....................................... 60
Consolidated Statements of Cash Flows............................................................ 61
III. Notes to Consolidated Financial Statements.......................................................... 62
IV. Report of Independent Auditors...................................................................... 93
V. Report of Management................................................................................ 94
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FINANCIAL REVIEW
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
TABLE 1. FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA (1)
(in thousands, except per share data) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR
Net interest income $ 301,782 $ 307,981 $ 314,874 $ 309,642 $ 292,424
Provision for loan losses 120,200 26,407 20,983 24,675 16,528
Noninterest income before securities gains (losses) 99,340 111,286 90,344 85,044 71,413
Investment securities gains (losses) 2,436 6,195 -- (3,052) 475
Noninterest expense before special charges 245,981 251,183 242,221 236,778 218,219
Special charge 13,402 -- 15,541 40,198 --
Income tax provision (benefit) (1,063) 43,215 35,813 27,989 39,283
Net income 25,038 104,657 90,660 61,994 90,282
Cash dividends (2) 50,659 50,158 48,108 30,035 22,991
PER COMMON SHARE DATA
Net income:
Basic $ 0.56 $ 2.27 $ 1.92 $ 1.29 $ 1.86
Diluted 0.56 2.25 1.91 1.28 1.84
Cash dividends (2) 1.130 1.085 1.015 0.915 0.82
Book value, end of year 14.88 15.46 14.62 13.32 14.07
Market value, end of year 24.78 32.88 29.06 22.38 33.75
AT YEAR END
Assets $ 7,522,034 $ 7,678,875 $ 8,405,091 $ 7,899,357 $ 6,930,533
Portfolio Loans (3) 5,432,561 5,771,963 6,422,806 5,917,483 5,264,706
Deposits 5,936,913 5,965,126 6,244,141 6,128,998 5,772,792
Long-term debt 599,313 629,099 471,117 127,104 226,171
Shareholders' equity 650,469 697,464 679,979 633,669 680,501
AVERAGE FOR THE YEAR
Assets $ 7,569,341 $ 7,935,843 $ 8,073,021 $ 7,342,167 $ 6,792,829
Earning assets 7,160,596 7,510,332 7,584,932 6,875,643 6,367,284
Portfolio Loans (3) 5,530,790 5,977,744 6,202,157 5,528,963 5,159,584
Deposits 5,924,442 6,008,096 6,121,373 5,906,664 5,616,894
Interest-bearing deposits 5,054,743 5,126,928 5,175,252 5,002,135 4,787,143
Repurchase agreements and
other short-term borrowings 251,315 538,673 920,323 478,920 202,639
Long-term debt 620,913 596,380 303,597 210,289 228,969
Shareholders' equity 691,834 702,381 650,251 672,227 655,034
FINANCIAL RATIOS
Return on average:
Shareholders' equity 3.62% 14.90% 13.94% 9.22% 13.78%
Earning assets 0.35 1.39 1.20 0.90 1.42
Assets 0.33 1.32 1.12 0.84 1.33
Average shareholders' equity/avg. assets 9.14 8.85 8.05 9.16 9.64
Dividend payout ratio (2) 202.33 47.93 53.06 59.13 40.49
Net interest margin (FTE) 4.45 4.32 4.32 4.68 4.78
Tier I leverage 7.18 7.79 7.11 7.21 8.95
Risk-based Tier I capital ratio 9.18 9.87 9.05 9.22 11.01
Risk-based Total capital ratio 10.43 11.12 10.30 10.47 12.26
===============================================================================================================================
(1) Except as indicated, all data presented has been restated to reflect the
acquisitions of F&M Bancorporation, Inc. in 1999 using the pooling of
interests method of accounting. Certain acquisitions by F&M Bancorporation,
Inc. in 1999 and 1998 accounted for as pooling of interests, were not
material to prior years' reported operating results and, accordingly,
previous years' results have not been restated. The branch office
acquisitions by Citizens in May 2000 and October 1999 and the bank
acquisitions by F&M Bancorporation, Inc. in January 1998 were accounted for
using the purchase method of accounting; accordingly, the financial data
includes their results of operations only since dates of acquisition.
(2) Cash dividends and cash dividends per share are for Citizens Banking
Corporation only, not restated for pooling of interests.
(3) Excludes mortgage loans held for sale.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS CITIZENS BANKING CORPORATION AND SUBSIDIARIES
The following commentary presents management's discussion and analysis of
Citizens Banking Corporation's financial condition and results of operations for
each of the past three years and should be read in conjunction with the
accompanying consolidated financial statements and notes presented on pages 56
through 88. Unless the context indicates otherwise, all references in the
discussion to "Citizens," the "Company," "our," "us" and "we" refer to Citizens
Banking Corporation and its subsidiaries. All financial data have been restated
to give effect to mergers accounted for on a pooling of interests basis in
previous periods. The results of other acquisitions, accounted for as purchases,
have been included effective with the respective dates of acquisition.
Discussions in this annual report that are not statements of historical fact
(including statements that include terms such as "believe", "expect", and
"anticipate") are forward-looking statements that involve risks and
uncertainties, and our actual future results could materially differ from those
discussed. Factors that could cause or contribute to such differences include,
but are not limited to, adverse changes in our loan portfolios and the resulting
credit risk-related losses and expenses, our future lending and collections
experience and the potential inadequacy of our loan loss reserves, interest rate
fluctuations and other adverse changes in economic or financial market
conditions, the potential inability to hedge certain risks economically, adverse
changes in competition and pricing environments, our potential failure to
maintain or improve loan quality levels and origination volume, our potential
inability to continue to attract core deposits, the potential lack of market
acceptance of our products and services, adverse changes in our relationship
with major customers, unanticipated technological changes that require major
capital expenditures, adverse changes in applicable laws and regulatory
requirements, unanticipated environmental liabilities or costs, our potential
inability to integrate acquired operations or complete our restructuring, the
effects of terrorist attacks and potential attacks, our success in managing the
risks involved in the foregoing, and other risks and uncertainties detailed from
time to time in our filings with the Securities and Exchange Commission.
Other factors not currently anticipated by management may also materially and
adversely affect our results of operations. We do not undertake, and expressly
disclaim any obligation, to update or alter our forward-looking statements
whether as a result of new information, future events or otherwise, except as
required by applicable law.
CRITICAL ACCOUNTING POLICIES
Citizens' consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and follow general
practices within the industries in which it operates. Application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates, assumptions and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such, have a greater
possibility of producing results that could be materially different than
originally reported. Based on the valuation techniques used and the sensitivity
of financial statement amounts to the methods, assumptions and estimates
underlying those amounts, management has identified the determination of the
allowance for loan losses and the benefit obligation and net periodic pension
expense for our employee pension and postretirement benefit plans to be the
accounting areas that require the most subjective or complex judgments, and,
therefore, the most subject to revision as new information becomes available.
Our significant accounting policies are more fully described in Note 1 to the
consolidated financial statements.
The allowance for loan losses represents management's estimate of probable
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. Default frequency, internal risk ratings, expected future
cash collections, loss recovery rates, and general economic factors, among other
things, are considered in this evaluation, as are the size and diversity of
individual large credits. In the event that we overestimate future cash flows or
underestimate losses on loan pools, we may be required to increase our provision
for loan losses, which would have a negative impact on results of operations in
the period in which the increase occurred, as was the case in the third quarter
of 2002. The loan portfolio also represents the largest asset type on the
consolidated balance sheet. Note 1 to the consolidated financial statements
describes the methodology used to determine the allowance for loan losses and a
discussion of the factors driving changes in the amount of the allowance for
loan losses is included under - "Provision and Allowance for Loan Losses."
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Pension liabilities are established and pension costs are charged to current
operations based on actuarially determined present value calculations. The
valuation of the pension obligation and net periodic pension expense is
considered critical as it requires management to make estimates regarding the
amount and timing of expected future cash outflows including assumptions about
employee mortality, expected employee service periods, rate of employee
compensation increases, and the long-term return on plan assets. If we were to
determine that more conservative assumptions were necessary, our costs would
likely increase and have a negative impact on results of operations in the
period in which the increase occurred. Note 13 to the consolidated financial
statements provides further discussion on the accounting for Citizens' employee
benefit plans and the estimates used in determining the actuarial present value
of the benefit obligations and the net periodic pension expense.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note 2 to the consolidated financial statements discusses new accounting
policies adopted by Citizens during 2002 and the expected impact of accounting
policies recently issued or proposed but not yet required to be adopted. To the
extent the adoption of new accounting standards materially affects Citizens'
financial condition, results of operations or liquidity, the impact is discussed
elsewhere in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and in the notes to the consolidated financial
statements.
STRATEGIC INITIATIVES AND OTHER KEY ACTIONS IN 2002
In February 2002, we named William R. Hartman our president and chief executive
officer, and in January 2003 he became our chairman. We also significantly
strengthened our management team by hiring a new chief financial officer and a
chief credit officer, and by naming executives in charge of operations and
technology, consumer banking and branch delivery. In addition, we named new
regional presidents in our important Southeast and Northern Michigan markets.
These appointments added depth of experience in vital areas of management.
After Mr. Hartman's arrival, he and other key members of management spent a
number of months reviewing our franchise and with the assistance of industry
consultants developed a restructuring plan to improve the overall performance of
the Company. In concept, the restructuring plan is simple and straightforward -
manage the Company on a line of business basis and make process improvements to
improve efficiency and create opportunities to grow revenues. The expectation is
to make the franchise more market driven and client centric, which are vital
characteristics for improving client service, cross-selling and attracting new
clients. Some of the operational or process changes have already been
implemented and some are still ongoing.
Also, during this franchise analysis period, a number of loan quality problems
surfaced in the span of a few months, which precipitated an extensive
loan-by-loan analysis, above and beyond the periodic review normally performed,
on a large portion of the commercial loan portfolio. In the third quarter, this
review along with the rapid deterioration of certain commercial credits
culminated in a large increase in nonperforming loans, significant loan
write-downs and a large loan loss provision.
To strengthen our credit risk profile and to implement restructuring and process
improvement initiatives, we took the following key actions in the second half of
2002.
Credit risk restructuring and process improvement initiatives:
- - We separated the relationship management function from the credit approval
process and established regional credit officer positions, staffed with our
most experienced credit officers whose sole responsibility is to evaluate
and approve credit decisions in accordance with Company-wide guidelines.
Separating the relationship management function from the credit approval
process is designed to improve accountability and credit quality.
- - We implemented an automated credit approval process for loans below
$500,000 and strengthened our loan risk rating scale and criteria to
improve risk management and to allow us to detect credit problems earlier.
- - We increased the allowance for loan losses with a third quarter charge of
$89.3 million to the provision. The additional allowance reflects discerned
credit deterioration manifested by elevated past-due and nonperforming
loans,
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a weakened economy and an unusually high amount of commercial credits that
deteriorated to charge-off status during the third quarter. Additionally,
we implemented enhancements to the loan loss allocation model that result
in relatively higher allocations. These enhancements included the
incorporation of more recent historical loss data in the determination of
projected loss rates for pools of loans evaluated collectively for loss.
The implementation of these three credit risk restructuring and process
improvement initiatives are expected to benefit future results of operation,
cash flows and financial condition through lower loan charge-offs and lower
nonperforming assets. However, in the near term (i.e. the next three to four
quarters) the effects of this initiative may be to increase net charge-offs and
nonperforming assets as the new credit process allows us to detect credit
problems earlier. The amount and timing of the expected benefits of these
initiatives cannot be precisely determined.
Other restructuring and process improvement initiatives:
- - We established the position of branch manager in all of our retail offices.
This decision supports the practice of one contact person for all client
service needs and more effectively coordinates sales and delivery of
services to our clients.
- - We implemented new cost reduction initiatives aimed at improving core
earnings and operating efficiency. Cost reduction initiatives included
renegotiating contracts for procurement of various banking services,
equipment and suppliers, including microcomputer equipment and support
services, telecommunication services, courier services and forms and
supplies. We also executed an ATM redeployment plan and began the first
phase of our image capture project, both of which are expected to produce
operational cost savings beginning in 2003.
- - We launched restructuring initiatives within our three major lines of
business (consumer banking, business banking and wealth management) to
enable us to compete more effectively, reduce layers of management, be more
customer oriented, and better position us to grow core deposits and loans.
As part of the restructuring, we closed 12 branches in the fourth quarter
of 2002 and expect to close an additional 6 branches in the first half of
2003.
As a result of these restructuring and cost reduction initiatives, we anticipate
lower noninterest expense, due to reduced salaries and employee benefits,
equipment, occupancy, postage and delivery, telephone and stationery and
supplies expense. We began to realize expense reduction in salaries and employee
benefits and equipment expense in the fourth quarter of 2002 from the
restructuring of our three major lines of business and the fourth quarter branch
closures. Additional expense reductions in salaries and employee benefits and
equipment expense and the other aforementioned expense categories will be
realized beginning in the first quarter of 2003. Annual expense reduction from
these initiatives is anticipated to be approximately $8 million to $10 million
in 2003 compared with 2002.
Other key actions:
- - We recorded a special charge of $13.4 million and other charges of $9.4
million, as more fully described below.
- - We prepaid $75 million of high cost FHLB debt to improve balance sheet
flexibility, further reduce our funding costs and improve our interest rate
sensitivity. The prepayment penalty amounted to $3.3 million and was
included as part of the $9.4 million of other charges in the third quarter
of 2002. The effect of the prepayment was a reduction of approximately $1.0
million in interest expense in the fourth quarter of 2002. The favorable
effect on interest expense is expected to continue at the same level into
the third quarter of 2003.
SPECIAL CHARGES, ACQUISITIONS, DIVESTITURE AND OTHER INITIATIVES
SPECIAL AND OTHER SIGNIFICANT CHARGES
In 2002, we recorded a special charge of $13.4 million ($8.7 million after-tax)
that included restructuring and impairment costs associated with reorganization
of our consumer, business and wealth management lines of business. The
reorganization resulted from a detailed review of our consumer banking, business
banking and wealth management areas by key members of management with assistance
from industry consultants. This review revealed opportunities for process
change, staff reassignment, reporting structure changes, branch closures,
expense reduction and business growth. As a result of the reorganization, we
displaced 157 employees. In the fourth quarter of 2002, 128 of these employees
were released, of whom seventeen were subsequently rehired for other available
positions. The remaining employees will be released during the first half of
2003. Displaced employees are offered severance packages and outplacement
29
assistance. Twelve banking offices were closed in the fourth quarter of 2002 and
six additional offices were identified for closure during the first half of
2003.
In the third quarter of 2002, we also charged to earnings $9.4 million ($6.1
million after-tax) of other significant items we consider unusual in nature. Net
interest income was charged $701,000, comprised of an adjustment of $668,000 to
premium amortization on mortgage-backed securities and a $33,000 write-off of
accrued interest on a pool of government subsidized loans. Noninterest income
was charged $1.6 million, which included market value adjustments of $662,000 in
an equity investment and $650,000 to life insurance cash surrender values, and
write-offs of $200,000 for obsolete assets and $75,000 for cash management fees
accrued but not collectable. Noninterest expense was charged $7.1 million,
comprised of a $3.3 million prepayment penalty on high cost FHLB debt, a $2.0
million contribution to our charitable trust, a $979,000 market valuation
adjustment in other real estate, $406,000 in additional depreciation on
equipment to be retired early and $452,000 in other items.
We adjusted premium amortization on mortgage-backed securities as a result of
our quarterly review of prepayment assumptions. Low mortgage interest rate
levels resulted in an increase in prepayments and shortened the expected average
life of the securities. Because the increase in prepayments was inconsistent
with historical norms, the adjustment was determined to be unusual in nature.
Our analysis of prepayments is derived from information supplied by an
independent third party. The securities involved in the adjustment were
collateralized mortgage-backed securities, which were purchased in the secondary
markets and were not part of any securitization done by us.
The equity investment writedown relates to a venture capital partnership that
specializes in financing technology companies. During the third quarter, we
received an accounting from the partnership showing significant writedowns in
the carrying value of some of the investments in technology companies within the
partnership. The partnership reduced the value of its investments due to the
poor financial performance of some of the companies in which it was invested and
the poor prospects of recovering some of these investments given the unfavorable
market conditions for technology companies. As a result of these factors, we
reduced the book value of our investment in the partnership from $1.1 million to
$438,000, and, because of the broad scope and degree of decline in the
technology sector, we determined the adjustment to be unusual in nature.
The cash surrender value of separate-account life insurance policies is
determined based upon the value of the underlying securities held in the
policies. During the third quarter, the value of the underlying securities
experienced a swift and significant decline due to the decrease in values in the
equity markets. As a result, we reduced the book value on these policies from
$2.2 million to $1.55 million, and considered the adjustment unusual due to the
sharp and significant amount of the decline as a percent of the total cash
surrender value of the policies.
During 2000, conversion and integration efforts resulting from our November 1999
merger with F&M Bancorporation, Inc. ("F&M") were completed. Net costs of $12.3
million ($7.4 million after-tax) incurred to complete these efforts (including
system conversions, business unit integration, branch closures and other items)
were recorded in noninterest expense as a special charge. The net costs included
reversals of prior year business restructuring reserves of $6.2 million,
pre-tax, due to the successful settlement of a contract with a former vendor of
F&M and favorable experience in employee separations. At year-end 2001, our
special charge reserve from the 1999 merger was fully utilized. Total deductions
to the special charge reserve were $3.3 million in 2001 and $16.0 million in
2000. Included in these deductions were cash payments of $3.3 million and $9.7
million in 2001 and 2000, respectively. See Note 3 to the consolidated financial
statements for additional information regarding the special charge in 2000.
In the fourth quarter of 2000, we recorded an additional pre-tax charge of $3.2
million ($2.1 million after-tax) consisting of restructuring costs of $2.0
million and asset impairment and other charges of $1.2 million associated with
corporate and organizational re-engineering initiatives. The restructuring plans
include reorganization of our trust and investment management business into one
nationally chartered trust bank, streamlining our community bank organizational
structure, consolidation of our direct and indirect lending operations, and
exiting certain unprofitable indirect lending dealer relationships. These
initiatives were completed by year-end 2001.
ACQUISITIONS AND DIVESTITURE
In November 2001, we sold F&M Bank-Minnesota with assets of $27.0 million. The
bank was our sole location in Minnesota. This divestiture resulted in a pretax
gain of $793,000.
On May 12, 2000, we purchased three Jackson, Michigan offices of Great Lakes
National Bank. The purchase added approximately $31 million in deposits for
which we paid a premium of $3.9 million. On October 8, 1999, we completed the
acquisition of seventeen former Bank One offices located in the northern section
of Michigan's Lower Peninsula.
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The purchase added approximately $88 million in loans and $442 million in
deposits. We paid a premium of $36.1 million or 10.13% of certain core deposits.
These transactions were accounted for as purchases.
RESULTS OF OPERATIONS
EARNINGS PERFORMANCE
An analysis of the major components of net income in 2002, 2001 and 2000 is
presented below. Additional data on our performance during the past five years
appear in Table 1, "Five Year Summary of Selected Financial Data".
Year Ended December 31,
---------------------------------------
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
Interest income $ 464,092 $ 573,559 $ 622,008
Interest expense 161,609 265,578 307,134
--------- --------- ---------
Net interest income 302,483 307,981 314,874
Provision for loan losses 120,200 26,407 20,983
Noninterest income 95,527 97,676 90,344
Noninterest expense 238,844 251,183 242,221
Income tax provision 4,184 36,878 41,890
--------- --------- ---------
NET INCOME BEFORE ADJUSTMENT FOR SIGNIFICANT ITEMS 34,782 91,189 100,124
--------- --------- ---------
Adjustments for significant charges and one-time gains:
Gains from sale of securitized portfolio mortgages 2,436 5,372 --
Gains from sale of merchant business, an equity investment and other assets 5,400 14,433 --
Special charges (13,402) -- (15,541)
Other significant charges (9,425) -- --
Tax benefit (expense) 5,247 (6,337) 6,077
--------- --------- ---------
Net increase (decrease) to income (9,744) 13,468 (9,464)
--------- --------- ---------
NET INCOME AS REPORTED $ 25,038 $ 104,657 $ 90,660
========= ========= =========
=========================================================================================================================
For the year ended December 31, 2002, we recorded net income of $25.0 million,
or $0.56 per diluted share, compared with $104.7 million, or $2.25 per diluted
share for 2001 and $90.7 million, or $1.91, per diluted share in 2000. Returns
on average assets and average equity for 2002 were 0.33% and 3.62%,
respectively, compared to returns of 1.32% and 14.90%, respectively, in 2001 and
returns of 1.12% and 13.94%, respectively, in 2000.
Net income decreased 76% in 2002 due largely to actions taken in the third
quarter of 2002 to improve our credit quality risk profile, restructure the
Company along its three major lines of business, improve client service and
reduce future operating costs. The actions included a large incremental loan
loss provision ($89.3 million compared to previous quarterly provisions of $5-$9
million) in the third quarter, and the aforementioned special charge of $13.4
million and other charges of $9.4 million. Full year net income for 2002 was
also impacted by lower gains on sale of securitized portfolio mortgages and
other assets in 2002 than in 2001 and a decline in net interest income due to a
lower volume of earning assets.
In 2001, net income was up 15% compared to 2000 due to higher noninterest
income, driven by higher mortgage banking activity and gains of $14.4 million
from the sale of an equity investment and other assets in 2001, as well as a
reduction in noninterest expense due to a $15.5 million special charge recorded
in 2000. The increase was partially offset by lower net interest income and a
higher loan loss provision. The decline in net interest income reflected a lower
level of earning assets from planned balance sheet restructuring activities. The
special charge in 2000 included $12.3 million of merger-related integration
costs and an additional $3.2 million of restructuring and other costs associated
with separate strategic initiatives and impairment write-offs.
NET INTEREST INCOME
The primary source of our revenue is net interest income. Net interest income is
the difference between interest income on earning assets, such as loans and
securities, and interest expense on liabilities, including interest-bearing
deposits and borrowings, used to fund those assets. The amount of net interest
income is affected by fluctuations in the amount and
31
composition of earning assets and funding sources and in the yields earned and
rates paid, respectively on these assets and liabilities. Changes in net
interest income are most often measured through two statistics - interest spread
and net interest margin. The interest spread represents the difference between
yields on earning assets and the rates paid for interest-bearing liabilities.
The net interest margin is expressed as the percentage of net interest income to
average earning assets. Both the interest spread and net interest margin are
presented on a tax-equivalent basis. Because noninterest-bearing funding
sources, demand deposits, and other liabilities and shareholders' equity, or
free funding also support earning assets, the net interest margin exceeds the
interest spread. Table 2 on the following page presents net interest income,
interest spread and net interest margin with average balances and related
interest rates for the past three years.
Net interest income, was $301.8 million in 2002, down from $308.0 million in
2001 and $314.9 million in 2000. The net interest margin increased to 4.45% in
2002 from 4.32% in both 2001 and 2000. Though unchanged in 2001 from 2000, the
net interest margin improved steadily throughout 2001 growing from 4.10% in the
fourth quarter of 2000 to 4.48% in the fourth quarter of 2001. Average interest
earning assets decreased $363.3 million, or 4.9%, in 2002 and $135.1 million, or
1.8% in 2001, while average interest bearing liabilities decreased $335.0
million, or 5.3%, in 2002 and $137.2 million, or 2.1%, in 2001.
The decline in net interest income in both 2002 and 2001 was attributable to a
lower level of earning assets partially offset by a more favorable asset mix and
reduced reliance on wholesale (short-term) funding. Over the past two years, we
have taken several steps to improve our earning asset mix and increase our net
interest margin. In 2001, we restructured our balance sheet by securitizing and
selling $247 million of mortgage loans previously held within our mortgage
portfolio, selling 59% of our new mortgage loan production, into the secondary
market for $638.4 million, selling our $30 million Michigan-based credit card
portfolio, and selling a $27 million affiliate - F&M Bank-Minnesota.
Additionally, we limited growth in our indirect lending portfolio and refocused
the commercial loan portfolio in Wisconsin to de-emphasize certain types of
commercial real estate lending. In 2002, we sold 81% of our new mortgage loan
production, into the secondary market for $1.024 billion and securitized an
additional $28.6 million, or 2%, of new mortgage loan production which we
transferred to our investment portfolio. Additionally, $114.3 million of fixed
and variable rate, seasoned mortgage loans previously held within our mortgage
portfolio were securitized through Federal National Mortgage Association
("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"). As of December
31, 2002, we still retained $63.0 million of these newly created mortgage-backed
securities in our investment portfolio. In 2002, we also refinanced $75 million
of high cost Federal Home Loan Bank advances, reducing the interest rate we pay
on these funds by 486 basis points.
Net interest margin improved through most of 2002 and 2001, spurred by the
balance sheet restructuring and significantly lower funding costs as our cost of
funds, especially the cost of deposits and short-term borrowings, declined more
than the yields on our loans and investments. Funding costs and yields on
earning assets declined primarily in response to a lower interest rate
environment engineered by the Federal Reserve Board which cut short-term
interest rates eleven times in 2001, for a total reduction of 4.75%, and again
in November 2002 by 50 basis points. Lower yields on earning assets were also
affected by competitive pressures. Lower funding costs are also due to a higher
level of core deposits in 2002 and refinancing of $75 million Federal Home Loan
Bank advances in September 2002.
32
TABLE 2. AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
2002 2001 2000
--------------------------------- ------------------------------ ------------------------------
Year Ended December 31 AVERAGE AVERAGE Average Average Average Average
(in millions) BALANCE INTEREST(1) RATE(2) Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
- ------------------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS
Money market investments $ 50.6 $ 0.8 1.61% $ 46.9 $ 1.8 3.75% $ 4.1 $ 0.3 5.67%
Investment securities(3):
Taxable 963.6 55.5 5.75 896.1 57.6 6.43 1,007.0 66.2 6.57
Tax-exempt 416.6 21.3 7.87 419.2 21.7 7.97 393.2 20.3 7.96
Mortgage loans held for sale 146.4 9.2 6.27 131.3 9.0 6.85 -- -- --
Portfolio Loans(4):
Commercial 3,343.3 207.8 6.31 3,440.8 269.7 7.93 3,178.2 279.3 8.89
Real estate mortgage 686.2 49.8 7.24 1,001.8 76.9 7.67 1,488.7 113.8 7.64
Consumer 1,501.3 119.0 7.93 1,535.2 136.9 8.91 1,535.2 142.1 9.26
--------- --------- ---------- ------- ---------- -------
Total earning assets(3) 7,108.0 463.4 6.72 7,471.3 573.6 7.87 7,606.4 622.0 8.36
NONEARNING ASSETS
Allowance for loan losses (87.6) (81.2) (80.2)
Investment security
fair value adjustment 52.6 39.0 (21.5)
Nonearning assets 496.3 506.7 568.3
--------- ---------- ----------
Total assets $ 7,569.3 $ 7,935.8 $ 8,073.0
========= ========== ==========
INTEREST BEARING LIABILITIES
Deposits:
Interest-bearing demand $ 1,148.0 18.0 1.57 $ 744.8 14.0 1.88 $ 581.5 8.5 1.46
Savings 1,363.5 15.5 1.14 1,474.5 34.8 2.36 1,701.7 55.2 3.24
Time 2,543.3 94.4 3.71 2,907.6 156.1 5.37 2,892.1 165.4 5.72
Short-term borrowings 251.3 4.0 1.60 538.7 27.5 5.09 920.3 58.5 6.36
Long-term debt 620.9 29.7 4.79 596.4 33.2 5.57 303.6 19.5 6.41
--------- --------- ---------- ------- ---------- -------
Total interest
bearing liabilities 5,927.0 161.6 2.73 6,262.0 265.6 4.24 6,399.2 307.1 4.80
NONINTEREST BEARING LIABILITIES
AND SHAREHOLDERS' EQUITY
Noninterest-bearing demand 869.7 881.2 946.1
Other liabilities 80.8 90.3 77.4
Shareholders' equity 691.8 702.4 650.3
--------- ---------- ----------
Total liabilities and
shareholders' equity $ 7,569.3 $ 7,935.8 $ 8,073.0
========= ========== ==========
NET INTEREST INCOME $ 301.8 $ 308.0 $ 314.9
========= ======= =======
INTEREST SPREAD 3.99% 3.63% 3.56%
Contribution of noninterest-bearing
sources of funds 0.46 0.69 0.76
-------- ---- ----
NET INTEREST MARGIN 4.45% 4.32% 4.32%
======== ==== ====
====================================================================================================================================
(1) Interest income is shown on an unadjusted basis and therefore does not
include taxable equivalent adjustments.
(2) Average rates include taxable equivalent adjustments to interest income of
$14,470,000, $14,835,000, and $14,097,000 for the years ended December 31,
2002, 2001, and 2000, respectively, based on a 35% tax rate.
(3) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost,
adjusted for amortization of premiums and accretion of discounts.
(4) Nonaccrual loans are included in average balances.
The November 2002 rate reduction coupled with our asset-sensitive interest rate
risk position will negatively impact our net interest margin in future periods.
This anticipated decline in net interest margin combined with slow growth in
commercial and consumer loans, and the sale of most new mortgage loan
production, will result in lower net interest income in the first quarter of
2003 and may adversely impact net interest income in the remainder of 2003. In
addition, our net interest margin and net interest income will be negatively
impacted by the $125 million of subordinated debt issued in January 2003
described in "Borrowed Funds" and "Liquidity and Debt Capacity."
33
Table 3 below shows changes in interest income, interest expense and net
interest income due to volume and rate variances for major categories of earning
assets and interest-bearing liabilities.
TABLE 3. ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
2002 COMPARED TO 2001 2001 Compared to 2000
------------------------------------------ ------------------------------------------
INCREASE (DECREASE) Increase (Decrease)
Year Ended December 31 DUE TO CHANGE IN Due to Change in
NET --------------------------- Net ---------------------------
(in thousands) CHANGE(1) RATE(2) VOLUME(2) Change(1) Rate(2) Volume(2)
- ------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Money market investments $ (950) $ (1,077) $ 127 $ 1,541 $ (120) $ 1,661
Investment securities:
Taxable (2,186) (6,332) 4,146 (8,557) (653) (7,904)
Tax-exempt (414) (280) (134) 1,365 21 1,344
Mortgage loans held for sale 172 (810) 982 9,003 -- 9,003
Loans:
Commercial (61,821) (54,922) (6,899) (9,614) (32,461) 22,847
Real estate (27,164) (4,079) (23,085) (36,917) 472 (37,389)
Consumer (17,812) (13,436) (4,376) (5,270) (4,384) (886)
------------ ------------ ------------ ------------ ------------ ------------
Total (110,175) (80,936) (29,239) (48,449) (37,125) (11,324)
------------ ------------ ------------ ------------ ------------ ------------
INTEREST EXPENSE:
Deposits:
Demand 4,042 (2,573) 6,615 5,495 2,774 2,721
Savings (19,298) (15,985) (3,313) (20,410) (16,786) (3,624)
Time (61,824) (44,609) (17,215) (9,293) (10,473) 1,180
Short-term borrowings (23,425) (13,171) (10,254) (31,074) (10,060) (21,014)
Long-term debt (3,471) (4,794) 1,323 13,726 (2,866) 16,592
------------ ------------ ------------ ------------ ------------ ------------
Total (103,976) (81,132) (22,844) (41,556) (37,411) (4,145)
------------ ------------ ------------ ------------ ------------ ------------
NET INTEREST INCOME $ (6,199) $ 196 $ (6,395) $ (6,893) $ 286 $ (7,179)
============ ============ ============ ============ ============ ============
==============================================================================================================================
(1) Changes are based on actual interest income and do not reflect taxable
equivalent adjustments.
(2) The change in interest not solely due to changes in volume or rates has
been allocated in proportion to the absolute dollar amounts of the change
in each.
Interest income declined $110.2 million in 2002 and $48.4 million in 2001
primarily due to a lower rate environment and, to a lesser extent, a lower level
of earning assets. Yields on commercial loans and certain consumer home equity
loans were particularly impacted as many of these loans are tied to the prime
interest rate, which declined in step with the aforementioned decline in the
federal discount rate. Average earning assets decreased to $7.108 billion in
2002, down from $7.471 billion in 2001 and $7.606 billion in 2000. The decrease
is principally due to the aforementioned balance sheet restructuring efforts in
2001 and 2002, and, to a lesser extent, to weakened loan demand caused by the
impact of the economic slowdown. Commercial loans in the Michigan market
continued to grow in 2002 over 2001 but at a slower pace due to a still sagging
manufacturing sector. Commercial loans in the Wisconsin market decreased in both
years as we tightened credit standards and de-emphasized certain types of
commercial real estate lending. Within the consumer portfolio, home equity loans
continued to show strong growth but were offset by declines in the direct auto
and indirect lending portfolios due to increased competition from finance
subsidiaries of auto manufacturers and from other indirect lenders. As a result,
the ratio of average loans to average earning assets declined in 2002 to 79.3%
from 81.3% in 2001 and 81.8% in 2000. Investment securities, including money
market investments, comprise the remaining 20.7% of earning assets, up from
18.7% in 2001 and 18.2% in 2000. The average yield on earning assets decreased
to 6.72% in 2002 from 7.87% in 2001and 8.36% in 2000.
Interest expense decreased $104.0 million in 2002 and $41.6 million in 2001,
reflecting lower rates paid on funding sources and less reliance on wholesale
funding due to the balance sheet restructuring in 2002 and 2001. The average
rates paid on interest bearing liabilities decreased to 2.73% in 2002 from 4.24%
in 2001 and 4.80% in 2000. We experienced significant rate reductions in all
categories of interest bearing liabilities in both 2002 and 2001, except for
34
interest bearing demand accounts in 2001, reflecting the previously discussed
lower interest rate environment. The increase in the average rate paid on
interest-bearing demand accounts in 2001 resulted from growth of a highly
successful new product offering with a tiered rate structure, which pays higher
rates of interest. Average deposits decreased $83.7 million in 2002 and $113.3
million in 2001. In 2002, growth in core deposits was more than offset by
declines in higher cost brokered and large denomination time deposits, which
reduced funding costs and minimized our reliance on purchased deposits.
Additionally, in both 2002 and 2001, interest bearing deposits decreased as
clients sought higher yielding investment alternatives such as fixed and
variable annuities offered through our retail and brokerage units and, to a
lesser extent for 2001, the sale of F&M Bank-Minnesota. Average short-term and
long-term borrowings comprised 14.7% of interest bearing liabilities in 2002
down from 18.1% in 2001 and 19.1% in 2000. Average short-term borrowings
declined $287.4 million in 2002 and $381.7 million in 2001 as we reduced
reliance on borrowed funds through the balance sheet restructuring and utilized
the low rate environment to convert a portion of our wholesale funding to
long-term debt.
NONINTEREST INCOME
An analysis of the components of noninterest income is presented in the table
below. To provide more meaningful trend analysis certain significant
transactions not normally incurred are presented separately.
NONINTEREST INCOME
Year Ended December 31, $ Change % Change
----------------------------------- ---------------------- --------------------
(dollars in thousands) 2002 2001 2000 2002-2001 2001-2000 2002-2001 2001-2000
- ------------------------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $ 26,456 $ 27,773 $ 26,260 $ (1,317) $ 1,513 (4.74)% 5.76%
Trust fees 18,956 21,028 24,253 (2,072) (3,225) (9.9) (13.3)
Mortgage and other loan income 16,845 13,159 4,997 3,686 8,162 28.0 163.3
Bankcard fees 6,142 11,799 11,258 (5,657) 541 (47.9) 4.8
Brokerage and investment fees 9,502 8,157 7,693 1,345 464 16.5 6.0
ATM network user fees 3,658 3,448 3,202 210 246 6.1 7.7
Financial services 2,888 3,134 2,813 (246) 321 (7.8) 11.4
Other 11,080 8,355 9,868 2,725 (1,513) 32.6 (15.3)
--------- --------- --------- --------- ---------
TOTAL FEES & OTHER INCOME 95,527 96,853 90,344 (1,326) 6,509 (1.4) 7.2
Securities gains before
securitized mortgage sales -- 823 -- (823) 823 (100.0) --
--------- --------- --------- --------- ---------
SUBTOTAL 95,527 97,676 90,344 (2,149) 7,332 (2.2) 8.1
--------- --------- --------- --------- ---------
Significant gains (charges):
Security gains - sale of
securitized mortgages 2,436 5,372 -- (2,936) 5,372 (54.7) --
Sale of merchant business 5,400 -- -- 5,400 -- -- --
Sale of credit card portfolio -- 2,623 -- (2,623) 2,623 (100.0) --
Sale of F&M Bank Minnesota -- 793 -- (793) 793 (100.0) --
Sale (writedown) of equity investment (662) 11,017 -- (11,679) 11,017 (106.0) --
Cash surrender value adjustment (650) -- -- 650) -- -- --
Other charges (275) -- -- (275) -- -- --
--------- --------- --------- --------- ---------
TOTAL SIGNIFICANT ITEMS 6,249 19,805 -- (13,556) 19,805 (68.4) --
--------- --------- --------- --------- ---------
TOTAL NONINTEREST INCOME $ 101,776 $ 117,481 $ 90,344 $ (15,705) $ 27,137 (13.4) 30.0
========= ========= ========= ========= =========
=============================================================================================================================
Noninterest income declined $15.7 million, or 13.4%, in 2002 following an
increase of $27.1 million, or 30.0% in 2001. Fewer gains from sales of assets
and investment securities in 2002 of $12.8 million, the aforementioned
significant charges of $1.6 million in 2002 and lower bankcard, deposit service
charges and trust fees accounted for the decline in 2002. These items were
offset, in part, by higher mortgage banking revenue and brokerage and investment
fees. In 2001, gains on sale of investment securities and other assets accounted
for $20.6 million of that year's increase with the remainder of the increase
primarily due to higher mortgage banking revenue and deposit service charges
partially offset by lower trust fees. Noninterest income before securities gains
contributed 17.7% of total revenues in 2002, compared to 16.2% in 2001 and 12.7%
in 2000.
35
Service charges on deposit accounts consist of fees on interest bearing and
noninterest bearing deposit accounts as well as charges for items such as
nonsufficient funds ("NSF" fees), overdrafts and stop payment requests. Certain
commercial checking customers receive a non-cash earnings credit based on their
account balance and short-term interest rates. The earnings credit is used to
reduce the activity fees that are charged to these accounts. Lower account
balances or short-term interest rates result in reduced earnings credits and
higher net service charges. Service charges on deposit accounts decreased in
2002 due to a decline in NSF and overdraft fees partially offset by higher
commercial checking account service charges. The increase in service charge
revenue in 2001 reflects higher service charges on commercial checking accounts
due to greater transaction volumes combined with a lower earnings credit, as
well as new marketing and fee initiatives.
Trust fees include personal, institutional and employee benefit products and
services. Trust fees are based primarily on the market value of assets under
administration, but also may include, although to a much lesser extent, fixed
activity based fees for certain ancillary services performed. Trust fees have
declined since 2000 principally as a result of the decline in the equity
markets, which has reduced the value of assets under administration. At December
31, 2002, we had total assets under administration of $2.555 billion, compared
to $3.162 billion at December 31, 2001, and $3.448 billion at December 31, 2000.
The increase in mortgage and other loan income reflected higher mortgage banking
revenue. Mortgage banking revenue includes mortgage loan servicing, origination
and sales activity conducted through our wholly owned subsidiary, Citizens Bank
Mortgage Company LLC, and our banking affiliates. Mortgage banking revenue
increased to $14.5 million in 2002 from $10.9 million in 2001 and $3.1 million
in 2000. The increases in both years were due to higher gains on sales of
mortgages and the related servicing rights, which increased $3.0 million in 2002
and $5.7 million in 2001. Typically we sell the mortgage servicing rights
concurrently with the sale of the underlying mortgage loan. Falling interest
rates coupled with appreciating home values helped create a strong mortgage
origination market in both 2002 and 2001. Mortgage originations reached $1.3
billion in 2002, up from $1.1 billion in 2001 and $457 million in 2000. The
majority of all new mortgage loan originations in both 2002 and 2001 were sold
in the secondary market.
Bankcard fees include revenue generated from personal and business debit and
credit cards as well as merchant services. We sold our merchant services
business in the second quarter of 2002 and our $30 million Michigan-based credit
card portfolio in June 2001. As a result, bankcard fees declined significantly
in 2002 following a modest increase in 2001. The increase in 2001 was generated
by higher debit card and merchant transaction volume, partially offset by lower
credit card fees due to the mid-year sale of the Michigan credit card portfolio.
Brokerage and investment fees in both 2002 and 2001 benefited from increased
fixed annuity product sales driven by clients' preference for this product over
certificates of deposit or equity investments and more emphasis on selling this
product through the retail branch network.
ATM network fees have continued to rise since 2000, due to higher ATM surcharge
revenue from a convenience fee charged to non-client users of our ATM network. A
fee increase in March 2002 as well as higher transaction volumes due to
strategic redeployment and upgrading of ATMs within our branch network
contributed to the higher surcharge revenue.
Financial services include fees generated from banking services, such as safe
deposit box rentals, redemption of savings bonds, wire transfers, paying agent
services, and issuance of negotiable items such as travelers' checks, money
orders and official checks. Lower rental income from safe deposit boxes
accounted for the decrease in 2002. Higher official check fees partially offset
by lower safe deposit box rental income accounted for most of the increase in
2001.
Other noninterest income increased in 2002 due primarily to higher revenue from
sale of checks, the sale of four branch properties in the fourth quarter of 2002
and an increase in life insurance income due, in part, to our purchase of
bank-owned life insurance in the third quarter of 2002. We purchased $78 million
of separate account, bank-owned life insurance with a national insurance carrier
rated in the top ranking levels by insurance carrier rating agencies. The
policies, on which Citizens is the beneficiary, insure the lives of our officers
and are designed as a funding source for our payment of employee benefits and
deferred compensation. The policies were purchased with proceeds from the sale
of securitized mortgages, the Michigan credit card portfolio, and other
short-term investments. Bank-owned life insurance income represents the cash
buildup from the life insurance policies. The cash buildup is afforded
tax-favored treatment. The tax equivalent yield on the bank owned life insurance
policies at December 31, 2002, which had a balance of $78.4
36
million, was 3.63%. Other noninterest income in 2001 reflects lower revenue from
cash management services and taxable bond syndications partially offset by
higher title insurance fees. Title insurance fees include closing fees and title
insurance commissions generated by our wholly-owned title company, Citizens
Title Services, Inc. Title insurance fee revenue was basically flat in 2002 as
higher closing fees were offset by a decline in insurance commissions but was up
in 2001, due to the higher volume of mortgage origination in 2001 over 2000.
We recognized net gains of $2.4 million on sale of investment securities in 2002
compared to $6.2 million in 2001 and none in 2000. Sales of securitized mortgage
loans accounted for the entire net gain in 2002 and $5.4 million in 2001. The
sales were part of our strategy to restructure the balance sheet to decrease
reliance on wholesale funding and minimize interest rate risk. As presented in
Note 5 to the consolidated financial statements, we realized gross gains of $2.5
million, $6.2 million and $67,000 and gross losses of $91,000, $7,000 and
$67,000 on sale of investment securities in 2002, 2001 and 2000, respectively.
In both 2002 and 2001 we also recorded certain significant gains and charges
that we consider unusual in nature. In 2002, such items included the
aforementioned security gain of $2.4 million on securitized mortgages, a $5.4
million gain on the aforementioned sale of our merchant services business, and
other charges of $1.6 million that are more fully described under the caption
"Special Charges, Acquisitions, Divestiture and Other Initiatives" on page 29 of
this report. The significant items in 2001 consisted of securities gains of $5.4
million from securitized mortgages, a $2.6 million gain on the sale of credit
card assets, a $793,000 gain on the sale of F&M Bank - Minnesota, and a gain of
$11.0 million on the sale of NYCE stock. NYCE Corporation is an ATM network
provider in which we held an equity position.
NONINTEREST EXPENSE
An analysis of the components of noninterest expense is presented in the table
below. In order to provide more meaningful trend analysis, special and other
significant charges are presented separately.
NONINTEREST EXPENSE
Year Ended December 31, $ Change % Change
----------------------------------- ---------------------- --------------------
(dollars in thousands) 2002 2001 2000 2002-2001 2001-2000 2002-2001 2001-2000
- ------------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $ 126,847 $ 126,278 $ 122,577 $ 569 $ 3,701 0.5% 3.0%
Equipment 19,463 19,317 19,264 146 53 0.8 0.3
Occupancy 17,855 17,713 16,770 142 943 0.8 5.6
Data processing services 12,641 13,101 12,608 (460) 493 (3.5) 3.9
Professional services 14,790 12,277 10,088 2,513 2,189 20.5 21.7
Intangible asset amortization 2,899 10,115 9,917 (7,216) 198 (71.3) 2.0
Bankcard fees 3,879 9,308 8,959 (5,429) 349 (58.3) 3.9
Postage and delivery 7,120 7,746 6,924 (626) 822 (8.1) 11.9
Telephone 5,279 5,556 6,364 (277) (808) (5.0) (12.7)
Advertising and public relations 5,112 5,219 5,034 (107) 185 (2.1) 3.7
Stationery and supplies 4,032 4,426 5,602 (394) (1,176) (8.9) (21.0)
Other 18,927 20,127 18,114 (1,200) 2,013 (6.0) 11.1
--------- --------- --------- --------- ---------
SUBTOTAL 238,844 251,183 242,221 (12,339) 8,962 (4.9) 3.7
--------- --------- --------- --------- ---------
Significant charges:
Special Charge 13,402 -- 15,541 13,402 (15,541) -- 100.0)
Prepayment penalty on FHLB advances 3,300 -- -- 3,300 -- -- --
Contribution to charitable trust 2,000 -- -- 2,000 -- -- --
O.R.E valuation adjustment 979 -- -- 979 -- -- --
Additional equipment depreciation 406 -- -- 406 -- -- --
Other charges 452 -- -- 452 -- -- --
--------- --------- --------- --------- ---------
TOTAL SIGNIFICANT ITEMS 20,539 -- 15,541 20,539 (15,541) -- (100.0)
--------- --------- --------- --------- ---------
TOTAL NONINTEREST EXPENSE $ 259,383 $ 251,183 $ 257,762 $ 8,200 $ (6,579) 3.3 (2.6)
========= ========= ========= ========= =========
==============================================================================================================================
Noninterest expense increased $8.2 million, or 3.3%, in 2002 after decreasing
$6.6 million, or 2.6%, in 2001. In general, the increase in 2002 reflected
special and other significant charges of $20.5 million as well as an increase in
professional services, partially offset by lower intangible asset amortization
and bankcard fees. The decrease in 2001 primarily
37
reflected the $15.5 million special charge recorded in 2000. Higher
incentive-based compensation, pension costs and professional service expenses in
2001 partially offset this decrease. The special and other significant charges
recorded are more fully described under the caption "Special Charges,
Acquisitions, Divestiture and Other Initiatives" on page 29 of this report and
in Note 4 to the consolidated financial statements.
Salaries and employee benefits were essentially unchanged in 2002 after
increasing 3.0% in 2001. For 2002, lower salary costs due to the restructuring
initiatives were offset by higher pension and medical expenses. Salaries and
employee benefits increased in 2001 due to normal merit increases, higher
incentive-based compensation associated with mortgage loan origination and sales
activity, and increased pension costs. The defined benefit pension plan for our
Michigan and Illinois employees ("CBC Plan") was amended, effective January 1,
2002, to provide a cash balance pension benefit. The amendment increased the
projected benefit obligation of the CBC Plan by $1.1 million and increased
pension expense by approximately $450,000 annually. In the third quarter of
2002, as part of our restructuring initiatives, we recognized a pension
curtailment related to the early termination of certain officers' employment
earlier than expected. These pension benefits were provided under unfunded
supplemental benefit plans. The curtailment resulted in a charge of $891,870 for
the accelerated recognition of their prior service cost bases and was recorded
as a component of the special charge. Staff reductions tied to our 2002
restructuring initiatives are expected to reduce future pension expense by
approximately $200,000 annually.
Equipment expense, excluding the charge in 2002, was essentially unchanged in
both 2002 and 2001. The charge of $406,000 in 2002 reflects accelerated
depreciation of $389,000 on personal computer equipment scheduled for early
retirement due to system upgrades and $17,000 on ATMs to be retired early.
Occupancy expense was essentially unchanged in 2002, but increased in 2001 due
to higher maintenance and energy costs.
Expenses related to data processing services were down in 2002 due to improved
pricing from a new contract. The increase in 2001 reflected higher processing
volumes and to a lesser extent the cost of additional services.
Professional services expenses increased in 2002 due to the costs associated
with our engagement of banking industry consultants to assist us in defining our
new business model and reorganizing our consumer, business and wealth management
lines of business. We reviewed and analyzed a number of issues including costs,
revenues, activity levels, workflow, client attrition and market potential. We
also looked at a cross section our branches to gather information on processes
and practices, identifying how different branches sell and deliver services. We
then used this information to create an organizational model that expedited
decision making and created a more immediate and interactive relationship
between our bankers and their clients. As a result, we anticipate future
improvement in customer service levels, lower noninterest expenses, increased
revenue generation capacity, improved credit quality and enhanced risk
management techniques. However, in the near term, we expect higher noninterest
expense as we continue to implement these improvements. Professional services
increased in 2001 due to higher legal costs associated with loan and other
collection activities, increased technology support costs at F&M and other
corporate initiatives.
Intangible asset amortization decreased in 2002 due to the adoption on January
1, 2002 of Statement of Financial Accounting Standards (SFAS) 142 that
eliminated goodwill amortization. Further discussion of the adoption of SFAS 142
and additional information regarding goodwill and other intangible assets is
included in Note 2 and Note 7 to the consolidated financial statements.
Lower bankcard fee expenses in 2002 reflect the sale of our merchant services
business in the second quarter of 2002 and the sale of the Michigan credit card
portfolio in the second quarter of 2001. The increase in 2001 was generated by
higher debit card and merchant transaction volume, partially offset by lower
processing due to the mid-year sale of the Michigan credit card portfolio.
Postage and delivery expenses decreased in 2002 due to lower delivery costs
associated with branch office consolidations and better pricing. The increase in
2001 was due to higher delivery cost associated with the centralization of our
check processing operations and outsourcing of the cash vault function.
Partially offsetting this increase was a related reduction in staffing costs.
Telephone and stationery and supplies expenses decreased in 2002 and 2001
reflecting improved pricing in 2002 from new or renegotiated contracts and
efficiencies related to the F&M merger in November 1999 and expense reduction
initiatives completed in 2001.
38
Discretionary advertising and public relations expenses were higher in 2002 as a
result of the charge of $2.0 million for our contribution to our charitable
trust, and were relatively unchanged in 2001. Other expenses, excluding the
unusual charges described previously, were down in 2002 after increasing in
2001. Other expenses decreased $1.2 million in 2002 of which $1.0 million was
due to lower state taxes and a decline in checking and other losses. Other
expenses in 2001 reflected an increase of $1.6 million in forgery, fraud and
other losses.
FEDERAL INCOME TAXES
Citizens recorded an income tax benefit of $1.1 million in 2002 as compared to
an income tax expense of $43.2 million in 2001 and $35.8 million in 2000. The
effective tax rate, computed by dividing the provision for income taxes by
income before taxes, was a negative 4.4% in 2002, compared to 29.2% in 2001 and
28.3% in 2000. The effective tax rate is lower than the statutory tax rate due
to tax-exempt interest income and to a lesser extent other permanent
differences. Citizens' effective tax rate decreased in 2002 due to lower pre-tax
earnings resulting from a large loan loss provision and special and other
significant charges recorded in the third quarter. The increase in 2001
reflected higher pre-tax earnings.
LINE OF BUSINESS RESULTS
Beginning in 2002, all activities formerly housed in our F&M business line were
integrated into our other lines of business: Commercial Banking, Retail Banking,
Financial Services and Other and the three major business lines were renamed
Business Banking, Consumer Banking and Wealth Management, respectively. The
activities of the renamed business lines remained the same. A description of
each business line, selected financial performance and the methodologies used to
measure financial performance are presented in Note 19 to the consolidated
financial statements. Financial information for the year 2001 has been restated
to reflect the new organizational structure. As it was impractical to restate
all amounts in 2000, current and prior year financial information is presented
under both the "old" and "new" organizational structure.
Net income by line of business is presented below for 2002 and 2001 under the
new organizational structure and for the current and prior two years under the
old organizational structure:
NEW ORGANIZATIONAL STRUCTURE
Net Income
--------------------
(in thousands) 2002 2001
- -----------------------------------------------------------------
Business Banking $ (12,648) $ 46,501
Consumer Banking 37,200 47,553
Wealth Management 4,284 6,148
Other (3,798) 4,455
--------- --------
Total $ 25,038 $104,657
========= ========
=================================================================
OLD ORGANIZATIONAL STRUCTURE
Net Income
------------------------------
(in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------
Comercial Banking $ 2,853 $ 35,723 $ 35,789
Retail Banking 33,496 40,409 33,401
Financial Services 4,468 6,508 6,354
F&M (14,026) 20,065 25,967
Other (1,753 1,952 (10,851)
--------- --------- --------
Total $ 25,038 $ 104,657 $ 90,660
========= ========= ========
- ---------------------------------------------------------------------------
2002 COMPARED TO 2001
Business Banking recorded a net loss of $12.6 million in 2002 compared with net
income of $46.5 million in 2001, due to a significantly higher loan loss
provision and, to a lesser extent, increased operating expenses. The loan loss
provision
39
increased by $90.6 million in 2002 from the prior year, attributable to
increased charge-offs and nonperforming loans in the commercial loan portfolio.
Taxable equivalent net interest income increased $1.2 million as net interest
spreads on commercial loans improved while average loan balances declined.
Noninterest expense increased $2.3 million due to higher other real estate and
loan collection costs.
Consumer Banking net income declined $10.4 million to $37.2 million in 2002
compared to $47.6 million in the prior year. The decrease in Consumer Banking
net income was attributable to lower net interest income, a higher provision for
loan losses and lower noninterest income, partially offset by lower noninterest
expense. Net interest income declined due to lower average loan balances and
narrower interest spreads on deposits. Loan balances declined due to the sale of
the majority of new mortgage loan production, the current and prior year
securitization of new and portfolio mortgage loans, the June 2001 sale of the
Michigan credit card portfolio and a decline in indirect loans. The higher loan
loss provision was attributable to increased charge-offs in the direct and
indirect loan portfolios. Noninterest expense declined $6.5 million, of which
$5.4 million was attributable to lower bankcard expense due to the sale of the
merchant services business in June 2002.
Wealth Management net income declined $1.8 million to $4.3 million in 2002 from
$6.1 million in the prior year. The decrease in Wealth Management net income is
attributable to a decline in trust fees, lower net interest income and higher
noninterest expenses. Trust fees declined due to a lower level of assets under
administration resulting primarily from weak equity markets and, to a lesser
extent, net account attrition. Noninterest expense increased due to higher
compensation expense.
The Other category recorded a net loss of $3.8 million compared with net income
of $4.5 million in 2001, due to lower noninterest income and higher noninterest
expenses. Noninterest income decreased $11.5 million due to lower gains on sales
of assets. Noninterest expense increased due to the special and other charges
resulting from the third quarter 2002 restructuring actions. Combined special
and other charges of $21.1 million were attributed to the Other category.
Noninterest expense was charged $19.2 million, noninterest income was charged
$1.3 million and net interest income was charged $0.7 million. Partially
offsetting the increase in noninterest expense is reduced goodwill amortization
costs of $7.2 million, resulting from the implementation of SFAS No. 142. See
Note 7 to the consolidated financial statements for additional information.
2001 COMPARED TO 2000
Commercial Banking net income of $35.7 million in 2001 was essentially unchanged
from the 2000 net income of $35.8 million as higher net interest income and
noninterest income were offset by an increased provision for loan losses and
higher operating expenses. Net interest income increased due to higher average
commercial loan balances in 2001. The improvement in noninterest income reflects
greater deposit service charges and increased cash management fees. The
increased loan loss provision is the result of higher loan charge-offs.
Operating expenses increased due to higher compensation and loan collection
costs.
Retail Banking net income in 2001 improved to $40.4 million compared with net
income of $33.4 million in 2000 due to increased noninterest income, gains on
sales of assets and a lower provision for loan losses offset, in part, by a
decline in net interest income and higher operating expenses. The growth in
noninterest income before gains on sale of assets reflects increased mortgage
income from higher mortgage loan origination volume and increased sales of new
mortgage production into the secondary market. Noninterest income also increased
due to greater title insurance fees and higher annuity sales by licensed retail
bankers. In 2001, gains from the sale of securitized mortgages and the sale of
the Michigan-based credit card portfolio totaled $8.0 million. The provision for
loan loss declined due to lower net charge-offs in the indirect loan and credit
card portfolios. The decline in net interest income was due in part to the sale
of the Michigan-based credit card portfolio in June 2001 and narrower interest
spreads on retail deposits due to the lower interest rate environment. Net
interest income also declined as a result of lower average balances in the
mortgage portfolio. Mortgage loan balances declined due to the securitization
and sale of $247 million of seasoned mortgage loans in the first half of 2001
and the sale of most new mortgage loan production throughout 2001.
Financial Services net income in 2001 improved slightly to $6.5 million compared
with net income of $6.4 million in 2000 despite lower revenue as operating
expenses decreased more than the decline in noninterest income. Noninterest
income decreased due to lower trust and brokerage revenues. Trust fees were
impacted by the weak equity markets, which reduced asset values upon which fees
are based. Lower transaction volume led to the decline in brokerage
40
revenue. Noninterest expense decreased due to lower volume-oriented incentive
compensation and efficiencies achieved from the strategic realignment of the
financial services organizational structure.
F&M net income in 2001 declined to $20.1 million compared with net income of
$26.0 million in 2000 due to lower net interest income and a higher provision
for loan losses, partially offset by an increase in noninterest income and lower
noninterest expense. The decrease in net interest income resulted from a decline
in earning assets and a lower net interest margin. The higher loan loss
provision resulted from an increase in commercial loan net charge-offs and
higher nonperforming assets. Noninterest income increased due to higher mortgage
banking income and brokerage fees. Noninterest expense declined due to lower
special charges. We had zero special charge expense in 2001 compared to special
charges in 2000 of $15.5 million for the conversion and integration of F&M's
existing operating systems, branch closure and other costs.
Net income in the Other category in 2001 improved to $2.0 million compared with
a loss of $10.9 million in 2000, reflecting an improvement in net interest
income and noninterest income. Net interest income improved due to a decline in
the cost of borrowed funds. The lower cost of borrowed funds resulted from the
decrease in interest rates and a reduced reliance on borrowed funds due to the
balance sheet restructuring activities. Noninterest income increased due to
significant gains of $11.0 million on the sale of NYCE stock, an ATM network
provider in which we held an equity position.
FINANCIAL CONDITION
Proper management of the volume and composition of our earning assets and
funding sources is essential for ensuring strong and consistent earnings
performance, maintaining adequate liquidity and limiting exposure to risks
caused by changing market conditions. Our investment securities portfolio is
structured to provide a source of liquidity principally through the maturity of
the securities held in the portfolio and to generate an income stream with
relatively low levels of principal risk. Loans comprise the largest component of
earning assets and are our highest yielding assets. Client deposits are the
primary source of funding for earning assets while short-term debt and other
managed sources of funds are utilized as market conditions and liquidity needs
change.
Average total assets for 2002 were $7.569 billion, a decrease of $367 million or
4.6% from 2001. Average earning assets as a percent of average total assets were
94.6% for 2002, the same as 2001. Average loans, including mortgage loans held
for sale, comprised 75.0% of average assets during 2002, down from 77.0% in
2001. Interest-bearing deposits comprised 85.3% of average interest bearing
liabilities for 2002, increasing from 81.9% in 2001. The ratio of average
noninterest bearing deposits to average deposits remained the same in both 2002
and 2001 at 14.7%.
INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS
Average investment securities and money market investments comprised 20.7% of
total average earning assets in 2002, up from 18.7% in 2001. The increase is
consistent with the overall balance sheet restructuring initiatives discussed
under net interest income and the decline in loans as a percentage of earning
assets.
Our investment portfolio management practice is that all securities purchases
are classified as available for sale. Our objectives in managing the securities
portfolio are driven by the interest rate environment and the dynamics of the
balance sheet, including growth, maturity and repricing of loans, deposits, and
borrowed funds.
A summary of available for sale securities balances at December 31, 2002, 2001
and 2000 is provided below.
41
AVAILABLE FOR SALE SECURITIES
December 31 (in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------
U.S. Treasury $ 6,135 $ 8,163 $ 21,490
Federal agencies
Mortgage-backed securities 787,821 565,393 582,618
Other agencies 148,687 166,236 269,127
State and municipal:
Taxable 9,338 10,776 12,257
Tax-exempt 435,613 433,180 418,518
Mortgage and asset-backed 6,452 10,558 15,755
Other securities 63,235 65,200 64,343
----------- --------- ----------
Total $ 1,457,281 $1,259,50 $1,384,108
=========== ========= ==========
===================================================================================
Mortgage-backed assets increased $218.3 million or 37.9% in 2002 after
decreasing in 2001. The increase was due to retention of securities created from
mortgage loan securitizations and purchase of additional securities in 2002 as
proceeds from the maturity of treasury and other federal agency securities were
reinvested in more attractive mortgage-backed agency securities. Securitizations
in 2002 included $28.6 million of current fixed rate mortgage loan production
and $114.3 million of fixed and variable rate, seasoned portfolio mortgage
loans. All securitizations were done through FNMA or FHLMC, and as of December
31, 2002, we still retained $63.0 million of these newly created mortgage-backed
securities in our investment portfolio. Mortgage-backed securities created in
2001 from the securitization of seasoned mortgage loans from our portfolio were
not retained but were sold following their securitization. High prepayment rates
due to a low interest rate environment partially offset the growth in
mortgage-backed assets in 2002.
State and municipal securities were purchased in 2002 and 2001 due to their
higher tax equivalent yields. Purchases of these securities remain dependent on
our capacity to effectively utilize tax-exempt income. Other securities,
consisting primarily of Federal Reserve stock, Federal Home Loan Bank stock and
money market funds, totaled 6.3% of total average investment securities during
2002, down from 6.6% during 2001.
Money market investments comprised of federal funds sold and government money
market investments averaged $50.6 million for 2002, up from $46.9 million in
2001. The amount of funds invested in these assets is based on the present and
anticipated interest rate environment, liquidity needs and other economic
factors.
Maturities and average yields of available for sale securities at December 31,
2002 are presented in Table 4 below.
TABLE 4. MATURITIES AND AVERAGE YIELDS OF AVAILABLE FOR SALE SECURITIES AT
DECEMBER 31, 2002
U.S. Treasury and
Federal Agency(1) State and Municipal(1),(2) Other(1) Total
------------------------ --------------------------- -------------------------- --------------------------
Amortized Fair Amortized Fair Amortized Fair Amortized Fair
(in millions) Cost Value Yield Cost Value Yield Cost Value Yield Cost Value Yield
- ------------------------------------------------------------------------------------------------------------------------------------
Due within one year $ 276.2 $ 278.1 5.71% $ 22.4 $ 22.7 7.83% $ 1.9 $ 1.9 4.19% $ 300.5 $ 302.7 5.86%
One to five years 563.1 594.9 5.82 75.4 80.2 7.61 4.3 4.5 6.37 642.8 679.6 6.04
Five to ten years 57.9 62.6 6.27 180.6 194.2 7.62 0.3 0.3 6.85 238.8 257.1 7.29
After ten years 6.9 7.0 5.03 139.2 147.9 7.40 62.9 63.0 6.01 209.0 217.9 6.90
-------- ------- ------- ------ ------ ------ -------- --------
$ 904.1 $ 942.6 5.81 $ 417.6 $445.0 7.55 $ 69.4 $ 69.7 5.95 $1,391.1 $1,457.3 6.34
======== ======= ======= ====== ====== ====== ======== ========
Average maturity(3)
1.97 yrs. 7.01 yrs. 2.78 yrs. 3.56 yrs.
===================================================================================================================================
(1) Maturities for Federal agency, collateralized mortgage obligations and
asset-backed securities are based upon projections of independent cash flow
models. Maturities for state an municipal securities incorporate early call
features, if applicable.
(2) Yields for state and municipal securities are calculated on a tax equivalent
basis using a 35% tax rate.
(3) Average maturity information excludes Federal Reserve and Federal Home Loan
Bank stock with no stated maturity.
As of December 31, 2002, the estimated aggregate fair value of our investment
securities portfolio was $66.2 million above amortized cost consisting of gross
unrealized gains of $66.7 million and gross unrealized losses of $0.5 million. A
summary of estimated fair values and unrealized gains and losses for the major
components of the investment securities portfolio is provided in Note 5 to the
consolidated financial statements. Our present policies with respect to the
42
classification of investments in debt and equity securities are discussed in
Note 1 to the consolidated financial statements.
MORTGAGE LOANS HELD FOR SALE
During 2002, mortgage loans held for sale increased $10.3 million, or 6.8%, to
$160.7 million at December 31, 2002. Average loans held for sale were $146.4
million in 2002 and $131.3 million in 2001. The increase in 2002 reflects a
higher volume of residential mortgage loans originated due to the low interest
rate environment. Balances grew in 2001 from zero in 2000, reflecting the
balance sheet restructuring initiatives we began in the first quarter of 2001.
As discussed previously, the initiatives included selling most of our new
residential mortgage loan production into the secondary market in both 2002 and
2001.
PORTFOLIO LOANS
We extend credit primarily within the local markets of our banking subsidiaries
located in Michigan, Wisconsin, Iowa and Illinois. We generally lend to
consumers and small to mid-sized businesses and, consistent with our emphasis on
relationship banking, most of these credits represent core, multi-relationship
customers who also maintain deposit relationships and utilize other banking
services such as cash management. Our loan portfolio is diversified by borrower
and industry with no concentration within a single industry that exceeds 10% of
total loans. We do not have any loans to foreign debtors and do not purchase
nationally syndicated loans or participate in highly leveraged transactions. We
seek to limit our credit risk by establishing guidelines to review the aggregate
outstanding commitments and loans to particular borrowers, industries, and
geographic areas. We obtain collateral based on the nature of the credit and our
credit assessment of the customer.
Loan balances by category at December 31 and an analysis of the maturity and
interest rate sensitivity of commercial and real estate construction loans is
presented below.
TABLE 5. PORTFOLIO LOANS(1)
(in millions) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------
PORTFOLIO LOANS OUTSTANDING AT DECEMBER 31
Commercial $ 1,784.7 $ 1,923,4 $ 2,127.2 $ 1,822.4 $ 1,619.9
Commercial real estate 1,326.5 1,323.0 1,205.0 1,053.0 790.5
Real estate construction 262.4 216.0 235.1 185.4 149.5
Real estate mortgage 545.8 821.1 1,282.8 1,440.1 1,417.9
Consumer 1,513.2 1,488.5 1,572.7 1,416.6 1,286.9
--------- --------- --------- --------- ---------
Total $ 5,432.6 $ 5,772.0 $ 6,422.8 $ 5,917.5 $ 5,264.7
========= ========= ========= ========= =========
PORTFOLIO LOAN MATURITIES AND INTEREST RATE SENSITIVITY AT DECEMBER 31, 2002
Within One to After
One Year Five Years Five Years Total
- ---------------------------------------------------------------------------------------
Commercial and commercial real estate $ 1,340.2 $ 1,602.3 $ 168.7 $ 3,111.2
Real estate construction 262.4 -- -- 262.4
---------- ---------- -------- ----------
Total $ 1,602.6 $ 1,602.3 $ 168.7 $ 3,373.6
========== ========== ======== ==========
Loans above:
With floating interest rates $ 1,062.5 $ 582.4 $ 89.1 $ 1,734.0
With predetermined interest rates 540.1 1,019.9 79.6 1,639.6
---------- ---------- -------- ----------
Total $ 1,602.6 $ 1,602.3 $ 168.7 $ 3,373.6
========== ========== ======== ==========
=======================================================================================
(1)Excludes mortgage loans held for sale
43
Total portfolio loans decreased $339.4 million, or 5.9%, to $5.433 billion in
2002, after a decrease of $650.8 million, or 10.1% in 2001. The decreases in
both years primarily reflect declining commercial loan and residential mortgage
loan balances due to our balance sheet restructuring initiatives and a weakened
economy which dampened commercial loan demand. On an average basis, portfolio
loans comprised 77.2% of total average earning assets during 2002, as compared
to 80.0% in 2001.
The commercial loan category includes mostly in-market small (less than
$500,000) and lower-middle market ($500,000 to $2 million) business loans to a
wide variety of businesses across many industries. Our commercial lending policy
requires each loan to have viable repayment sources. Commercial loans are
evaluated for adequacy of repayment sources at the time of approval and are
regularly reviewed for any possible deterioration in the ability of the borrower
to repay the loan. In certain instances, collateral is required to provide us
with an additional source of repayment in the event of default by a commercial
borrower. Credit risk for commercial loans arises when borrowers are unwilling
or unable to repay the loan and, in the case of secured loans, when the
collateral value is less than the outstanding loan balance.
Commercial loans declined $138.7 million, or 7.2%, to $1.785 billion at December
31, 2002, after decreasing $203.8 million, or 9.6%, in 2001. The decrease in
2002 resulted from dampened loan demand due to a weakened economic environment
and an unusually high amount of commercial loans that deteriorated to loan
charge-off status during the year. Commercial loan originations slowed in 2001
due to the weaker economy and a cutback in commercial lending in Wisconsin and
Iowa as a result of business loan portfolio restructuring and the introduction
of stricter credit standards and loan structuring criteria in these markets.
The commercial real estate category includes mortgage loans to developers and
owners of commercial real estate and multi-unit residential properties.
Approximately one-half of these loans are secured by mortgages on owner-occupied
properties. Commercial real estate loans are governed by the same lending
policies and subject to substantially the same credit risks as commercial loans.
Commercial real estate balances were essentially unchanged in 2002 as growth in
the Michigan market was offset by a decrease in the Wisconsin market due to
stricter credit standards and de-emphasis of certain types of commercial real
estate lending. Commercial real estate balances increased 9.8% in 2001 primarily
due to strong demand in the Michigan market.
Real estate construction loans consist primarily of single family and
multi-family residential projects made to builders or developers of real estate
properties. These loans are typically refinanced at completion, becoming either
income-producing or owner-occupied properties. Real estate construction loans
are governed by the same lending policies and subject to substantially the same
credit risks as commercial loans. Real estate construction loans increased 21.5%
to $262.4 million at December 31, 2002, following a decrease of 8.1% in 2001.
The increase in 2002 was a result of low interest rates, which helped spur
demand for new construction.
The residential real estate category is comprised predominately of
owner-occupied residential properties. Our residential real estate lending
policy requires each loan to have viable repayment sources. Residential real
estate loans are evaluated for the adequacy of these repayment sources at the
time of approval, including credit scores, debt-to-income ratios and collateral
values. They are predominately originated in accordance with underwriting
standards set forth by the government-sponsored entities, FNMA, FHLMC and the
Government National Mortgage Association, who serve as the primary purchasers of
loans sold in the secondary market by mortgage lenders. These underwriting
standards generally require that the loans be collateralized by one-to-four
family residential real estate, have loan-to-collateral value ratios of 80% or
less and are made to borrowers in good credit standing. Our wholly-owned
subsidiary, Citizens Bank Mortgage Company LLC, originates mortgage loans
through our banking offices and a wholesale network of brokers and mortgage
originators. Substantially all of our residential mortgage loans are sold in the
secondary mortgage market. The right to service the loans and receive servicing
fee income is typically sold along with the underlying mortgages. Credit risks
for residential real estate loans are similar to those arising from commercial
loans.
In 2002, residential mortgage loans declined $275.3 million, or 33.5%, to $545.8
million at December 31, 2002 following a decrease of $461.7 million, or 36.0%,
in 2001. The decline in both years reflected higher payoffs due to significant
refinance activity and low mortgage interest rates, the sale of new mortgage
loan production into the secondary market and the aforementioned balance sheet
restructuring initiatives, which included the securitization and sale of
seasoned, fixed and adjustable rate mortgage loans in both years.
44
The consumer loan category primarily includes home equity loans, and direct and
indirect installment loans used by customers to purchase boats, recreational
vehicles and autos. Home equity loans consist mainly of revolving lines of
credit to consumers that are secured by residential real estate. These loans are
originated through our banking offices with loan-to-value ratios generally
limited to 90% of collateral value. The same lending policies as described above
for residential real estate loans generally govern consumer loans. Credit risk
in the consumer loan portfolio arises from borrowers lacking the ability or
willingness to repay the loan, and in the case of secured loans, by a shortfall
in the collateral value in relation to the outstanding loan balance in the event
of default and subsequent liquidation of collateral.
In 2002, consumer loans increased $24.7 million, or 1.7%, to $1.513 billion at
December 31, 2002 after decreasing 5.4% in 2001. The increase in consumer loans
in 2002 reflects higher home equity loan balances, partially offset by reduced
direct and indirect balances as a result of increased competition from captive
finance subsidiaries of auto manufacturers and from other indirect lenders. In
2002, home equity loans increased $101.5 million, or 22.5%, to $552.7 million at
December 31, 2002. The increase reflected strong loan demand due to the low
interest rate environment and success of targeted sales and marketing efforts.
The decrease in consumer loans in 2001 reflected the sale of the $30 million
Michigan credit card portfolio, and declines in the direct auto loan and
indirect lending portfolios, partially offset by growth in home equity loans.
The declines in direct and indirect lending in 2001 resulted from the same
increased competition mentioned above as well as fourth quarter 2000
restructuring initiatives, which included exiting certain unprofitable indirect
lending dealer relationships.
CREDIT RISK MANAGEMENT
Extending credit to businesses and consumers exposes us to credit risk. As
discussed in the previous section entitled "Portfolio Loans," credit risk is the
risk that the principal balance of a loan and any related interest will not be
collected due to the inability or unwillingness of the borrower to repay the
loan. Credit risk is mitigated through portfolio diversification that limits
exposure to any single industry or customer. Similarly, credit risk is also
mitigated through the establishment of a comprehensive system of internal
controls, which includes standard lending policies and procedures, underwriting
criteria, collateral safeguards, and surveillance and evaluation by an
independent internal loan review staff of the quality, trends, collectibility
and collateral protection within the loan portfolio. Lending policies and
procedures are reviewed and modified on an ongoing basis as conditions change
and new credit products are offered. Our commercial and commercial real estate
credit administration policies include a loan rating system and an analysis by
the internal loan review staff of all loans over a fixed amount and of a
sampling of loans under such amount. Furthermore, account officers are vested
with the responsibility of monitoring their customer relationships and act as
the first line of defense in determining changes in the loan ratings on credits
for which they are responsible. Loans that have migrated within the loan rating
system to a level that requires remediation are actively reviewed by senior
management at regularly scheduled quarterly meetings with the credit
administration staff and the account officers. At these meetings, action plans
are developed to either remediate any emerging problem loans or develop a
specific plan for removing such loans from the portfolio within a short time
frame.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents a charge against income and a
corresponding increase in the allowance for loan losses. Credit losses are
charged and recoveries are credited to the allowance for loan losses. The amount
of the provision for loan losses is based on our review of the historical credit
loss experience and such factors that, in our judgment, deserve consideration
under existing economic conditions in estimating probable credit losses. While
we consider the allowance for loan losses to be adequate based on information
currently available, future adjustments to the allowance may be necessary due to
changes in economic conditions, delinquencies or loss rates. See "Critical
Accounting Policies" presented previously on page 27.
A summary of our loan loss experience for the past five years appears in Table
6.
45
TABLE 6. SUMMARY OF LOAN LOSS EXPERIENCE
Year Ended December 31 (dollars in thousands) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses - January 1 $ 80,299 $ 80,070 $ 76,397 $ 69,740 $ 67,010
Allowance of acquired (sold) banks and branches -- (240) -- 2,400 1,745
Provision for loan losses 120,200 26,407 20,983 24,675 16,528
CHARGE-OFFS:
Commercial 83,503 18,265 10,920 8,675 4,557
Real estate 2,027 189 169 436 359
Consumer 16,174 14,278 14,359 17,751 14,879
----------- ----------- ----------- ----------- -----------
Total charge-offs 101,704 32,732 25,448 26,862 19,795
----------- ----------- ----------- ----------- -----------
RECOVERIES:
Commercial 5,860 1,950 3,577 2,483 1,387
Real estate 11 47 45 149 28
Consumer 4,801 4,797 4,516 3,812 2,837
----------- ----------- ----------- ----------- -----------
Total recoveries 10,672 6,794 8,138 6,444 4,252
----------- ----------- ----------- ----------- -----------
Net charge-offs 91,032 25,938 17,310 20,418 15,543
----------- ----------- ----------- ----------- -----------
Allowance for loan losses - December 31 $ 109,467 $ 80,299 $ 80,070 $ 76,397 $ 69,740
=========== =========== =========== =========== ===========
Portfolio loans outstanding at year-end(1) $ 5,432,561 $ 5,771,963 $ 6,422,806 $ 5,917,483 $ 5,264,706
Average portfolio loans outstanding(1) 5,530,790 5,977,744 6,202,157 5,528,963 5,159,584
Ratio of allowance for loan losses to
portfolio loans outstanding at year-end 2.02% 1.39% 1.25% 1.29% 1.32%
Ratio of net loans charged off as a percentage
of average portfolio loans outstanding 1.65 0.43 0.28 0.37 0.30
===============================================================================================================================
(1) Balances exclude mortgage loans held for sale
The provision for loan losses was $120.2 million in 2002, up from $26.4 million
in 2001. This increase was due to elevated past-due and nonperforming loan
levels, a weakened economy and enhancements to the loan loss allocation model
that result in relatively higher allocations. These enhancements included the
incorporation of more recent historical loss data in the determination of
projected loss rates for pools of loans evaluated collectively and refinements
to our internal risk rating system for our commercial loans, which has led to an
increase in downgrades.
Net charge-offs in 2002 as a percentage of average loans were 1.64%, compared
with 0.43% in 2001. The increase is primarily the result of higher net
charge-offs in the commercial loan portfolio, which totaled $77.6 million in
2002, up from $16.3 million in 2001. Mortgage and consumer loans net charge-offs
also increased, but by lesser amounts. Of the total commercial loans charged off
in 2002, $45.5 million, or nearly 55%, related to eight customers. The loans
charged-off were from a variety of industries, including automotive
manufacturing and packaging, heavy construction, health supplement products and
real estate development. Many of our commercial clients have been negatively
affected by a weak economy that has yet to show significant signs of recovery.
Consequently, business expansion plans have been curtailed, inventory levels
have been reduced and our clients' ability to repay their debt, in some cases,
has been compromised. Net residential mortgage loans charged-off aggregated $2.0
million in 2002, driven largely by the discount taken in December 2002 in
connection with the sale of $6.0 million of nonperforming residential mortgage
loans from the F&M banks.
Based on the current economic climate and because of a large, unanticipated loan
loss from fraud discovered in the first quarter of 2003 on a $14.5 million
commercial credit relationship, we expect net charge-offs and the loan loss
provision to be significantly higher in the first quarter of 2003 than the same
quarter in 2002. In addition, we expect net loan charge-offs in the remainder of
2003 to continue at higher than historical levels, although not at the level
experienced in 2002 or in the first quarter of 2003. The anticipated higher
level of charge-offs in 2003 will be generated primarily within the commercial
loan portfolio due to the current elevated level of non-performing commercial
and commercial real estate loans, and expectations of a stagnant to slowly
growing economy. Consumer and mortgage loan charge-offs may also be adversely
affected in 2003 if the economy fails to improve or if the housing market
slumps. Additionally, sales of non-performing mortgage or commercial loans in
2003 may also adversely affect net loan charge-offs.
46
Similarly, we expect the loan loss provision in 2003 to be at higher than
historical levels, although not at the level experienced in 2002, due to
anticipation of higher net charge-offs and nonperforming assets, and migration
of commercial loans to higher risk ratings as a result of a flat to slowly
growing economy, with particular concern regarding the manufacturing sector of
the economy.
The allowance for credit losses represents our estimate of probable losses
inherent in the loan portfolio. The allowance is based on ongoing quarterly
assessments and is maintained at a level management considers to be adequate to
absorb probable loan losses identified with specific customer relationships and
for probable losses believed to be inherent in the loan portfolio, which have
not been specifically identified. Our evaluation process is inherently
subjective as it requires estimates that may be susceptible to significant
change and have the potential to materially affect net income. Default
frequency, internal risk ratings, expected future cash collections, loss
recovery rates, and general economic factors, among other things, are considered
in this evaluation, as are the size and diversity of individual large credits.
We have not substantively changed our overall approach in the determination of
the allowance for loan losses in 2002 from 2001 and the allocation methods used
at December 31, 2002 and December 31, 2001 were consistent. Our methodology for
measuring the adequacy of the allowance relies on several key elements, which
include specific allowances for identified problem loans, a formula-based
risk-allocated allowance for the remainder of the portfolio and an unallocated
allowance. This methodology is discussed below and in Note 1 to Consolidated
Financial Statements.
Specific allowances are established for larger commercial and commercial
mortgage loans where management has identified significant conditions or
circumstances that indicate it is probable that a loss has been or will be
incurred on such credits. Credits are identified through a regular quarterly
analysis of all commercial and commercial mortgage loans over a fixed dollar
amount where the internal risk rating is at or below a predetermined
classification. The allowance attributed to these credits is determined in
accordance with the methods prescribed by SFAS 114, "Accounting by Creditors for
Impairment of a Loan" by analyzing the borrower's debt service capacity (a
discounted estimate of future cash flows); overall financial condition,
resources and payment record; the prospects for support from any financially
responsible guarantors; and the liquidation value of any collateral. Management
may also consider overall portfolio indicators, including trends in historical
charge-offs, a review of industry, geographic and portfolio performance, and
other qualitative factors.
Internal risk ratings are assigned to each commercial and commercial mortgage
loan at the time of approval and are subject to subsequent periodic reviews by
senior management. These ratings encompass ten categories that define a
borrower's estimated ability to repay their loan obligations. In the third
quarter of 2002, we added a new 6 minus subcategory to our ten point rating
system and incorporated a new scoring methodology for certain larger balance
watch list commercial credits that lowered the number of factors considered from
eight to five and gave additional weight toward discounted service ability (cash
flow capacity), financial condition and capitalization of the borrower, and less
from collateral coverage and prior relationship history. As a result of these
changes a number of commercial credits were downgraded to higher risk ratings
resulting in higher loss rates being applied to the same dollar of exposure.
These changes did not affect the level of net charge-offs or the calculation of
the specific reserves mentioned above, but increased the risk allocation
allowance by approximately $23 million at December 31, 2002.
A risk allocation allowance is determined for the remaining loan portfolio by
applying projected loss rates to each loan type (commercial without specific
loss allocation, consumer credit, home equity, residential mortgage, and credit
cards), stratified by risk rating for commercial loans and by accrual,
nonaccrual and past due status for homogenous loans, such as consumer
installment, residential mortgage loans, home equity and credit cards that are
not individually risk-rated. The process of assigning projected loss rates
begins with the calculation of historical loss rates. These rates are then
adjusted for other quantitative and qualitative factors such as historical loan
loss experience, trends in past due and nonaccrual amounts, the effects of the
national and local economies and portfolio migration. We also consider the
current business strategy and credit process, including credit limit setting and
compliance, credit approvals, loan underwriting criteria, and loan workout
procedures. Generally, we have used a historical three-year rolling average of
net charge-offs as the base for developing loss factors for commercial credits.
Beginning in the third quarter of 2002, in order to emphasize more recent loss
trends in our methodology, we utilized an eighteen-month rolling average of net
charge-offs. The loss rates were more heavily weighted toward more current loss
experience as we view the most recent loss history as more representative of the
current economic conditions inherent in its loan portfolio.
47
We also maintain an unallocated allowance in recognition of the imprecision in
estimating and measuring loss when evaluating reserves for individual loans or
pools of loans. The unallocated portion of the allowance is determined based
upon our evaluation of various conditions, the effects of which are not directly
measured in the determination of the specific and formula allowances. The
conditions evaluated in connection with the unallocated allowance include
general economic and business conditions in our key lending markets, the level
and composition of nonperforming loans, underwriting standards within specific
portfolio segments, specific industry conditions within portfolio segments, loan
volumes and concentrations, regulatory examination results, internal credit
examination results and other factors. This determination inherently involves a
higher degree of uncertainty and considers current risk factors that may not
have yet manifested themselves in our specific allowances or in the historical
loss factors used to determine the formula allowances, such as our geographic
expansion and recent changes in the composition of our portfolio.
Table 7 below summarizes the allocation of the allowance for loan losses for
risk allocated, specific allocated and unallocated allowances by loan type and
the percentage of each loan type of total portfolio loans.
TABLE 7. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (1)
2002 2001 2000 1999 1998
------------------ ----------------- ------------------ ------------------ ----------------
% OF % of % of % of % of
December 31 TOTAL Total Total Total Total
(dollars in millions) AMOUNT LOANS Amount Loans Amount Loans Amount Loans Amount Loans
- ---------------------------------------------------------------------------------------------------------------------------------
Specific allocated allowance:
Commercial (2) $ 18.7 $ 9.5 $ 5.5 $ -- $ --
Risk allocated allowances:
Commercial (2) 64.5 57.3% 32.5 56.2% 29.7 51.9% 21.3 48.6% 19.2 45.8%
Real estate construction 1.0 4.8 0.5 3.7 1.1 3.7 0.8 3.2 0.3 2.8
Real estate mortgage 2.3 10.0 3.5 14.2 5.9 20.0 6.0 24.3 8.2 26.9
Consumer 15.6 27.9 16.2 25.9 16.4 24.4 23.5 23.9 21.4 24.5
-------- ---- -------- ----- -------- ----- --------- ----- ------- -----
Total risk allocated
allowance 83.4 52.7 53.1 51.6 49.1
-------- -------- -------- --------- -------
Total allocated 102.1 100.0% 62.2 100.0% 58.6 100.0% 51.6 100.0% 49.1 100.0%
===== ===== ===== ===== =====
Unallocated 7.4 18.1 21.5 24.8 20.6
-------- -------- -------- --------- -------
Total $ 109.5 $ 80.3 $ 80.1 $ 76.4 $ 69.7
======== ======== ======== ========= =======
=================================================================================================================================
(1) The allocation of the allowance for loan losses in the above table is based
upon ranges of estimates and is not intended to imply either limitations on
the usage of the allowance or precision of the specific amounts. Citizens
and its subsidiaries do not view the allowance for loan losses as being
divisible among the various categories of loans. The entire allowance is
available to absorb any future losses without regard to the category or
categories in which the charged-off loans are classified.
(2) The commercial category includes both commercial and commercial real estate
loans
The allowance for loan losses was $109.5 million at December 31, 2002, an
increase of $29.2 million compared to December 31, 2001. The higher allowance at
December 31, 2002 reflects an increase in both the specific allocated and risk
allocated reserves. At December 31, 2002, the allowance allocated to specific
commercial and commercial real estate credits was $18.7 million, up from $9.5
million at December 31, 2001. The increase primarily reflects a large increase
in classified credits (i.e., those internally risk rated as special mention,
substandard or doubtful) due to deterioration in the economy and enhancements in
the loan monitoring and risk grading systems. Classified credits, subject to
specific reserves, increased to $90.4 million at December 31, 2002 from $22.7
million at December 31, 2001. The amount of the specific allowance, however, as
a percent of outstanding loan balances subject to such specific reserves
declined significantly to 20.7% at December 31, 2002 from 41.7% at December 31,
2001 as fewer credits were classified as doubtful. Credits classified as
doubtful have critical weaknesses that make full collection improbable.
Substandard credits have well-defined weaknesses which, if not corrected, could
jeopardize the full satisfaction of the debt. Special mention credits are
potentially weak, as the borrower has begun to exhibit deteriorating trends
that, if not corrected, could jeopardize repayment of the loan and result in
further downgrade.
48
The total risk allocated allowance was $83.4 million at December 31, 2002, up
from $52.7 million at December 31, 2001. The amount allocated to commercial and
commercial real estate loans increased significantly in 2002 reflecting
adjustment of the loss rates for recent loan loss experience, higher levels of
classified and nonperforming loans, a significant migration of loans to higher
risk ratings as well as our assessment of current economic conditions within our
local markets. Our shift in weighting toward more current loss experience as
described above contributed to the increase in the risk allocated allowance.
The increase in the real estate construction risk allocated allowance at
year-end 2002 was predominately a function of higher loan balances. The risk
allocated allowance for residential real estate loans declined $1.2 million at
December 31, 2002 from December 31, 2001, reflecting lower loan balances and a
reduction in nonaccrual loans. Lower nonaccrual loan levels were affected, in
part, by the sale in December 2002 of $3.9 million of nonperforming residential
mortgage loans from the F&M banks. We also sold an additional $2.1 million of
nonperforming residential mortgage loans from the same portfolio in January
2003. Even with the discount taken in December 2002 for these sales, historical
loss ratios in the residential mortgage portfolio remain very low. The decrease
in the risk allocated allowance for consumer loans in 2002 reflected a decrease
in nonaccrual loans and our continued expectation of stable net charge-offs in
this portfolio, due to a risk-adjusted pricing structure and aggressive
collection efforts.
The unallocated allowance was $7.4 million at December 31, 2002, down $10.7
million from December 31, 2001. The decrease reflects our view that the inherent
losses related to certain factors, such as general economic and business
conditions and the possible imprecision due to changes in the portfolio mix,
which we considered in our evaluation of the unallocated allowance at December
31, 2001 are now recognized at December 31, 2002 in the allocated allowance
through increased specific reserves or in the higher loss factors utilized in
determining the risk allocated allowance.
NONPERFORMING ASSETS
A five-year history of nonperforming assets is presented in Table 8.
Nonperforming assets are comprised of nonaccrual, restructured loans and
repossessed assets. Although these assets have more than a normal risk of loss,
they will not necessarily result in a higher level of losses in the future.
Nonperforming assets totaled $95.7 million as of December 31, 2002, an increase
of 20.8% from the December 31, 2001 balance of $79.2 million. As a percentage of
total assets, nonperforming assets increased to 1.27% at December 31, 2002, from
1.03% at December 31, 2001. The increase is attributable to higher nonperforming
commercial and commercial real estate loans.
Nonperforming commercial and commercial real estate loans increased to $71.0
million at December 31, 2002 from $48.0 million a year ago. These loans
comprised 81.1% of total nonperforming loans at December 31, 2002, compared with
65.5% in 2001. Commercial real estate loans represented $19.3 million in 2002
and $11.1 million in 2001 of such nonperforming loans. The increase in
nonperforming commercial and commercial real estate loans is reflected in the
allowance for loan losses through specific and risk allocated allowances as of
December 31, 2002. The allocated allowance for commercial and commercial real
estate loans increased $41.2 million to $83.2 million at December 31, 2002 from
the prior year-end. We believe the risk of loss in the commercial real estate
nonperforming loans is significantly less than the total principal balance, due
to the nature of the underlying collateral and the value of such collateral in
relation to the total credit exposure. These loans are generally for
owner-occupied properties and the sources of repayment are not dependent on the
performance of the real estate market.
Nonperforming loans in both the residential mortgage and consumer loan
portfolios were down at December 31, 2002 from December 31, 2001. The lower
level of nonperforming residential real estate loans reflects, in part, the
aforementioned sale in December 2002 of $3.9 million of nonperforming
residential mortgage loans from the F&M banks. In the consumer portfolio, a
change in asset mix, which included strong growth in home equity loans, has
helped reduce nonperforming levels.
The level and composition of nonperforming assets are affected by economic
conditions in our local markets. Nonperforming assets, charge-offs and
provisions for loan losses tend to decline in a strong economy and increase in a
weak economy, potentially impacting our results. In addition to loans classified
as nonperforming, we carefully monitor other credits that are current in terms
of principal and interest payments but which we believe may deteriorate in
quality if economic conditions change. As of December 31, 2002, such loans
amounted to $134.6 million or 2.5% of total portfolio loans compared with $78.9
million or 1.4% of total portfolio loans as of December 31, 2001. These loans
are commercial and commercial real estate loans made in the normal course of
business and do not represent a concentration
49
in any one industry or geographic location.
TABLE 8. NONPERFORMING ASSETS AND PAST DUE LOANS
December 31 (in thousands) 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
NONPERFORMING LOANS (1),(2)
Nonaccrual
Less than 30 days past due $ 15,869 $ 6,528 $ 7,237 $ 1,661 $ 2,016
From 30 to 89 days past due 23,210 5,218 7,297 772 1,641
90 or more days past due 47,638 57,047 44,881 26,498 31,485
----------- ---------- ----------- ---------- ----------
Total 86,717 68,793 59,415 28,931 35,142
90 days past due and still accruing 860 4,168 889 2,139 2,474
Restuctured (1) -- 337 1,068 9 114
----------- ---------- ----------- ---------- ----------
Total nonperforming loans 87,577 73,298 61,372 31,079 37,730
OTHER REPOSSESSED ASSETS ACQUIRED 8,094 5,947 4,917 4,039 4,790
----------- ---------- ----------- ---------- ----------
Total nonperforming assets $ 95,671 $ 79,245 $ 66,289 $ 35,118 $ 42,520
=========== ========== =========== ========== ==========
Nonperforming assets as a percent of portfolio loans
plus other repossessed assets acquired 1.76% 1.37% 1.03% 0.59% 0.81%
Nonperforming assets as a percent of total assets 1.27 1.03 0.79 0.45 0.61
NONPERFORMING LOANS BYTYPE
Commercial $ 51,745 $ 36,926 $ 24,758 $ 11,920 $ 14,589
Commercial real estate 19,301 11,052 12,471 6,085 5,241
Real estate mortgage 10,865 17,304 17,057 7,366 8,032
Consumer 5,666 8,016 7,086 5,708 9,868
----------- ---------- ----------- ---------- ----------
Total $ 87,577 $ 73,298 $ 61,372 $ 31,079 $ 37,730
=========== ========== =========== ========== ==========
============================================================================================================================
(1) Nonperforming loans include loans on which interest is being recognized only
upon receipt (nonaccrual), those on which interest has been renegotiated to
lower than market rates because of the financial condition of the borrowers
(restructured), and loans 90 days past due and still accruing.
(2) Gross interest income that would have been recorded in 2002 for nonaccrual
and restructured loans, as of December 31, 2002, assuming interest had been
accrued throughout the year in accordance with original terms was $7.721
million. The comparable 2001 and 2000 totals were $6.392 million, and $4.953
million, respectively. Interest collected on these loans and included in
income was $4.685 million in 2002, $3.344 million in 2001 and $3.045 million
in 2000.Therefore, on a net basis, total income foregone due to these loans
was $3.036 million in 2002, $3.048 million in 2001 and $1.908 million in
2000.
Under our credit policies and practices, a loan is placed on nonaccrual status
when there is doubt regarding collection of principal or interest, or when
principal or interest is past due 90 days or more and the loan is not well
secured and in the process of collection. Interest accrued but not collected is
reversed and charged against income when the loan is placed on nonaccrual
status. A loan is considered impaired when we determines that it is probable
that all the principal and interest due under the loans may not be collected. In
most instances, impairment is measured based on the fair value of the underlying
collateral. Impairment may also be measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate. We
maintain a valuation allowance for impaired loans. Cash collected on impaired
nonaccrual loans is applied to outstanding principal. Interest income on all
other impaired loans is recorded on an accrual basis.
Certain of our nonperforming loans included in Table 8 are considered to be
impaired. We measure impairment on all large balance nonaccrual commercial and
commercial real estate loans. Certain large balance accruing loans rated
substandard or lower are also measured for impairment. Impairment losses are
included in the provision for loan losses. The policy does not apply to large
groups of smaller balance homogeneous loans that are collectively evaluated for
impairment, except for those loans restructured under a troubled debt
restructuring. Loans collectively evaluated for impairment include certain
smaller balance commercial loans, consumer loans, and residential real estate
loans, and are not included in the impaired loan data. Total loans considered
impaired and their related reserve balances at December 31, 2002 and 2001 as
well as their effect on net income in 2002 and 2001 follows:
50
- -----------------------------------------------------------------------------------------------------------------------
IMPAIRED LOAN INFORMATION Valuation Reserve
-----------------
(in thousands) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Balances - December 31
Impaired loans with valuation reserve $41,240 $39,795 $13,338 $10,373
Impaired loans with no valuation reserve 35,272 22,256 -- --
------- ------- ------- -------
Total impaired loans $76,512 $62,051 $13,338 $10,373
======= ======= ======= =======
Impaired loans on nonaccrual basis $70,345 $43,549 $ 8,690 $ 5,838
Impaired loans on accrual basis 6,167 18,502 4,648 4,535
------- ------- ------- -------
Total impaired loans $76,512 $62,051 $13,338 $10,373
======= ======= ======= =======
Average balance for the year $80,487 $77,995
Interest income recognized for the year 1,376 3,273
Cash collected applied to outstanding principal 4,415 3,118
=======================================================================================================================
During 2002, our banking subsidiaries received a normally scheduled examination
by their governing regulatory agencies. There was no material reclassification
of assets as nonperforming resulting from these examinations.
DEPOSITS
Table 9 below provides a year-to-year comparison of our average deposit balances
over the last three years. Average, rather than period-end, balances are more
meaningful in analyzing our deposit funding sources because of inherent
fluctuations that occur on a monthly basis with most deposit categories.
TABLE 9. AVERAGE DEPOSITS
2002 2001 2000
------------------------- ---------------------- --------------------
Year Ended December 31 AVERAGE AVERAGE Average Average Average Average
(dollars in millions) BALANCE RATE Balance Rate Balance Rate
- --------------------------------------------------------------------- ---------------------- --------------------
Noninterest-bearing demand $ 869.7 --% $ 881.2 --% $ 946.1 --%
Interest-bearing demand 1,148.0 1.57 744.8 1.88 581.5 1.46
Savings 1,363.5 1.14 1,474.5 2.36 1,701.7 3.24
Time 2,543.3 3.71 2,907.6 5.37 2,892.1 5.72
-------- -------- --------
Total $5,924.4 2.16 $6,008.1 3.41 $6,121.4 3.74
======== ======== ========
==============================================================================================================================
Total average deposits declined 1.4% in 2002. Interest bearing demand deposits
increased while time deposits, savings deposits and noninterest bearing demand
deposits decreased. Average interest-bearing demand balances increased 54.1% in
2002 primarily due to growth of a highly successful product offering, which pays
higher rates of interest. Average time deposits decreased 12.5% in 2002. A
decrease in large denomination single maturity certificates of deposit balances
accounted for approximately 65% of this change. The remainder reflected lower
renewable and IRA certificates of deposit balances. Savings accounts and
noninterest-bearing demand deposits declined on average 7.5% and 1.3%,
respectively, in 2002 due to a shift in client preferences from noninterest
bearing demand and money market savings accounts to the higher-rate interest
bearing demand product. The overall average rate for the deposit portfolio
declined in 2002 to 2.16% from 3.41% in 2001. The decrease was the result of the
lower interest rate environment in 2002. As of December 31, 2002, certificates
of deposit of $100,000 or more accounted for approximately 11.4% of total
deposits.
The maturities of these deposits are summarized below in Table 10.
51
TABLE 10. MATURITY OF TIME CERTIFICATES OF DEPOSIT OF $100,000 OR MORE AT
DECEMBER 31, 2002
(in thousands)
- ---------------------------------------------------------------
Three months or less $202,359
After three but within six months 88,679
After six but within twelve months 142,049
After twelve months 244,541
--------
Total $677,628
========
===============================================================
We gather deposits primarily from the local markets of our banking subsidiaries
and have not traditionally relied on purchased deposits for any significant
funding. Brokered deposits and time deposits greater than $100,000 declined by
$141 million at December 31, 2002 from the prior year-end due to balance sheet
restructuring and the reduced need for such funding. We will continue to
evaluate the use of alternative funding sources such as brokered deposits as
funding needs change. We continue to promote relationship driven core deposit
growth and stability through focused marketing efforts and competitive pricing
strategies.
BORROWED FUNDS
Short-term borrowings are comprised of Federal funds purchased, securities sold
under agreements to repurchase, Federal Home Loan Bank ("FHLB") advances and
Treasury Tax and Loan notes. Total short-term borrowings averaged $251.3 million
in 2002, or 4.2%, of total average interest-bearing liabilities, compared with
$538.7 million, or 8.6%, during 2001. The decline in short-term borrowings was
due to our balance sheet restructuring and reduced need for this wholesale
funding. See Note 11 to the consolidated financial statements for additional
information on short-term borrowings.
As of December 31, 2002, our parent company maintained a $75 million short-term
revolving credit facility with three unaffiliated banks, which had an unused
commitment of $45 million. The current facility will mature on August 28, 2003
and is expected to renew at that time. The interest rate on the $30 million
outstanding at December 31, 2002 reprices daily and is based on the federal
funds rate plus 75 basis points. The parent company services the debt's
principal and interest payments with dividends from its subsidiary banks. The
credit agreement also requires Citizens to maintain certain financial covenants.
We were in full compliance with all debt covenants as of December 31, 2002. On
January 27, 2003, we issued $125 million of 5.75% subordinated notes due in
2013. This new long-term funding allowed us to reduce the amount outstanding
under the credit facility to zero.
During 2002, we prepaid $75 million in high cost FHLB debt with a remaining
maturity of approximately one year to improve balance sheet flexibility, further
reduce our funding costs and improve our interest rate sensitivity. New FHLB
borrowings with contractual maturity of greater than one year replaced a major
portion of the prepaid debt.
Long-term debt comprised of FHLB notes and other long-term debt, accounted for
$620.9 million, or 10.5%, of average interest-bearing funds during 2002
increasing from $596.4 million or 9.5% during 2001. This increase reflects an
extension of wholesale funding maturities in the low interest rate environment.
A summary of long-term debt balances as of December 31, 2002 and 2001 appears in
Note 12 to the consolidated financial statements. Borrowed funds are expected to
remain an important, reliable and cost-effective funding vehicle for us.
In February 2003, we entered into ten-year interest rate swap agreements for the
notional amount of $125 million to effectively convert our new fixed rate
subordinated debt described above into a variable rate instrument. The swap
agreements are fair value hedges under FAS 133. Under the agreements, we receive
fixed interest payments at a weighted average rate of 4.36% and pay a variable
rate equal to six month LIBOR. The initial weighted-average rate is 1.35% and
reprices every six months. The initial net interest spread on the swap contracts
is 3.01%, effectively reducing the stated rate of the subordinated notes from
5.75% to 2.74% for the first six-month interest period.
CAPITAL RESOURCES
We continue to maintain a strong capital position which supports our current
needs and provides a sound foundation to support further expansion. Our
regulatory capital ratios are consistently at or above the "well-capitalized"
standards and all our bank subsidiaries have sufficient capital to maintain a
well-capitalized designation. Our capital ratios for the past
52
three years are presented below.
Regulatory Minimum
-------------------------------
December 31,
"Well- ---------------------------------------
Required Capitalized" 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
Risk based:
Tier 1 capital 4.00% 6.00% 9.18% 9.87% 9.05%
Total capital 8.00 10.00 10.43 11.12 10.30
Tier 1 leverage 4.00 5.00 7.18 7.79 7.11
==================================================================================================================================
Average shareholders equity was $691.8 million, or 9.14% of average assets for
2002 compared with $702.4 million, or 8.85%, for 2001 and $650.3 million, or
8.05% for 2000. At December 31, 2002, shareholders' equity was $650.5 million,
compared with $697.5 million at December 31, 2001. Book value per common share
at December 31, 2002 and 2001 was $14.88 and $15.46, respectively. We declared
and paid cash dividends of $1.13 per share in 2002, up from $1.085 per share in
2001 and 1.015 per share in 2000. Shareholders' equity declined in 2002 as net
income was more than offset by higher cash dividends and the capital
requirements of our share repurchase program.
In October 2001, our board of directors approved a plan to repurchase up to
3,000,000 shares of Citizens common stock for general corporate purposes. At
December 31, 2002, 1,934,600 shares of common stock had been purchased under
this plan at an average price of $29.12.
LIQUIDITY AND DEBT CAPACITY
We monitor our liquidity position so that funds will be available at a
reasonable cost to meet financial commitments, to finance business expansion and
to take advantage of unforeseen opportunities. Our subsidiary banks derive
liquidity primarily through core deposit growth, maturity of money market
investments, and maturity and sale of investment securities and loans.
Additionally, our subsidiary banks have access to market borrowing sources on an
unsecured, as well as a collateralized basis, for both short-term and long-term
purposes including, but not limited to, the Federal Reserve and Federal Home
Loan Banks where the subsidiary banks are members. Another source of liquidity
is the ability of our parent company to borrow funds on both a short-term and
long-term basis. Our parent company has a credit facility with a group of
unaffiliated banks and has used this facility for various corporate purposes
from time to time.
The subsidiary banks manage liquidity to meet client cash flow needs while
maintaining funds available for loan and investment opportunities. As discussed
in Note 20 to the consolidated financial statements, the Federal Reserve Bank
requires our banking subsidiaries to maintain certain noninterest-bearing
deposits with the Federal Reserve Bank. These balance requirements averaged
$35.3 million and $41.9 million during 2002 and 2001, respectively, and were
satisfied with cash balances maintained by our subsidiaries. The liquidity of
our parent company is managed to provide funds to pay dividends to shareholders,
service debt, invest in subsidiaries and to satisfy other operating
requirements. The primary source of liquidity for the parent company is
dividends and returns of investment from its subsidiaries. The parent company
may also derive liquidity from both short and long-term borrowed funds. During
2002, our parent company received $93.2 million in dividends from subsidiaries
and paid $50.7 million in dividends to its shareholders. All of our subsidiary
banks maintained sufficient capital to be designated well capitalized.
As discussed in Note 20 to the consolidated financial statements, as of January
1, 2003, our banking subsidiaries are temporarily unable to pay dividends to our
parent company without further regulatory approval due to statutory restrictions
resulting from the net loss in the third quarter of 2002.
We also have contractual obligations that require future cash payments and other
commitments that may impact liquidity. Table 11 below summarizes our
non-cancelable contractual obligations and future required minimum payments at
December 31, 2002. Refer to Notes 9 and 12 to the consolidated financial
statements for a further discussion of these contractual obligations.
53
TABLE 11. CONTRACTUAL OBLIGATIONS
Minimum Payments Due by Period
-------------------------------------------------------------
Less than More than
(in thousands) Total 1 year 1-3 years 4-5 years 5 years
- --------------------------------------------------------------------------------------------------------------
Federal Home Loan Bank borrowings $599,139 $ 26,202 $241,781 $ 27,014 $304,142
Capital lease/mortgage debt 174 80 94 -- --
Operating leases and non-cancelable contracts 9,783 3,622 3,140 1,168 1,853
-------- -------- -------- -------- --------
Total $609,096 $ 29,904 $245,015 $ 28,182 $305,995
======== ======== ======== ======== ========
=============================================================================================================
Table 12 below suxmarize our other commitments that may impact lixuidit and
their expected expiration dates by pexio at December 31, 2002. Since many o
these commitments historically have expired without bexn drawn upon, the total
amount of thxs commitments does not necessarily represent our fuxur cash
requirements. Further information on these coxmitment is presented in Note 17 to
th consolidated financial statements.
TABLE 12. LOAN COMMITMENTS AND LETTERS OF CREDIT
Expected Expiration Dates by Period
------------------------------------------------------------------------
Less than More than
(in thousands) Total 1 year 1-3 years 4-5 years 5 years
- ----------------------------------------------------------------------------------------------------------------------
Loan commitments to extend credit $1,739,091 $1,341,654 $ 96,845 $ 37,376 $ 263,216
Standby letters of credit 36,396 31,363 4,729 304 --
Commercial letters of credit 138,679 2,995 67,967 47,232 20,485
Forward commitments to sell mortgage loans 175,537 175,537 -- -- --
---------- ---------- ---------- ---------- ----------
Total $ 2,089,70 $1,551,549 $ 169,541 $ 84,912 $ 283,701
========== ========== ========== ========== ==========
======================================================================================================================
Our long-term debt to equity ratio was 92.1% as of December 31, 2002 compared to
90.2% in 2001. Changes in long-term debt during 2002 are discussed in the
section titled "Borrowed Funds". On January 27, 2003, we sold $125 million of
5.75% subordinated notes due 2013. A portion of the net proceeds of the offering
was used to reduce the amount outstanding under our parent company's short-term
line of credit with three unaffiliated banks. The remainder of the net proceeds
will be available for general corporate purposes. This new long-term funding
allows us to take advantage of the lowest rates in 40 years to repay short-term
debt and provides us with a new funding source. Because it is subordinated debt,
the new debt qualifies as a component of our capital, bolstering our overall
capital ratios. The higher capital ratios are viewed favorably by regulators and
credit rating agencies. We believe that we have sufficient liquidity and capital
sources to meet presently known short and long term cash flow requirements
arising from ongoing business transactions.
INTEREST RATE RISK
Interest rate risk generally arises when the maturity or repricing structure of
our assets and liabilities differ significantly. Asset/liability management,
which we use to address such risk, is the process of developing, testing and
implementing strategies that seek to maximize net interest income, maintain
sufficient liquidity and minimize exposure to significant changes in interest
rates. This process includes monitoring contractual and expected repricing of
assets and liabilities as well as forecasting earnings under different interest
rate scenarios and balance sheet structures. Generally, we seek a structure that
insulates net interest income from large swings attributable to changes in
market interest rates. Table 13 depicts our asset/liability static sensitivity
("GAP") as of December 31, 2002 and 2001. As shown, our interest rate risk
position at December 31, 2002 is asset sensitive in the less than one-year time
frame with rate sensitive assets exceeding rate sensitive liabilities by $1.222
billion. Application of GAP theory would suggest that with such a position our
net interest income could decline if interest rates fall; (i.e., assets are
likely to reprice faster than liabilities, resulting in a decrease in net income
in a declining rate environment). Conversely, net interest income could increase
in a rising rate environment. Net interest income is not only affected by the
level and direction of interest rates, but also by the shape of
54
the yield curve, relationships between interest sensitive instruments and key
driver rates, as well as balance sheet growth, client loan and deposit
preferences and the timing of changes in these variables.
TABLE 13. INTEREST RATE SENSITIVITY
TOTAL
0 - 3 4 - 6 7 - 12 WITHIN 1 - 5 Over
(dollars in millions) Months Months Months 1 YEAR Years 5 Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
RATE SENSITIVE ASSETS (1)
Loans and leases (2) $ 2,831.2 $ 247.3 $ 474.6 $ 3,553.1 $ 1,723.1 $ 317.1 $ 5,593.3
Investment securities 132.4 53.6 180.7 366.7 645.0 445.6 1,457.3
Short-term investments 71.3 -- -- 71.3 -- -- 71.3
--------- -------- -------- ---------- --------- -------- ----------
Total $ 3,034.9 $ 300.9 $ 655.3 $ 3,991.1 $ 2,368.1 $ 762.7 $ 7,121.9
========= ======== ======== ========== ========= ======== ==========
RATE SENSITIVE LIABILITIES
Deposits (3) $ 704.9 $ 570.5 $1,065.8 $ 2,341.2 $ 2,338.8 $ 356.2 $ 5,036.2
Other interest bearing liabilities 418.0 9.9 -- 427.9 165.6 308.2 901.7
--------- -------- -------- ---------- --------- -------- ----------
Total $ 1,122.9 $ 580.4 $1,065.8 $ 2,769.1 $ 2,504.4 $ 664.4 $ 5,937.9
========= ======== ======== ========== ========= ======== ==========
Period GAP (4) $ 1,912.0 $ (279.5) $ (410.5) $ 1,222.0 $ (136.3) $ 98.3 $ 1,184.0
Cumulative GAP 1,912.0 1,632.5 1,222.0 1,085.7 1,184.0
Cumulative GAP to total assets 25.42% 21.70% 16.25% 16.25% 14.43% 15.74% 15.74%
Multiple of rate sensitive assets to liabilities 2.70 0.52 0.61 1.44 0.95 1.15 1.20
====================================================================================================================================
DECEMBER 31, 2001
RATE SENSITIVE ASSETS (1)
Loans and leases (2) $ 2,486.5 $ 271.4 $ 516.5 $ 3,274.4 $ 2,175.6 $ 472.4 $ 5,922.4
Investment securities 133.7 21.5 47.1 202.3 568.0 527.4 1,297.7
Short-term investments 4.3 -- -- 4.3 -- -- 4.3
--------- -------- -------- ---------- --------- -------- ----------
Total $ 2,624.5 $ 292.9 $ 563.6 $ 3,481.0 $ 2,743.6 $ 999.8 $ 7,224.4
========= ======== ======== ========== ========= ======== ==========
RATE SENSITIVE LIABILITIES
Deposit (3) $ 873.6 $ 666.4 $1,192.5 $ 2,732.5 $ 2,029.2 $ 299.5 $ 5,061.2
Other interest bearing liabilities 320.2 19.7 100.1 440.0 221.0 282.5 943.5
--------- -------- -------- ---------- --------- -------- ----------
Total $ 1,193.8 $ 686.1 $1,292.6 $ 3,172.5 $ 2,250.2 $ 582.0 $ 6,004.7
========= ======== ======== ========== ========= ======== ==========
Period GAP (4) $ 1,430.7 $ (393.2) $ (729.0) $ 308.5 $ 493.4 $ 417.8 $ 1,219.7
Cumulative GAP 1,430.7 1,037.5 308.5 801.9 1,219.7
Cumulative GAP to total assets 18.63% 13.51% 4.02% 4.02% 10.44% 15.88% 15.88%
Multiple of rate sensitive assets to liabilities 2.20 0.43 0.44 1.10 1.22 1.72 1.20
====================================================================================================================================
(1) Incorporates prepayment projections for certain assets which may shorten the
time frame for repricing or maturity compared to contractual runoff.
(2) Includes mortgage loans held for sale.
(3) Includes interest bearing savings and demand deposits without contractual
maturities of $811 million in the less than one year category and $1.855
billion in the over one year category as of December 31, 2002. The same
amounts as of December 31, 2001 were $770 million and $1.636 billion,
respectively. This runoff is based on historical trends, which reflects
industry standards.
(4) GAP is the excess of rate sensitive assets (liabilities).
We are continually reviewing our interest rate risk position and modifying our
strategies based on projections to minimize the impact of future interest rate
changes. While traditional GAP analysis does not always incorporate adjustments
for the magnitude or timing of non-contractual repricing, Table 13 does
incorporate appropriate adjustments as indicated in footnotes 1 and 3 to the
table. Because of these and other inherent limitations of any GAP analysis, we
utilize net interest income simulation modeling as our primary tool to evaluate
the impact of changes in interest rates and balance sheet strategies, and to
develop strategies that can limit interest rate risk and provide liquidity to
meet client loan demand and deposit preferences.
55
Holding residential mortgage loans for sale and committing to fund residential
mortgage loan applications at specific rates also exposes us to interest rate
risk during the period from loan funding until sale. To minimize this risk, we
enter into mandatory forward commitments to sell residential mortgage loans.
These mandatory forward commitments are considered a derivative under SFAS 133.
Our policy to hedge our market rate risk with mandatory forward commitments has
been highly effective and has not generated any material gains or losses.
INTEREST RATE SENSITIVITY
A number of measures are used to monitor and manage interest rate risk,
including income simulation and interest rate sensitivity GAP analyses. An
income simulation model is our primary tool used to assess the direction and
magnitude of variations in net interest income resulting from changes in
interest rates. Key assumptions in the model include prepayment speeds on
various loan and investment assets; cash flows and maturities of financial
instruments held for purposes other than trading; changes in market conditions,
loan volumes, and pricing; deposit sensitivity; client preferences; and our
financial capital plans. These assumptions are inherently uncertain, subject to
fluctuation and revision in a dynamic environment and, as a result, the model
cannot precisely estimate net interest income nor exactly predict the impact of
higher or lower interest rates on net interest income. Actual results will
differ from simulated results due to timing, magnitude, and frequency of balance
sheet component and interest rate changes, differences in client behavior,
market conditions and management strategies, among other factors.
Results of the multiple simulations done as of December 31, 2002 suggest that we
could expect net interest income to decrease from 2002 levels by $21 million if
asset and liability balances remain static and interest rates gradually decline
by 200 basis points over the next twelve months, and to increase by $5 million
if asset and liability balances remain static and interest rates gradually
increase by 200 basis points over the next twelve months. These variances in net
interest income were within our policy parameters established to manage such
risk. They are based on a worse case scenario and the model as used may not
adequately compensate for interest rate floors and management actions that would
be taken to moderate the effect of such changes in the rate environment.
We perform a large number of net interest income simulations using varying
balance sheet scenarios and differing interest rate environments. The model
results presented herein are intended to illustrate the potential variation in
net interest income from the indicated changes in interest rates, and not to
project future levels of net interest income. In addition to changes in interest
rates, the level of future net interest income is also dependent on a number of
other variables including the growth, composition and absolute levels of
deposits, loans, and other earning assets and interest bearing liabilities,
economic and competitive conditions, client preferences and other factors.
56
TABLE 14. SELECTED QUARTERLY INFORMATION
2002 2001
(in thousands except, ----------------------------------------------- ---------------------------------------------
per share data) FOURTH THIRD SECOND FIRST Fourth Third Second First
- ---------------------------------------------------------------------------------------------------------------------------------
Interest income $ 112,558 $ 115,558 $ 116,993 $ 118,275 $ 129,335 $ 140,406 $ 147,260 $ 156,558
Interest expense 36,326 40,376 41,584 43,316 51,659 62,146 70,835 80,938
Net interest income 76,232 75,182 75,409 74,959 77,676 78,260 76,425 75,620
Provision for loan losses 16,300 89,250 9,400 5,250 7,496 8,500 6,362 4,049
Noninterest income
before securities gains (1) 26,689 19,689 28,238 24,724 25,599 34,658 28,587 22,442
Investment securities gains (2) 12 45 2,377 2 423 49 3,504 2,219
Noninterest expense
before special charge (3) 57,531 65,738 61,521 61,191 60,586 64,270 63,616 62,711
Special charge (4) (405) 13,807 -- -- -- -- -- --
Net income (loss) 21,525 (45,929) 25,339 24,103 25,742 27,962 27,148 23,805
PER SHARE OF COMMON STOCK
Net income (loss):
Basic 0.49 (1.03) 0.57 0.53 0.57 0.60 0.59 0.51
Diluted 0.48 (1.03) 0.56 0.53 0.56 0.60 0.58 0.51
Cash dividends declared 0.285 0.285 0.285 0.275 0.275 0.275 0.275 0.260
Market value:(5)
High 26.46 29.43 33.88 33.20 34.02 32.75 30.55 29.38
Low 21.25 23.35 27.82 30.67 27.70 27.30 24.51 23.69
Close 24.78 24.17 28.98 32.47 32.88 32.08 29.25 26.69
=================================================================================================================================
(1) Noninterest income in 2002 includes a $5.4 million gain on the sale of
the merchant services business in the second quarter. Noninterest
income in 2001 includes a $2.6 million gain on the sale of the credit
card portfolio in the second quarter, an $11.0 million gain on sale of
NYCE stock in the third quarter and a $793,000 gain on the sale of F&M
Bank-Minnesota in the fourth quarter.
(2) Investment securities gains include $2.4 million in the second quarter
of 2002, $3.3 million in the second quarter of 2001 and $2.1 million in
the first quarter of 2001 from the securitization of mortgages and
subsequent sale of the related mortgage-backed securities.
(3) Noninterest expense before special charge in the third quarter of 2002
includes a $3.3 million prepayment penalty on FHLB advances, a $2.0
million contribution to Citizens' charitable trust, $1.0 million
valuation allowance on other real estate owned, $406,000 in additional
equipment depreciation and $452,000 in losses and other items.
(4) The special charge of $13.8 million recorded in the third quarter of
2002 covers the cost of restructuring our consumer, business and wealth
management lines of business.
(5) Citizens Banking Corporation common stock is traded on the National
Market tier of the Nasdaq stock market (trading symbol: CBCF). At
December 31, 2002, there were approximately 15,497 shareholders of the
Corporation's common stock.
57
CONSOLIDATED BALANCE SHEETS
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
December 31,
(in thousands, except share amounts) 2002 2001
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 171,864 $ 224,416
Money market investments:
Federal funds sold 69,000 891
Interest-bearing deposits with banks 2,332 3,455
----------- -----------
Total money market investments 71,332 4,346
Securities available for sale (amortized cost $1,391,089 in 2002; $1,225,230 in 2001) 1,457,281 1,297,696
Mortgage loans held for sale 160,743 150,443
Loans:
Commercial 3,111,208 3,246,380
Real estate construction 262,363 216,041
Real estate mortgage 545,834 821,090
Consumer 1,513,156 1,488,452
----------- -----------
Total loans 5,432,561 5,771,963
Less: Allowance for loan losses (109,467) (80,299)
----------- -----------
Net loans 5,323,094 5,691,664
Premises and equipment 117,704 128,805
Goodwill 54,785 54,785
Other intangible assets 19,862 26,032
Bank owned life insurance 78,434 --
Other assets 66,935 100,688
----------- -----------
TOTAL ASSETS $ 7,522,034 $ 7,678,875
=========== ===========
LIABILITIES
Noninterest-bearing deposits $ 900,674 $ 903,900
Interest-bearing deposits 5,036,239 5,061,226
----------- -----------
Total deposits 5,936,913 5,965,126
Federal funds purchased and securities sold
under agreements to repurchase 223,289 233,077
Other short-term borrowings 79,062 81,353
Other liabilities 32,988 72,756
Long-term debt 599,313 629,099
----------- -----------
Total liabilities 6,871,565 6,981,411
SHAREHOLDERS' EQUITY
Preferred stock - no par value:
Authorized - 5,000,000 shares; Issued - none
Common stock - no par value:
Authorized - 100,000,000 shares
Issued and outstanding - 43,702,371 in 2002; 45,097,614 in 2001 112,253 155,720
Retained earnings 495,570 521,191
Other accumulated comprehensive net income 42,646 20,553
----------- -----------
Total shareholders' equity 650,469 697,464
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,522,034 $ 7,678,875
=========== ===========
===================================================================================================================
See notes to consolidated financial statements.
58
CONSOLIDATED STATEMENTS OF INCOME
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
(in thousands, except share amounts) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans $ 385,812 $ 492,437 $ 535,235
Interest and dividends on investment securities:
Taxable 55,447 57,633 66,190
Tax-exempt 21,301 21,715 20,350
Money market investments 824 1,774 233
------------ ------------ ------------
Total interest income 463,384 573,559 622,008
INTEREST EXPENSE
Deposits 127,849 204,929 229,137
Short-term borrowings 4,033 27,458 58,532
Long-term debt 29,720 33,191 19,465
------------ ------------ ------------
Total interest expense 161,602 265,578 307,134
------------ ------------ ------------
NET INTEREST INCOME 301,782 307,981 314,874
Provision for loan losses 120,200 26,407 20,983
------------ ------------ ------------
Net interest income after provision for loan losses 181,582 281,574 293,891
------------ ------------ ------------
NONINTEREST INCOME
Service charges on deposit accounts 26,456 27,773 26,260
Trust fees 18,956 21,028 24,253
Mortgage and other loan income 16,845 13,159 4,997
Bankcard fees 6,142 11,799 11,258
Brokerage and investment fees 9,502 8,157 7,693
Investment securities gains 2,436 6,195 --
Gain on sale of merchant business 5,400 -- --
Gain on sale of equity investment -- 11,017 --
Gain on sale of credit card assets -- 2,623 --
Gain on sale of bank -- 793 --
Other 16,039 14,937 15,883
------------ ------------ ------------
Total noninterest income 101,776 117,481 90,344
------------ ------------ ------------
NONINTEREST EXPENSE
Salaries and employee benefits 126,847 126,278 122,577
Equipment 19,869 19,317 19,264
Occupancy 17,855 17,713 16,770
Data processing fees 12,641 13,101 12,608
Professional services 14,790 12,277 10,088
Postage and delivery 7,120 7,746 6,924
Telephone 5,279 5,556 6,364
Advertising and public relations 5,112 5,219 5,034
Stationery and supplies 4,032 4,426 5,602
Intangible asset amortization 2,899 10,115 9,917
Bankcard fees 3,879 9,308 8,959
Special charge 13,402 -- 15,541
Other 25,658 20,127 18,114
------------ ------------ ------------
Total noninterest expense 259,383 251,183 257,762
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 23,975 147,872 126,473
Income tax provision (benefit) (1,063) 43,215 35,813
------------ ------------ ------------
NET INCOME $ 25,038 $ 104,657 $ 90,660
============ ============ ============
NET INCOME PER SHARE:
Basic $ 0.56 $ 2.27 $ 1.92
Diluted 0.56 2.25 1.91
AVERAGE SHARES OUTSTANDING:
Basic 44,657,153 46,085,405 47,310,375
Diluted 45,076,684 46,589,962 47,542,815
===============================================================================================================
See notes to consolidated financial statements.
59
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Accumulated
Other
Common Retained Comprehensive
(in thousands, except per share amounts) Stock Earnings Income (loss) Total
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE - JANUARY 1, 2000 $ 226,972 $ 424,140 $ (17,443) $ 633,669
Comprehensive income:
Net income 90,660 90,660
Other comprehensive income:
Net unrealized gain on securities available-for-sale,
net of tax effect of $15,718 29,181 29,181
-------------
Total comprehensive income 119,841
Exercise of stock options, net of
shares purchased 1,879 1,879
Cash dividends - $1.015 per share (48,108) (48,108)
Shares acquired for retirement (27,302) (27,302)
------------ ------------ ------------- -------------
BALANCE - DECEMBER 31, 2000 201,549 466,692 11,738 679,979
Comprehensive income:
Net income 104,657 104,657
Other comprehensive income:
Net unrealized gain on securities available-for-sale,
net of tax effect of $5,690 14,569
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of $2,168 (4,027)
Minimum pension liability (1,727)
-------------
Other comprehensive income total 8,815
-------------
Total comprehensive income 113,472
Exercise of stock options, net of
shares purchased 12,662 12,662
Cash dividends - $1.085 per share (50,158) (50,158)
Shares acquired for retirement (58,491) (58,491)
------------ ------------ ------------- -------------
BALANCE - DECEMBER 31, 2001 155,720 521,191 20,553 697,464
Comprehensive income:
Net income 25,038 25,038
Other comprehensive income:
Net unrealized gain on securities available-for-sale,
net of tax effect of $11,170 22,328
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of $853 (1,583)
Minimum pension liability 1,348
-------------
Other comprehensive income total 22,093
-------------
Total comprehensive income 47,131
Exercise of stock options, net of
shares purchased 6,562 6,562
Net change in deferred compensation, net of tax effect 267 267
Cash dividends - $1.130 per share (50,659) (50,659)
Shares acquired for retirement (50,296) (50,296)
------------ ------------ ------------- -------------
BALANCE - DECEMBER 31, 2002 $ 112,253 $ 495,570 $ 42,646 $ 650,469
============ ============ ============= =============
==================================================================================================================================
See notes to consolidated financial statements.
60
CONSOLIDATED STATEMENTS OF CASH FLOWS
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
YEAR ENDED DECEMBER 31,
(in thousands) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 25,038 $ 104,657 $ 90,660
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 120,200 26,407 20,983
Depreciation and amortization 17,045 16,241 15,995
Amortization of goodwill and other intangibles 2,899 11,063 10,733
Deferred income tax (credit) (5,110) (279) 3,585
Net amortization (accretion) on investment securities 1,926 (563) (147)
Investment securities gains (2,436) (6,195) --
Loans originated for sale (1,024,257) (782,009) (132,878)
Proceeds from sales of mortgage loans held for sale 1,023,821 638,407 134,020
Gains from loan sales (9,864) (6,841) (1,142)
Donation of equity security -- -- 1,116
Gains on sale of equity securities, credit card assets and bank -- (14,433) --
Accrued merger related and other special charges (8,614) (3,337) (14,050)
Other 723 (4,720) 87
----------- ----------- -----------
Net cash provided by operating activities 141,371 (21,602) 128,962
INVESTING ACTIVITIES:
Net (increase) decrease in money market investments (66,986) (15,003) 36,270
Securities available-for-sale:
Proceeds from sales 69,677 297,492 6,755
Proceeds from maturities 307,546 352,369 183,185
Purchases (504,382) (502,261) (131,311)
Net (increase) decrease in loans and leases 248,370 595,211 (522,569)
Net increase in properties and equipment (5,944) (7,952) (10,519)
Purchase of bank owned life insurance (78,000) -- --
Sale of credit card assets -- 29,454 --
Net cash provided by acquisitions and sales -- 14,433 26,008
----------- ----------- -----------
Net cash used by investing activities (29,719) 763,743 (412,181)
FINANCING ACTIVITIES:
Net increase (decrease) in demand and savings deposits 255,720 143,669 (231,753)
Net increase (decrease) in time deposits (283,933) (422,684) 315,889
Net decrease in short-term borrowings (12,079) (618,820) (4,029)
Proceeds from issuance of long-term debt 121,000 183,182 740,150
Principal reductions in long-term debt (150,786) (25,200) (396,137)
Cash dividends paid (50,659) (50,158) (48,108)
Proceeds from stock options exercised 6,562 12,662 1,879
Shares acquired for retirement (50,296) (58,491) (27,302)
Net change in deferred compensation, net of tax effect 267 -- --
----------- ----------- -----------
Net cash provided by financing activities (164,204) (835,840) 350,589
----------- ----------- -----------
Net increase (decrease) in cash and due from banks (52,552) (93,699) 67,370
Cash and due from banks at beginning of period 224,416 318,115 250,745
----------- ----------- -----------
Cash and due from banks at end of period $ 171,864 $ 224,416 $ 318,115
=========== =========== ===========
Supplemental Cash Flow Information:
Interest paid $ 168,588 $ 278,979 $ 297,396
Income taxes paid 22,888 40,481 30,647
==============================================================================================================================
See notes to consolidated financial statements.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Citizens Banking Corporation (Citizens)
and its subsidiaries conform to generally accepted accounting principles in the
United States. Management makes estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual
results could differ from these estimates. The following describes Citizens'
policies:
CONSOLIDATION: The Consolidated Financial Statements include the accounts of
Citizens and its subsidiaries after elimination of all material intercompany
transactions and accounts.
BUSINESS COMBINATIONS: Since the issuance of SFAS 141, Business Combinations, by
the Financial Accounting Standards Board (FASB), business combinations initiated
after June 30, 2001, are required to be accounted for by the purchase method.
Under the purchase method, net assets of the business acquired are recorded at
their estimated fair values as of the date of acquisition with any excess of the
cost of the acquisition over the fair value of the net tangible and intangible
assets acquired recorded as goodwill. Results of operations of the acquired
business are included in the income statement from the date of acquisition.
Prior to SFAS 141, certain business combinations not accounted for as purchase
acquisitions were accounted for under the pooling-of-interests method, which
required the retroactive combining of the assets, liabilities, stockholders'
equity, and results of operations of the merged entity with Citizens' respective
accounts at historical amounts. Prior period financial statements were then
restated to give effect to business combinations accounted for under this
method.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE: Securities purchased under agreements to resell and
securities sold under agreements to repurchase are generally accounted for as
collateralized financing transactions and are recorded at the amounts at which
the securities were acquired or sold plus accrued interest. Securities,
generally U.S. government and Federal agency securities, pledged as collateral
under these financing arrangements cannot be sold or repledged by the secured
party. The fair value of collateral either received from or provided to a third
party is continually monitored and additional collateral obtained or requested
to be returned to Citizens as deemed appropriate.
INVESTMENT SECURITIES: Citizens classifies all debt and equity securities as
available for sale. Debt and marketable equity securities are reported at fair
value with unrealized gains and losses included in shareholders' equity.
Non-marketable equity securities such as Federal Reserve Bank and Federal Home
Loan Bank stock are reported at cost. In the event that an investment security
is sold, the adjusted cost of the specific security sold is used to compute the
applicable gain or loss. When it is determined that securities or other
investments are impaired and the impairment is other than temporary, an
impairment loss is recorded in earnings and a new basis is established.
LOANS: Loans are generally reported at the principal amount outstanding, net of
unearned income. Interest income is recognized on an accrual basis. Loan
origination fees, certain direct costs, and unearned discounts are deferred and
amortized into interest income as an adjustment to the yield over the term of
the loan. Loan commitment fees are generally deferred and amortized into fee
income on a straight-line basis over the commitment period. Other credit-related
fees, including letter and line of credit fees, are recognized as fee income
when earned.
Gains and losses on the sales of loans are determined using the
specific-identification method. Mortgage loans held for sale are valued on an
aggregate basis at the lower of carrying amount or fair value. The majority of
mortgage loans held for sale are sold within 60 days after closing. Citizens
uses mandatory forward commitments, generally entered into at time of
application, to protect the value of the mortgage loans from changes in interest
rates during the period held. The cost basis of mortgage loans held for sale is
adjusted, if material, by any gains or losses generated from mandatory forward
commitments to sell the loans to investors in the secondary market. Citizens'
policy to hedge its market rate risk with mandatory forward commitments has been
highly effective and has not generated any material gains or losses.
Loans are placed on nonaccrual status when the collection of principal or
interest is considered doubtful, or payment of principal or interest is past due
90 days or more and the loan is not well secured and in the process of
collection. When these loans (including a loan impaired) are placed on
nonaccrual status, all interest previously accrued but unpaid is reversed
against current year interest income. Interest payments received on nonaccrual
loans are credited to income if future collection of principal is probable.
Loans are normally restored to accrual status when interest and principal
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
payments are current and it is believed that the financial condition of the
borrower has improved to the extent that future principal and interest payments
will be met on a timely basis.
Commercial loans and commercial loans secured by real estate are generally
charged off to the extent principal and interest due exceed the net realizable
value of the collateral, with the charge-off occurring when the loss is
reasonably quantifiable but not later than when the loan becomes 180 days past
due. Loans secured by residential real estate are generally charged off after
foreclosure to the extent principal and interest due exceed 85% of the current
appraised value. Consumer loans (open and closed end) are generally charged off
before the loan becomes 120 days past due.
Commercial and commercial real estate loans exceeding certain fixed dollar
amounts based on their internal credit rating are evaluated for impairment in
accordance with the provisions of SFAS 114, Accounting by Creditors for
Impairment of a Loan, which requires an allowance to be established as a
component of the allowance for loan losses when it is probable all amounts due
will not be collected pursuant to the contractual terms of the loan and the
recorded investment in the loan exceeds its fair value. In most instances the
fair value is measured based on the fair value of the collateral. Fair value may
also be measured using either the present value of expected future cash flows
discounted at the loan's effective interest rate or the observable market price
of the loan.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses inherent in the
loan portfolio and is based on the size and current risk characteristics of the
loan portfolio, an assessment of individual problem loans and actual loss
experience, current economic events in specific industries and geographical
areas, including unemployment levels, and other pertinent factors, including
regulatory guidance and general economic conditions. Determination of the
allowance is inherently subjective as it requires significant estimates,
including the amounts and timing of expected future cash flows on impaired
loans, estimated losses on pools of homogeneous loans based on historical loss
experience, and consideration of current economic trends, all of which may be
susceptible to significant change. The allowance is increased by the provision
charged to income and reduced by the amount charged-off, net of recoveries. Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for loan
losses is charged to operations based on management's periodic evaluation of the
factors previously mentioned, as well as other pertinent factors. Evaluations
are conducted at least quarterly and more often if deemed necessary.
The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance for loan losses represent
an estimation done pursuant to either SFAS 5, Accounting for Contingencies, or
SFAS 114. The allocated component of the allowance for loan losses reflects
expected losses resulting from analysis developed through specific credit
allocations for individual loans (the specific allocation allowance) and on
historical loss experience for each loan category (the risk allocation
allowance). Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit that
management believes indicate it is probable that a loss has been or will be
incurred. The specific credit allocations are based on a regular analysis of all
commercial and commercial mortgage loans over a fixed dollar amount where the
internal credit rating is at or below a predetermined classification. The risk
allocated allowance is calculated by applying projected loss rates to
outstanding loans (excluding specifically identified credits) stratified by risk
rating for commercial credits and by accrual and past due status for homogenous
residential mortgage and consumer pools of loans. The projected loss rates are
based on historical loss experience (generally an eighteen month rolling average
of net charge-offs) adjusted for trends in past due and nonaccrual amounts, the
condition of the economy, and changes in portfolio concentrations, mix and
volume. The allocated component of the allowance for loan losses also includes
consideration of Citizens' current business strategy and credit process,
including credit limit setting and compliance, credit approvals, loan
underwriting, and loan workout procedures.
The unallocated portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates, and risk factors that have not yet manifested themselves in loss
allocation factors. In addition, the unallocated allowance includes a component
that explicitly accounts for the inherent imprecision in loan loss projection
models. Citizens has grown through acquisition, expanded the geographic
footprint in which it operates, and changed its portfolio mix in recent years.
As a result, historical loss experience data used to establish allocation
estimates may not precisely correspond to the current portfolio. The uncertainty
surrounding the strength and timing of economic cycles, including management's
concerns over the effects of the prolonged economic downturn in the current
63
cycle, also affects the allocation model's estimates of loss. The historical
losses used may not be representative of actual losses inherent in the portfolio
that have not yet been realized.
DEPRECIABLE ASSETS: Premises and equipment, including leasehold improvements,
are carried at cost less accumulated depreciation and amortization. Depreciation
and amortization are computed principally on a straight-line basis and are
charged to expense over the lesser of the estimated useful life of the assets or
lease term. Maintenance and repairs are charged to expense as incurred. Gains
and losses on dispositions are charged to income as incurred.
Long-lived depreciable assets are evaluated periodically for impairment when
events or changes in circumstances indicate the carrying amount may not be
recoverable. Impairment exists when the expected undiscounted future cash flows
of a long-lived asset are less than its carrying value. In that event, Citizens
recognizes a loss for the difference between the carrying amount and the
estimated fair value of the asset based on a quoted market price, if applicable,
or a discounted cash flow analysis.
OTHER REAL ESTATE: Other real estate is comprised of commercial and residential
real estate properties acquired in partial or total satisfaction of a debt.
These properties are carried at the lower of cost or fair value, net of
estimated costs to sell, based upon current appraised value. Losses arising from
the initial acquisition of such properties are charged against the allowance for
loan losses at time of transfer. Subsequent valuation adjustments and gains or
losses on disposal of these properties are charged to other expenses as
incurred.
BANK OWNED LIFE INSURANCE: Bank Owned Life Insurance is recorded as an asset at
the amount that could be realized under the insurance contracts as of the date
of the consolidated balance sheets. The change in cash surrender value during
the period is an adjustment of premiums paid in determining the expense or
income to be recognized under the contracts for the period. This change is
recorded in noninterest income as cash surrender value of life insurance
revenue.
GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill represents the excess of the cost
of an acquisition over the fair value of net identifiable tangible and
intangible assets acquired. Other intangible assets represent purchased assets
that also lack physical substance but can be distinguished from goodwill because
of contractual or other legal rights or because the asset is capable of being
sold or exchanged either on its own or in combination with a related contract,
asset, or liability. On January 1, 2002, Citizens adopted SFAS 142, Goodwill and
Other Intangible Assets. Under the provisions of SFAS 142, goodwill is no longer
ratably amortized into the income statement over an estimated life, but rather
is tested at least annually for impairment. Impairment of goodwill is evaluated
by line of business and geographic region and is based on a comparison of the
recorded balance of goodwill to the applicable market value or discounted cash
flows. To the extent that impairment may exist, the current carrying amount is
reduced by the estimated shortfall. Intangible assets which have finite lives
continue to be amortized over their estimated useful lives and also continue to
be subject to impairment testing. All of Citizens' other intangible assets have
finite lives and are amortized on a straight-line basis over varying periods not
exceeding 10 years. Prior to the adoption of SFAS 142, Citizens' goodwill was
amortized on a straight-line basis over varying periods not exceeding 20 years.
Note 7 includes a summary of Citizens' goodwill and other intangible assets as
well as further detail about the impact of the adoption of SFAS 142.
MORTGAGE SERVICING RIGHTS: Citizens recognizes as a separate asset rights to
service mortgage loans it does not own but services for others for a fee. This
asset is included in other assets on the balance sheet and is carried at the
lower of the initial carrying value, adjusted for amortization, or estimated
fair value. Amortization is determined in proportion to and over the period of
estimated net servicing income. Impairment of servicing assets is assessed based
on the fair value of those rights. For purposes of measuring impairment, the
rights are stratified by product type and interest rate.
The fair value of mortgage servicing assets is estimated by calculating the
present value of estimated future net servicing cash flows, taking into
consideration actual and expected mortgage loan prepayment rates, discount
rates, servicing costs, and other economic factors. The expected and actual rate
of mortgage loan prepayments are the most significant factors driving the value
of mortgage servicing assets. Increases in mortgage loan prepayments reduce
estimated future net servicing cash flows because the life of the underlying
loan is reduced.
SECURITIZATIONS AND SALES OF MORTGAGE LOANS: Citizens sells substantially all of
the fixed-rate single-family mortgage loans it originates, including
adjustable-rate loans that convert to fixed-rate loans. These sales are
accomplished through cash sales to Federal Home Loan Mortgage Corporation
("FHLMC"), Federal National Mortgage Association ("FNMA") and other third-party
investors, as well as through securitizations with FHLMC and FNMA. In general,
mortgage-backed securities ("MBSs") received from FHMLC or FNMA in exchange for
fixed-rate mortgage loans are sold immediately in the securities market. From
time to time, Citizens also exchanges fixed and variable rate mortgage loans
held in portfolio for FHLMC or FNMA MBSs backed by the same loans. The resulting
MBSs are sold to third party investors or classified as held for sale in
Citizens investment security portfolio.
64
If MBSs are retained in the investment portfolio, any gain or loss at time of
sale is recorded as a security gain or loss. All other gains or losses
associated with sales of single-family mortgage loans are recorded as a
component of mortgage banking revenue. Typically, Citizens does not service the
loans after they are sold or exchanged, but sells the mortgage servicing rights,
in a separate transaction, before or at the time of the securitization. Sales or
securitizations of mortgage loans through FHLMC and FNMA are done under terms
that do not provide for any material recourse to Citizens by the investor.
Citizens does not retain any interest in these securitized mortgage loans.
DERIVATIVE INSTRUMENTS: Citizens enters into derivative transactions principally
to protect against the risk of adverse price or interest rate movements on the
value of certain assets and liabilities and on future cash flows. Citizens is
also required to recognize certain contracts and commitments as derivatives when
the characteristics of those contracts and commitments meet the definition of a
derivative. Citizens has not utilized derivatives other than for the
aforementioned fair value hedge of its mortgage loans held for sale and interest
rate lock commitments with mandatory forward commitments. This hedging policy
has been highly effective and therefore the impact on income has been
immaterial.
Under the guidelines of SFAS 133, Accounting for Derivative Instruments and
Hedging Activities, as amended, all derivative instruments are required to be
carried at fair value on the balance sheet. SFAS 133 also provides special hedge
accounting provisions. Derivative instruments designated in a hedge relationship
to mitigate exposure to changes in the fair value of an asset, liability, or
firm commitment attributable to a particular risk, such as interest rate risk,
are considered fair value hedges under SFAS 133. Derivative instruments
designated in a hedge relationship to mitigate exposure to variability in
expected future cash flows, or other types of forecasted transactions, are
considered cash flow hedges.
Fair value hedges are accounted for by recording the fair value of the
derivative instrument and the fair value related to the risk being hedged of the
hedged asset or liability on the balance sheet with corresponding offsets
recorded in the income statement. The adjustment to the hedged asset or
liability is included in the basis of the hedged item, while the fair value of
the derivative is recorded as a freestanding asset or liability. Actual cash
receipts or payments and related amounts accrued during the period on
derivatives included in a fair value hedge relationship are recorded as
adjustments to the interest income or expense recorded on the hedged asset or
liability.
Cash flow hedges are accounted for by recording the fair value of the derivative
instrument on the balance sheet as either a freestanding asset or liability,
with a corresponding offset recorded in other comprehensive income within
shareholders' equity, net of tax. Amounts are reclassified from other
comprehensive income to the income statement in the period or periods the hedged
forecasted transaction affects earnings.
Under both the fair value and cash flow hedge methods, derivative gains and
losses not effective in hedging the change in fair value or expected cash flows
of the hedged item are recognized immediately in the income statement.
STOCK-BASED COMPENSATION: Citizens' stock-based compensation plans are accounted
for based on the intrinsic value method set forth in Accounting Principles Board
(APB) Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. Compensation expense for employee stock options is generally
not recognized if the exercise price of the option equals or exceeds the fair
value of the stock on the date of grant. Compensation expense for restricted
share awards is ratably recognized over the period of service, usually the
restricted period, based on the fair value of the stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if Citizens had applied the fair value recognition provisions of SFAS 123,
Accounting for Stock-Based Compensation, to its stock option awards.
65
- ------------------------------------------------------------------------------------------------
Year Ended December 31,
(in thousands, except per share amounts) 2002 2001 2000
- ------------------------------------------------------------------------------------------------
Net income, as reported $ 25,038 $ 104,657 $ 90,660
Less pro forma expense related to options granted 2,401 1,849 1,640
-------- --------- --------
Pro forma net income $ 22,637 $ 102,808 $ 89,020
======== ========= ========
Pro forma net income per share:
Basic - as reported $ 0.56 $ 2.27 $ 1.92
Basic - pro forma 0.51 2.23 1.88
Diluted - as reported 0.56 2.25 1.91
Diluted - pro forma 0.50 2.21 1.87
================================================================================================
The fair values of stock options granted were estimated at the date of grant
using a Black-Scholes option pricing model. The weighted-average assumptions
used to determine the fair value of options granted are provided in Note 16 to
the consolidated financial statements.
INCOME TAXES: Citizens and its subsidiaries file a consolidated federal income
tax return. Income tax expense is based on income as reported in the
Consolidated Statements of Income. When income and expenses are recognized in
different periods for tax purposes, applicable deferred taxes are provided in
the Consolidated Financial Statements.
NET INCOME PER SHARE: Basic net income per share is based on net income divided
by the weighted average number of shares outstanding in each period. Diluted net
income per share shows the dilutive effect of additional common shares issuable
upon the assumed exercise of stock options granted under Citizens' stock option
plans, using the treasury stock method.
CASH FLOWS: For purposes of reporting cash flows, cash and cash equivalents
include cash on hand and amounts due from banks.
RECLASSIFICATIONS: Certain amounts have been reclassified to conform to the
current year presentation.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
CONSOLIDATION OF VARIABLE INTEREST ENTITIES: In January 2003, the FASB issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities. The objective of this interpretation is to provide guidance on how to
identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE need
to be included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate the entity if the
company's interest in the VIE is such that the company will absorb a majority of
the VIE's expected losses and/or receive a majority of the entity's expected
residual returns, if they occur. FIN 46 also requires additional disclosures by
primary beneficiaries and other significant variable interest holders. The
provisions of this interpretation became effective upon issuance. Citizens does
not hold any variable interests in any entities. Therefore, the adoption of this
interpretation will have no impact on Citizens financial position, results of
operations or cash flows.
GUARANTEES: In November 2002, the FASB issued FASB Interpretation No. 45 (FIN
45), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. This interpretation
expands the disclosures to be made by a guarantor in its financial statements
about its obligations under certain guarantees and requires the guarantor to
recognize a liability for the fair value of an obligation assumed under a
guarantee. FIN 45 clarifies the requirements of SFAS 5, Accounting for
Contingencies, relating to guarantees. In general, FIN 45 applies to contracts
or indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, liability, or equity security of the guaranteed party.
Certain guarantee contracts are excluded from both the disclosure and
recognition requirements of this interpretation, including, among others,
guarantees relating to employee compensation, residual value guarantees under
capital lease arrangements, commercial letters of credit, loan commitments,
subordinated interests in an SPE, and
66
guarantees of a company's own future performance. Other guarantees are subject
to the disclosure requirements of FIN 45 but not to the recognition provisions
and include, among others, a guarantee accounted for as a derivative instrument
under SFAS 133, a parent's guarantee of debt owed to a third party by its
subsidiary or vice versa, and a guarantee which is based on performance not
price. The disclosure requirements of FIN 45 are effective for Citizens as of
December 31, 2002, and require disclosure of the nature of the guarantee, the
maximum potential amount of future payments that the guarantor could be required
to make under the guarantee, and the current amount of the liability, if any,
for the guarantor's obligations under the guarantee. The recognition
requirements of FIN 45 are to be applied prospectively to guarantees issued or
modified after December 31, 2002. Significant guarantees that have been entered
into by Citizens are disclosed in Note 17. Citizens does not expect the
requirements of FIN 45 to have a material impact on results of operations,
financial position, or liquidity.
ACCOUNTING FOR STOCK-BASED COMPENSATION: In December 2002, the FASB issued SFAS
148, Accounting for Stock-Based Compensation - Transition and Disclosure, which
provides guidance on how to transition from the intrinsic value method of
accounting for stock-based employee compensation under APB 25 to SFAS 123's fair
value method of accounting, if a company so elects. Citizens has elected to
continue its current practice of accounting for stock based employee
compensation in accordance with APB Opinion 25 and SFAS 123. Therefore, the
adoption of this interpretation will have no impact on Citizens' financial
position, results of operations or cash flows.
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS: In October 2002, the FASB issued
SFAS 147, Acquisitions of Certain Financial Institutions, which provides
guidance on the accounting for the acquisition of a financial institution and
supersedes the specialized accounting guidance provided in SFAS 72, Accounting
for Certain Acquisitions of Banking or Thrift Institutions. SFAS 147 became
effective upon issuance and requires companies to cease amortization of
unidentified intangible assets associated with certain branch acquisitions and
reclassify these assets to goodwill. SFAS 147 also modifies SFAS 144 to include
in its scope long-term customer-relationship intangible assets and thus subject
those intangible assets to the same undiscounted cash flow recoverability test
and impairment loss recognition and measurement provisions required for other
long-lived assets.
While SFAS 147 may affect how future business combinations, if undertaken, are
accounted for and disclosed in the financial statements, the issuance of the new
guidance had no effect on results of operations, financial position, or
liquidity because Citizens does not have any assets subject to the specialized
accounting guidance provided in SFAS 72 or SFAS 147.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES: SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities, was issued in
July 2002 and becomes effective for Citizens beginning January 1, 2003. This
statement requires a cost associated with an exit or disposal activity, such as
the sale or termination of a line of business, the closure of business
activities in a particular location, or a change in management structure, to be
recorded as a liability at fair value when it becomes probable the cost will be
incurred and no future economic benefit will be gained by the company for such
cost. Applicable costs include employee termination benefits, contract
termination costs, and costs to consolidate facilities or relocate employees.
SFAS 146 supersedes EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity, which in some
cases required certain costs to be recognized before a liability was actually
incurred. The adoption of this standard is not expected to have a material
impact on results of operations, financial position, or liquidity.
RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO.
13, AND TECHNICAL CORRECTIONS (SFAS 145): In April 2002, the FASB issued SFAS
145, which updates, clarifies, and simplifies certain existing accounting
pronouncements beginning at various dates in 2002 and 2003. The statement
rescinds SFAS 4 and SFAS 64, which required net gains or losses from the
extinguishment of debt to be classified as an extraordinary item in the income
statement. These gains and losses will now be classified as extraordinary only
if they meet the criteria for such classification as outlined in APB Opinion 30,
which allows for extraordinary treatment if the item is material and both
unusual and infrequent in nature. The statement also rescinds SFAS 44 related to
the accounting for intangible assets for motor carriers and amends SFAS 13 to
require certain lease modifications that have economic effects similar to
sale-leaseback transactions to be accounted for as such. The changes required by
SFAS 145 are not expected to have a material impact on results of operations,
financial position, or liquidity.
ACCOUNTING FOR LONG-LIVED ASSETS: SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, was issued in October 2001 and addresses how and
when to measure impairment on long-lived assets and how to account for
67
long-lived assets that an entity plans to dispose of either through sale,
abandonment, exchange, or distribution to owners. The statement's provisions
supersede SFAS 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of, which addressed asset impairment, and
certain provisions of APB Opinion 30 related to reporting the effects of the
disposal of a business segment and requires expected future operating losses
from discontinued operations to be recorded in the period in which the losses
are incurred rather than the measurement date. Under SFAS 144, more dispositions
may qualify for discontinued operations treatment in the income statement. The
provisions of SFAS 144 became effective for Citizens on January 1, 2002, and did
not have a material impact on results of operations, financial position, or
liquidity.
ASSET RETIREMENT OBLIGATIONS: In August 2001, the FASB issued SFAS 143,
Accounting for Asset Retirement Obligations. SFAS 143 requires an entity to
record a liability for an obligation associated with the retirement of an asset
at the time the liability is incurred by capitalizing the cost as part of the
carrying value of the related asset and depreciating it over the remaining
useful life of that asset. The standard is effective for Citizens beginning
January 1, 2003, and its adoption is not expected to have a material impact on
results of operations, financial position, or liquidity.
GOODWILL AND OTHER INTANGIBLE ASSETS: On January 1, 2002, Citizens adopted SFAS
142, Goodwill and Other Intangible Assets, which addresses the accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
Opinion 17, Intangible Assets. Notes 1 and 7 provide further detail on the
accounting for goodwill and intangible assets under the standard and the impact
of the adoption on the financial statements. The standard's adoption had no
impact on liquidity but reduced goodwill amortization by $7.2 million ($5.5
million after tax) in 2002 from the prior year.
68
NOTE 3. ACQUISITIONS AND DIVESTITURE
In November 2001, Citizens sold F&M Bank-Minnesota with assets of $27 million.
The bank was Citizens' sole location in Minnesota.
On May 12, 2000, Citizens purchased three Jackson, Michigan offices of Great
Lakes National Bank. The purchase added approximately $31 million in deposits,
for which Citizens paid a premium of $3.9 million. On October 8, 1999, Citizens
acquired seventeen offices of Bank One located in the northern section of
Michigan's Lower Peninsula. This purchase added approximately $88 million in
loans and $442 million in deposits, for which Citizens paid a premium of $36.1
million or 10.13% of certain core deposits. These transactions were accounted
for as purchases; accordingly, the financial statements include their results of
operations only since the acquisition dates.
NOTE 4. BUSINESS RESTRUCTURING, MERGER AND OTHER CHARGES
In the third quarter of 2002, Citizens recorded a charge of $13.8 million ($9.0
million after-tax) for restructuring, impairment and other costs associated with
reorganization of Citizens' consumer, business and wealth management lines of
business. In December, the charge was reduced to $13.4 million as Citizens
reversed $404,600 of employee benefits and severance, professional fees and
lease termination fees included in the original charge that were no longer
expected to be paid. The charge was recorded as a separate component of
noninterest expense and identified as the "special charge."
The reorganization was the result of a detailed review of Citizens' consumer
banking, business banking and wealth management areas by banking industry
consultants and key members of management during the second and third quarters
of this year. This review revealed opportunities for process change, staff
reassignment, reporting structure changes, branch closures, expense reduction
and business growth. As a result of the reorganization, we displaced 157
employees. In the fourth quarter of 2002, 128 of these employees were released
of whom seventeen were subsequently rehired for other available positions. The
remaining employees will be released during the first half of 2003. Displaced
employees are offered severance packages and outplacement assistance. Twelve
banking offices were closed in the fourth quarter of 2002 and six additional
offices were identified for closure during the first half of 2003. The following
provides details on the special charge recorded and presents the activity in the
related liability during 2002.
- ------------------------------------------------------------------------------------------------------------
Beginning Reserve
Reserve/ Balance
Special Cash Noncash December 31,
(in thousands) Charge Payments Charges(1) 2002
- ------------------------------------------------------------------------------------------------------------
Employee benefits and severance $ 8,072 $ 3,433 $ 358 $ 4,281
Professional fees 2,369 1,899 62 408
Facilities and lease impairment 2,358 77 1,959 322
Contract termination fees and write-off of
obsolete equipment, software and supplies 1,008 725 101 182
-------- -------- -------- --------
Total $ 13,807 $ 6,134 $ 2,480 $ 5,193
======== ======== ======== ========
===========================================================================================================
(1)Include a reserve accrual reversal of $404,600 primarily for employee
benefits and severance, and professional fees
During 2000, conversion and integration efforts resulting from our merger, in
November 1999, with F&M Bancorporation, Inc. (F&M) were completed. Net costs of
$12.3 million ($7.4 million after-tax) incurred to complete these efforts
(including system conversions, business unit integration, branch closures and
other items) were recorded in noninterest expense as a special charge. The net
costs included reversals of prior year business restructuring reserves of $6.2
million, pre-tax, due to successful settlement of a contract with a former
vendor of F&M and favorable experience in employee separations.
In the fourth quarter of 2000, Citizens recorded an additional pre-tax charge of
$3.2 million ($2.1 million after-tax) for restructuring costs of $2.0 million
and asset impairment and other charges of $1.2 million associated with new
corporate
69
and organizational re-engineering initiatives. The restructuring plans included
reorganization of Citizens' trust and investment management business into one
nationally chartered trust bank, streamlining of the Company's community bank
organizational structure, consolidation of its direct and indirect lending
operations, and exiting of certain unprofitable indirect lending dealer
relationships. These initiatives were also completed by year-end 2001
At year-end 2001, our special charge reserves from the 1999 merger as well as
the fourth quarter 2000 initiatives were fully utilized. Total deductions to the
special charge reserve were $3.3 million in 2001 and $16.0 million in 2000.
Included in these deductions were cash payments of $3.3 million and $9.7 million
in 2001 and 2000, respectively
The components of the special charge recorded in noninterest expense in 2000 are
as follows:
- --------------------------------------------------------------------------------
(in thousands) 2000
- --------------------------------------------------------------------------------
MERGER, RESTRUCTURING & OTHER COSTS RELATED TO
1999 ACQUISITION & STRATEGIC INITIATIVES APPROVED IN 1999
Employee salaries, benefits and severence $ 2,098
Contract termination and other conversion costs 9,981
Professional fees 477
Other merger integration costs 3,838
Asset impairment and other writeoffs:
Facilities and equipment 1,207
Other writeoffs 982
Changes in 1999 reserve estimates:
Contract settlement less than amount accrued (3,900)
Changes in benefits and severence estimates (2,324)
---------
Subtotal 12,359
ADDITIONAL RESTRUCTURING & OTHER COSTS FOR
STATEGIC INITIATIVES APPROVED IN 2000
Employee benefits and severence 1,962
Software & equipment writeoffs 654
Professional fees 463
Other 103
---------
Subtotal 3,182
---------
Total $ 15,541
=========
================================================================================
NOTE 5. INVESTMENT SECURITIES
The amortized cost, estimated fair value and gross unrealized gains and losses
of investment securities follow:
70
- --------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002 December 31, 2001
-------------------------------------------------- -------------------------------------------
ESTIMATED GROSS UNREALIZED Estimated Gross Unrealized
AMORTIZED FAIR ----------------- Amortized Fair ----------------
(in thousands) COST VALUE GAINS LOSSES Cost Value Gains Losses
- --------------------------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE:
U.S. Treasury $ 5,978 $ 6,135 $ 157 $ --- $ 7,949 $ 8,163 $ 214 $ ---
Federal agencies:
Mortgage-backed 762,733 787,821 25,281 193 551,377 565,393 14,714 698
Other 135,436 148,687 13,251 --- 157,921 166,236 8,316 1
State and municipal 417,549 444,951 27,670 268 432,425 443,956 13,378 1,847
Mortgage and asset-backed 6,228 6,452 236 12 10,448 10,558 1 70 60
Other 63,165 63,235 70 --- 65,110 65,200 90 ---
----------- ---------- -------- -------- ----------- ----------- -------- ------
Total available for sale $ 1,391,089 $1,457,281 $ 66,665 $ 473 $ 1,225,230 $ 1,259,506 $ 36,882 $2,606
=========== ========== ======== ======== =========== =========== ======== ======
================================================================================================================================
The amortized cost and estimated fair value of debt securities by contractual
maturity at December 31, 2002 are shown below.
- --------------------------------------------------------------------------------
Estimated
Amortized Fair
(in thousands) Cost Value
- --------------------------------------------------------------------------------
Due within one year $ 44,505 $ 39,849
One to five years 170,851 190,069
Five to ten years 204,789 222,290
After ten years 139,168 147,917
----------- -----------
559,313 600,125
Equity securities 62,816 62,883
Mortgage and asset-backed securities 768,960 794,273
----------- -----------
Total $ 1,391,089 $ 1,457,281
=========== ===========
================================================================================
Sales of investment securities resulted in realized gains and losses as follows:
- --------------------------------------------------
Year Ended December 31,
(in thousands) 2002 2001 2000
- --------------------------------------------------
Securities gains $ 2,527 $ 6,202 $ 67
Securities losses (91) (7) (67)
------- -------- ----
Net gain $ 2,436 $ 6,195 $---
======= ======== ====
=================================================
Securities with amortized cost of $775.2 million at December 31, 2002, and
$799.3 million at December 31, 2001, were pledged to secure public deposits,
repurchase agreements, and other liabilities. Except for obligations of the U.S.
Government and its agencies, no holdings of securities of any single issuer
exceeded 10% of consolidated shareholders' equity at December 31, 2002 or 2001.
NOTE 6. LOANS AND NONPERFORMING ASSETS
Citizens extends credit primarily within the Midwestern states of Michigan,
Wisconsin, Illinois and Iowa. In Michigan the primary market includes most parts
of the Lower Peninsula. In Wisconsin the primary market area is the Fox Valley
71
region extending from Green Bay to Appleton to Oshkosh as well as northeastern
and southwestern Wisconsin. Other primary market areas are central Iowa and the
western suburban market of Chicago, Illinois. Citizens seeks to limit its credit
risk by establishing guidelines to review its aggregate outstanding commitments
and loans to particular borrowers, industries and geographic areas. Collateral
is secured based on the nature of the credit and management's credit assessment
of the customer.
Citizens' loan portfolio is widely diversified by borrowers with no
concentration within a single industry that exceeds 10% of total loans. Citizens
does not have any loans to foreign debtors and generally does not purchase
nationally syndicated loans or participate in highly leveraged transactions.
Approximately one-half of Citizens' commercial real estate loans consist of
mortgages on owner-occupied properties. Those borrowers are involved in business
activities other than real estate, and the sources of repayment are not
dependent on the performance of the real estate market.
72
A summary of nonperforming assets follows:
- --------------------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- --------------------------------------------------------------------------
Nonperforming loans:
Nonaccrual $ 86,717 $ 68,793
Loans 9 days past due (still accruing) 860 4,168
Restructured --- 337
-------- --------
Total nonperforming loans 87,577 73,298
Other real estate 6,599 4,463
Other assets acquired by repossession 1,495 1,484
-------- --------
Total nonperforming assets $ 95,671 $ 79,245
======== ========
==========================================================================
The effect of nonperforming loans on interest income follows:
- -------------------------------------------------------------------------
Year Ended December 31,
(in thousands 2002 2001 2000
- -------------------------------------------------------------------------
Interest income:
At original contract rates $ 7,721 $ 6,392 $ 4,953
As actually recognized 4,685 3,344 3,045
-------- -------- --------
Interest foregone $ 3,036 $ 3,048 $ 1,908
======== ======== ========
=========================================================================
There are no significant commitments outstanding to lend additional funds to
clients whose loans were classified as nonaccrual or restructured at December
31, 2002.
A summary of impaired loans and their effect on interest income follows:
- --------------------------------------------------------------------------------------------
Valuation Reserve
-----------------
(in thousands) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------
Balances - December 31
Impaired loans with valuation reserve $ 41,240 $ 39,795 $ 13,338 $ 10,373
Impaired loans with no valuation reserve 35,272 22,256 --- ---
-------- -------- -------- --------
Total impaired loans $ 76,512 $ 62,051 $ 13,338 $ 10,373
======== ======== ======== ========
Impaired loans on nonaccrual basis $ 70,345 $ 43,549 $ 8,690 $ 5,838
Impaired loans on accrual basis 6,167 18,502 4,648 4,535
-------- -------- -------- --------
Total impaired loans $ 76,512 $ 62,051 $ 13,338 $ 10,373
======== ======== ======== ========
Average balance for the year $ 80,487 $ 77,995
Interest income recognized for the year 1,376 3,273
Cash collected applied to outstanding principal 4,415 3,118
- --------------------------------------------------------------------------------------------
Certain directors and executive officers of Citizens and its significant
subsidiaries, including their families and entities in which they have 10% or
more ownership, were clients of the banking subsidiaries. Total loans to these
clients aggregated $3.4 million and $13.2 million at December 31, 2002 and 2001,
respectively. During 2002, new loans of $0.6 million were made and repayments
totaled $10.4 million. Substantially all such loans were made in the ordinary
73
course of business on substantially the same terms, including interest rates and
collateral, as those for comparable transactions with unrelated parties and did
not involve more than normal risk of collectibility.
The consolidated financial statements do not include loans serviced for others,
which totaled $159.8 million and $257.9 million at December 31, 2002 and 2001,
respectively. The carrying value of mortgage servicing rights approximates fair
value at December 31, 2002 and 2001.
Changes in originated mortgage servicing rights for the years ended December 31
were as follows:
- ------------------------------------------------------------
(in thousands) 2002 2001
- ------------------------------------------------------------
Balance - January 1 $ 1,733 $ 2,680
Mortgage servicing rights capitalized --- ---
Amortization (1,051) (947)
Impairment loss (250) ---
------- --------
Balance - December 31 $ 432 $ 1,733
======= ========
============================================================
The valuation reserve for impairment of mortgage servicing rights was $510
million and $260 million at December 31, 2002 and 2001, respectively.
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002 Citizens adopted SFAS 142 which changed the accounting for
intangible assets. Upon adoption, Citizens ceased amortizing its goodwill, which
decreased noninterest expense and increased net income in 2002 as compared to
2001 and 2000. The following table shows the pro forma effects of applying SFAS
142 to the 2001 and 2000 periods.
- --------------------------------------------------------------------------------------------------------
2002 2001 2000
-------------------- -------------------- -------------------
(in thousands, except Net Earnings Net Earnings Net Earnings
per share amounts) Income Per Share Income Per Share Income Per Share
- --------------------------------------------------------------------------------------------------------
Diluted earnings per
common share computation:
Net income/diluted EPS as reported $ 25,038 $ 0.56 $104,657 $ 2.25 $90,660 $ 1.91
Add back: Goodwill amortization,
net of tax effect --- --- 5,545 0.12 5,482 0.12
-------- ------- -------- ------ ------- ------
Adjusted net income/diluted EPS $ 25,038 $ 0.56 $110,202 $ 2.37 $96,142 $ 2.03
======== ======= ======== ====== ======= ======
========================================================================================================
SFAS 142 requires that goodwill be tested for impairment at adoption and at
least annually thereafter. Citizens completed it's transitional impairment
testing in June 2002 and no impairment under SFAS 142 was identified. A summary
of goodwill allocated to Citizens' lines of business as of December 31, 2002
follows.
- --------------------------------------------------
December 31,
(in thousands) 2002
- --------------------------------------------------
Business Banking $ 23,982
Consumer Banking 29,002
Wealth Management 1,801
Other ---
--------
Total Goodwill $ 54,785
========
==================================================
74
No changes in the carrying amount of goodwill were recorded during 2002.
Citizens' other intangible assets are shown in the table below.
- -----------------------------------------------------
December 31,
(in thousands) 2002 2001
- -----------------------------------------------------
Core deposit intangibles $ 28,989 $ 28,989
Accumulated amortization 9,160 6,261
-------- --------
Net core deposit intangibles 19,829 22,728
Minimum pension liability 33 3,304
-------- --------
Total other intangibles $ 19,862 $ 26,032
======== ========
=====================================================
The estimated annual amortization expense for core deposit intangibles for each
of the next five years is $2.9 million. As part of adopting SFAS 142, Citizens
has had no material reclassifications or adjustments to the useful lives of
finite-lived (core deposit) intangible assets.
NOTE 8. ALLOWANCE FOR LOAN LOSSES
A summary of changes in the allowance for loan losses follows:
- ---------------------------------------------------------------------------
(in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------
Balance - January 1 $ 80,299 $ 80,070 $ 76,397
Allowance of sold banks and branches --- (240) ---
Provision for loan losses 120,200 26,407 20,983
Charge-offs (101,704) (32,732) (25,448)
Recoveries 10,672 6,794 8,138
--------- -------- --------
Net charge-offs (91,032) (25,938) (17,310)
--------- -------- --------
Balance - December 31 $ 109,467 $ 80,299 $ 80,070
========= ======== ========
===========================================================================
NOTE 9. PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
- ---------------------------------------------------------------------
December 31,
(in thousands) 2002 2001
- ---------------------------------------------------------------------
Land $ 21,115 $ 21,806
Buildings 145,511 146,775
Leasehold improvements 5,544 5,750
Furniture and equipment 124,450 124,939
---------- ---------
296,620 299,270
Accumulated depreciation and amortization (178,916) (170,465)
---------- ---------
Total $ 117,704 $ 128,805
========== =========
=====================================================================
Certain branch facilities and equipment are leased under various operating
leases. Total rental expense, including expenses related to these operating
leases, was $4.5 million in 2002, $4.8 million in 2001 and $4.8 million in 2000.
Future minimum rental commitments under non-cancelable operating leases are as
follows at December 31, 2002: $3.6 million in 2003, $1.8 million in 2004, $1.3
million in 2005, $0.8 million in 2006, $0.4 million in 2007, and $1.9 million
after 2007.
75
NOTE 10. DEPOSITS
A summary of deposits follows:
- --------------------------------------------------------
December 31,
(in thousands) 2002 2001
- --------------------------------------------------------
Noninterest-bearing demand $ 900,674 $ 903,900
Interest-bearing demand 1,307,524 995,191
Savings 1,358,042 1,411,429
Time deposits over $100,000 677,628 818,375
Other time deposits 1,693,045 1,836,231
---------- ----------
Total $5,936,913 $5,965,126
========== ==========
========================================================
Excluded from total deposits are demand deposit account overdrafts, which have
been reclassified as loans. At December 31, 2002 and 2001, these overdrafts
totaled $5.4 million and $5.6 million, respectively. Time deposits with
remaining maturities of one year or more are $840.1 million at December 31,
2002. The maturities of these time deposits are as follows: $561.9 million in
2004, $187.4 million in 2005, $70.3 million in 2006, $12.4 million in 2007 and
$8.1 million after 2007.
NOTE 11. SHORT-TERM BORROWINGS
Short-term borrowings consist of federal funds purchased and securities sold
under agreements to repurchase, Federal Home Loan Bank (FHLB) borrowings, other
bank borrowings, and demand notes to the U.S. Treasury. Federal funds purchased
are overnight borrowings from other financial institutions. Securities sold
under agreements to repurchase are secured transactions done principally with
clients and generally mature within thirty days.
Information relating to federal funds purchased and securities sold under
agreements to repurchase follows:
- -----------------------------------------------------------------------------
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------
At December 31:
Balance $ 223,289 $ 233,077 $ 394,466
Weighted average interest rate paid 1.29% 1.81% 6.35%
During the year:
Maximum outstanding at any month-end $ 281,676 $ 354,612 $ 540,652
Daily average 195,983 242,945 305,402
Weighted average interest rate paid 1.51% 4.32% 6.18%
=============================================================================
Citizens did have any significant short-term borrowings with the FHLB in 2002.
In 2001 and 2000 a significant amount of short-term borrowings consisted of FHLB
advances and lines of credit to Citizens' subsidiary banks. Information relating
to short-term FHLB borrowings in 2001 and 2000 follows:
- ----------------------------------------------------------------
(in thousands) 2001 2000
- ----------------------------------------------------------------
At December 31:
Balance $ --- $ 450,074
Weighted average interest rate paid --- 6.54%
During the year:
Maximum outstanding at any month-end $425,200 $ 622,874
Daily average 222,310 581,467
Weighted average interest rate paid 6.25% 6.47%
================================================================
76
Citizens' parent company maintains a short-term line of credit with three
unaffiliated banks totaling $75 million. The interest rate on the outstanding
balance of $30 million, at December 31, 2002, reprices daily and is based upon
the federal funds rate plus 75 basis points. Interest is payable monthly and the
line of credit matures in August 2003. The parent company services the debt's
principal and interest payments with dividends from the subsidiary banks. The
agreement also requires Citizens to maintain certain financial covenants.
Citizens is in full compliance with all debt covenants as of December 31, 2002.
On January 27, 2003, Citizens issued $125 million of 5.75% subordinated notes
due in 2013. This new long-term funding allowed us to reduce the amount
outstanding under the short-term credit facility to zero.
NOTE 12. LONG-TERM DEBT
A summary of long-term debt follows:
- --------------------------------------------------
December 31,
(in thousands) 2002 2001
- --------------------------------------------------
CITIZENS SUBSIDIARIES:
FHLB Notes $ 599,139 $ 628,818
Other 174 281
--------- ---------
Total long-term debt $ 599,313 $ 629,099
========= =========
==================================================
Long-term advances from the FHLB are at fixed and variable rates ranging from
1.34% to 7.10% and have original maturities ranging from two to seventeen years.
The majority of the fixed rate FHLB advances are convertible to a floating rate
at the option of the Federal Home Loan Bank. Interest is paid monthly. At
December 31, 2002 and 2001, qualifying mortgage loans of $699 million and $899
million, respectively, as well as FHLB stock collateralized long-term advances
from the FHLB.
Maturities of long-term debt during the next five years follow:
- -----------------------------------
(in thousands)
- -----------------------------------
2003 $ 26,282
2004 51,019
2005 190,856
2006 1,076
2007 25,938
Over 5 Years 304,142
--------
Total $599,313
========
===================================
NOTE 13. EMPLOYEE BENEFIT PLANS
PENSION AND POSTRETIREMENT BENEFITS: Citizens maintains cash balance defined
benefit pension plans covering the majority of its employees, and postretirement
benefit plans for retirees that include health care benefits and life insurance
coverage. Pension retirement benefits are based on the employee's length of
service and salary levels. Actuarially determined pension costs are charged to
current operations. It is Citizens' policy to fund pension costs in an amount
sufficient to meet or exceed the minimum funding requirements of applicable laws
and regulations, plus such additional amounts as Citizens deems appropriate up
to that allowable by federal tax regulations.
Citizens also maintains nonqualified supplemental benefit plans for certain key
employees. These plans are provided for by charges to earnings sufficient to
meet the projected benefit obligation. The defined pension benefits provided
under these plans are unfunded and any payments to plan participants are made by
Citizens. As part of the third quarter 2002
77
restructuring initiatives, Citizens recognized a curtailment related to the
termination of certain officers employment earlier than expected. The
curtailment caused a charge of $891,870 for accelerated recognition of their
prior service cost bases.
Effective January 1, 2002 the defined benefit plan for Citizens' Michigan and
Illinois employees (CBC Plan) was amended to provide for a new cash balance
pension benefit. This amendment increased the projected benefit obligation of
the CBC Plan at December 31, 2001 by $1.1 million. Full-time employees that
retire within the next five years with at least 10 years of service under the
CBC Plan may elect to receive a benefit under the old formula, which is, in
part, based on the employees' final five-year average base pay. The defined
benefit plan established for Citizens' F&M employees in 2000 also provides for a
cash balance pension benefit.
Citizens' postretirement benefit plan, as amended, is available to full-time
employees who retire at normal retirement age, were age 50 prior to January 1,
1993 and have at least 15 years of credited service under Citizens' defined
benefit pension plan. The medical portion of the plan is contributory to the
participants. The life insurance coverage is noncontributory and provided on a
reducing basis for 5 years. Those retired prior to January 1, 1993 receive
benefits provided by the plan prior to its amendment. That plan included dental
care, had some retiree contribution requirements, and had less restrictive
eligibility requirements.
The components of net periodic benefit cost charged to operations each year for
all plans follow:
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------
DEFINED BENEFIT PENSION PLANS
Service cost $ 3,893 $ 2,988 $ 2,922
Interest cost 5,095 4,878 4,420
Expected return on plan assets (6,837) (6,873) (6,568)
Curtailment loss 892
Amortization of unrecognized:
Net transition asset (18) (123) (218)
Prior service cost 728 626 180
Net actuarial gain (loss) 6 (586) (808)
------- ------- -------
Net pension cost (income) 3,759 910 (72)
------- ------- -------
POSTRETIREMENT BENEFIT PLANS
Service cost 8 12 12
Interest cost 1,249 1,148 1,094
Amortization of unrecognized:
Prior service cost (4) (5) (385)
Net actuarial loss 120 -- --
------- ------- -------
Net postretirement benefit cost 1,373 1,155 721
------- ------- -------
DEFINED CONTRIBUTION RETIREMENT AND 401(k) PLANS
Employer contributions 3,271 2,850 3,584
------- ------- -------
Total periodic benefit cost $ 8,403 $ 4,915 $ 4,233
======= ======= =======
===================================================================================
78
The following information summarizes activity in Citizens' pension and
postretirement benefit plans.
Pension Postretirement
Benefits Benefits
--------------------------------------------
(in thousands) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year $ 73,530 $ 63,825 $ 15,714 $ 15,613
Service cost 3,893 2,988 8 12
Interest cost 5,095 4,878 1,249 1,148
Participant contribution -- -- 779 304
Actuarial (gains) losses 4,698 3,916 2,702 160
Plan amendments -- 1,123 -- --
Benefits paid (5,788) (3,200) (1,950) (1,523)
-------- -------- -------- --------
Benefit obligation, end of year $ 81,428 $ 73,530 $ 18,502 $ 15,714
======== ======== ======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year $ 63,127 $ 69,036 $ -- $ --
Actual return on plan assets (6,951) (3,813) -- --
Employer contribution 24,780 1,439 1,171 1,219
Participant contribution -- -- 779 304
Expenses paid (241) (335) -- --
Benefits paid (5,788) (3,200) (1,950) (1,523)
-------- -------- -------- --------
Fair value of plan assets, end of year $ 74,927 $ 63,127 $ -- $ --
======== ======== ======== ========
RECONCILIATION OF FUNDED STATUS
(Under)/Over funded $ (6,501) $(10,403) $(18,502) $(15,714)
Unrecognized:
Net transition asset - 16 yr amortization (24) (42) -- --
Prior service cost (benefit) 1,785 3,404 (33) (37)
Net actuarial (gain) loss 22,724 4,001 3,510 930
Adjustment to recognize minimum liability -- (5,961) -- --
-------- -------- -------- --------
Net amount recognized in the
consolidated balance sheets $ 17,984 $ (9,001) $(15,025) $(14,821)
======== ======== ======== ========
================================================================================================
The assumptions used in determining the actuarial present value of the benefit
obligations and the net periodic pension expense follow:
Pension Postretirement
Benefits Benefits
----------------- --------------
2002 2001 2002 2001
- ----------------------------------------------------------------------------------
WEIGHTED-AVERAGE ASSUMPTIONS - DECEMBER 31
Discount rate 6.50% 7.25% 6.50% 7.25%
Expected return on plan assets 9.25 9.75 -- --
Rate of compensation increase: -- --
Cash balance defined benefit plans (1) (1)
Nonqualified supplemental benefit plans 5.00% 5.0-5.5%
=================================================================================
(1) Scaled by age of plan participant - 9.0% at age 24 or under declining to
4.0% at age 50 or older.
Pension plan assets consisted primarily of mutual and money market funds, and
listed bonds and equity securities, including $517,000 and $686,000 of Citizens
common stock at December 31, 2002 and 2001, respectively.
79
Except for the F&M cash balance plan in 2002, accumulated plan benefits exceeded
plan assets for all plans in both 2002 and 2001. The projected benefit
obligation, accumulated benefit obligation and plan assets for the F&M plan at
December 31, 2002 was $9.1, $9.0 million and $9.3 million, respectively.
Prior service pension costs are amortized on a straight-line basis over the
average remaining service period of employees expected to receive benefits under
the plans. For postretirement health care benefit plans, Citizens assumed a
constant 5% annual health care cost trend rate in 2002 and for all future years.
This assumption can have a significant effect on the amounts reported. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:
One Percentage One Percentage
(in thousands) Point Increase Point Decrease
- ------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 107 $ (95)
Effect on the postretirement benefit obligation 1,486 (1,312)
==========================================================================================
DEFINED CONTRIBUTION SAVINGS AND RETIREMENT PLANS: Substantially all employees
are eligible to contribute a portion of their pre-tax salary to a defined
contribution 401(k) savings plan. Under the plan, employee contributions are
partially matched by Citizens. The employer matching contribution is 75 percent
of the first 6% (100 percent of the first 3% plus 50 percent of the next 3%) of
each eligible employee's qualifying salary contributed to the plan. In addition,
one third of these matching contributions are used to fund a postretirement
medical savings account established within the plan for each contributing
employee. Plan assets from a defined contribution 401(k) savings plan and an
Employee Stock Ownership Plan maintained by F&M and one of its subsidiaries
prior to the 1999 merger were transferred into Citizens' plan during 2000.
Employer matching contributions for the F&M 401(k) savings plan were based on
the company's return on equity and incorporated a discretionary profit-sharing
contribution.
NOTE 14. INCOME TAXES
Significant components of income taxes are as follows:
Year Ended December 31,
(in thousands) 2002 2001 2000
- ----------------------------------------------------------------
Current tax expense:
Federal $ 3,676 $ 42,926 $ 31,773
State 371 568 455
-------- -------- --------
Total current tax expense 4,047 43,494 32,228
Deferred tax expense (credit) (5,110) (279) 3,585
-------- -------- --------
Total income tax expense $ (1,063) $ 43,215 $ 35,813
======== ======== ========
================================================================
80
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
Citizens' deferred tax assets and liabilities as of December 31, 2002 and 2001
follow:
(in thousands) 2002 2001
- ---------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $40,629 $29,349
Accrued postemployment benefits other than pensions 5,359 5,288
Alternative minimum tax 3,257 --
Accrued special charges 1,898 --
Other deferred tax assets 6,908 9,366
------- -------
Deferred tax assets 58,051 44,003
------- -------
Deferred tax liabilities:
Pension 8,414 --
Acquisition premium on loans 5,156 4,027
Tax over book depreciation 3,353 4,212
Net unrealized gains on securities 22,963 11,067
Other deferred tax liabilities 4,203 3,949
------- -------
Deferred tax liabilities 44,089 23,255
------- -------
Net deferred tax assets $13,962 $20,748
======= =======
===========================================================================
A reconciliation of income tax expense to the amount computed by applying the
federal statutory rate of 35% to income before income taxes follows:
Year Ended December 31,
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Tax at federal statutory rate applied to income before income taxes $ 8,391 $ 51,755 $ 44,266
Increase (decrease) in taxes resulting from:
Tax-exempt interest (8,623) (8,793) (8,229)
Other (831) 253 (224)
-------- -------- --------
Total income tax expense $ (1,063) $ 43,215 $ 35,813
======== ======== ========
=======================================================================================================
81
NOTE 15. EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations follows:
Year Ended December 31,
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------
NUMERATOR:
Numerator for basic and dilutive earnings per share --
net income available to common shareholders $ 25,038 $104,657 $ 90,660
======== ======== ========
DENOMINATOR:
Denominator for basic earnings per share --
weighted average shares 44,657 46,085 47,310
Effect of dilutive securities -- potential conversion
of employee stock options 420 505 233
-------- -------- --------
Denominator for diluted earnings per share --
adjusted weighted-average shares and assumed 45,077 46,590 47,543
======== ======== ========
BASIC EARNINGS PER SHARE $ 0.56 $ 2.27 $ 1.92
======== ======== ========
DILUTED EARNINGS PER SHARE $ 0.56 $ 2.25 $ 1.91
======== ======== ========
===========================================================================================
Basic net income per share is calculated by dividing net income by the
weighted-average number of shares outstanding for the period. Diluted net income
per share takes into consideration the pro forma dilution assuming all
in-the-money outstanding stock options were exercised. The average price of
Citizens' stock for the period is used to determine the dilutive effect of
outstanding stock options. See Note 16 for additional disclosures regarding
employee stock options.
NOTE 16. SHAREHOLDERS' EQUITY
RIGHTS AGREEMENT: Citizens is a party to a Rights Agreement, dated May 23, 2000,
designed to protect shareholders from unfair takeover offers by encouraging a
potential buyer to negotiate with Citizens' board prior to attempting a
takeover. Owners of Citizens' common shares have been granted rights under the
Rights Agreement to purchase one one-thousandth of a share of Series B Preferred
Stock at an exercise price of $65, subject to adjustment. The rights are not
exercisable or separately tradable until after a public announcement that a
person or group, without board approval, has acquired 15% or more of Citizens'
common shares or has commenced a tender offer to do so. If a person or group
acquires 15% or more of the common shares, the rights (other than those held by
the acquiror, which become void) become exercisable to purchase common shares
having a fair value of $130 for $65, or the board may exchange one common share
for each outstanding right (other than those held by the acquiror). If the
acquiror merges Citizens into another entity, the rights become exercisable for
common shares of the surviving entity having a fair value of $130 for $65. The
rights are redeemable by the board at any time prior to May 23, 2010 for $.001
per right. The Rights Agreement may be amended by the board without shareholder
or right holder approval at any time prior to the acquisition by a person or
group of 15% or more of the common shares. The rights will cause substantial
dilution to a person or group attempting to acquire Citizens without action by
Citizens' board to deactivate the rights.
STOCK REPURCHASE PLANS: Citizens purchased shares under a stock repurchase
program initiated October 2001. This program authorizes Citizens to purchase up
to 3,000,000 shares for treasury. During the year, 1,746,900 shares were
purchased under this plan at an average price of $28.79. As of December 31,
2002, there were 1,065,400 shares available for purchase under the program. The
treasury shares have been accorded the accounting treatment as if retired.
STOCK OPTION PLAN: Citizens' Stock Compensation plan, effective January 18, 2002
and approved by shareholders on April 16, 2002, authorizes the granting of
incentive and nonqualified stock options, restricted stock, restricted stock
units and performance awards to employees and non-employee directors at any time
prior to January 18, 2012. Aggregate grants under the plan may not exceed
7,000,000 shares, and grants other than stock options are further limited to
82
2,000,000 shares. The plan replaces the option plan for key employees that
expired January 16, 2002 and the Stock Option Plan for Directors, which was
terminated.
Options granted to employees expire ten years from the date of grant. Options
granted before the fourth quarter of 2002 are vested five years from the grant
date, but may vest sooner based on Citizens' achievement of certain earnings per
share targets. For options granted in the fourth quarter of 2002, the vesting
is 20% on each of the first five grant date anniversaries. At December 31,
2002, options outstanding under the plan to employees (including those issued
under the expired plan) totaled 2,976,729 shares of which 1,186,414 shares are
currently vested and exercisable. Canceled or expired options become available
for future grants.
Options granted to directors expire five years from the date of grant and are
fully vested six months from the grant date. At year-end, options outstanding to
directors (including those issued under the terminated plan) totaled 79,500
shares.
OTHER STOCK OPTIONS: On May 18, 2000, Citizens granted stock options to all
employees who did not receive grants under the key employee stock option plan.
Each full-time employee received 200 shares and each part-time employee received
100 shares. The $16.66 exercise price of the grant was the market price of
Citizens' stock on the grant date. The options are exercisable subject to
Citizens achieving $2.65 earnings per share on a rolling four-quarter basis or
three years, whichever comes first. No shares of this option grant are yet
exercisable. The options expire ten years from the date of grant. A total of
550,700 shares were granted of which 341,500 shares were outstanding as of
December 31, 2002. In addition, there were also at year-end 36,438 shares of
stock options from a previous acquisition of a subsidiary.
Citizens has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options as permitted by Financial
Accounting Standards Board Statement No. 123, "Accounting for Stock-Based
Compensation." Under APB 25, no compensation expense is recognized by Citizens
because the exercise price of the stock options equals the market price of the
underlying stock on the date of grant.
Statement 123 requires certain pro forma disclosures regarding net income and
earnings per share as if Citizens had accounted for its stock options under the
fair value method of that statement. The following table provides these
disclosures along with significant assumptions used to estimate the fair value
of these options:
2002 2001 2000
- -----------------------------------------------------------------------------------------
Pro forma amounts:
Net income (in thousands) $ 22,637 $ 102,808 $ 89,020
Net income per share:
Basic 0.51 2.23 1.88
Diluted 0.50 2.21 1.87
Weighted-average assumptions:
Dividend yield 3.5% 3.5% 3.5%
Expected volatility 28.0% 28.0% 25.0%
Risk-free interest rate 4.18% 5.02% 6.80%
Expected lives 5 yrs. 5 yrs. 5 yrs.
=========================================================================================
The weighted average fair values of stock options granted during 2002, 2001 and
2000 were $6.75, $5.77 and $3.93, respectively.
83
A summary of stock option transactions under the plans for 2002, 2001 and 2000
follows:
Options Option Price
------------------------------ ----------------------------
Available Per Share
for Grant Outstanding Range Average
- ----------------------------------------------------------------------------------------------------------
January 1, 2000 620,697 2,266,497 $ 5.40-36.31 $ 23.22
Authorized 803,897 -- -- --
Granted (1,224,350) 1,224,350 16.66-16.91 16.67
Exercised -- (158,544) 5.40-21.83 12.32
Canceled 52,336 (141,299) 16.66-35.63 20.54
---------- --------- ------------- -----------
December 31, 2000 252,580 3,191,004 8.50-36.31 21.36
Authorized 566,858 -- -- --
Granted (651,200) 651,200 25.42-25.72 25.43
Exercised -- (591,602) 8.50-28.21 18.07
Canceled 117,277 (207,729) 16.66-36.31 20.45
---------- --------- ------------- -----------
December 31, 2001 285,515 3,042,873 11.75-36.31 22.94
OLD PLANS EXPIRED OR TERMINATED (285,515) -- -- --
NEW PLAN AUTHORIZED 7,000,000 -- -- --
GRANTED (901,200) 901,200 25.11-33.41 30.85
RESTRICTED STOCK GRANTED (25,000) -- -- --
EXERCISED -- (327,629) 11.77-30.50 20.13
CANCELED 24,500 (182,277) 16.66-36.31 23.08
---------- --------- ------------- -----------
DECEMBER 31, 2002 6,098,300 3,434,167 $ 11.75-36.31 $ 25.28
========== ========= ============= ===========
==========================================================================================================
The following table summarizes information on stock options outstanding as of
December 31, 2002:
Options Outstanding Options Exercisable
-------------------------------------------------- ------------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range Amount Life Exercise Price Amount Exercise Price
- -----------------------------------------------------------------------------------------------------------
$ 11.75 - 19.99 1,115,753 6.3 years $ 17.03 405,073 $ 17.68
20.00 - 29.99 1,060,677 7.8 24.89 396,248 23.64
30.00 - 36.31 1,257,737 7.2 32.91 501,031 33.62
--------- ---------
$ 11.75 - 36.31 3,434,167 7.1 25.28 1,302,352 25.63
========= =========
==========================================================================================================
84
NOTE 17. COMMITMENTS AND CONTINGENT LIABILITIES
The consolidated financial statements do not reflect various loan commitments
(unfunded loans and unused lines of credit) and letters of credit originated in
the normal course of business. Loan commitments are made to accommodate the
financial needs of clients. Generally, new loan commitments do not extend beyond
90 days and unused lines of credit are reviewed at least annually. Letters of
credit guarantee future payment of client financial obligations to third
parties. They are issued primarily for services provided or to facilitate the
shipment of goods, and generally expire within one year. Both arrangements have
essentially the same level of credit risk as that associated with extending
loans to clients and are subject to Citizens' normal credit policies. Inasmuch
as these arrangements generally have fixed expiration dates or other termination
clauses, most expire unfunded and do not necessarily represent future liquidity
requirements. Collateral is obtained based on management's assessment of the
client and may include receivables, inventories, real property and equipment.
Amounts available to clients under loan commitments and letters of credit
follow:
December 31,
(in thousands) 2002 2001
- ---------------------------------------------------------------------------
LOAN COMMITMENTS AND LETTERS OF CREDIT:
Commitments to extend credit $1,739,091 $1,683,239
Standby letters of credit 36,396 53,718
Commercial letters of credit 138,679 91,807
===========================================================================
Loan commitments outstanding include $71.1 million of credit card commitments
and $298.3 million of home equity credit lines in 2002. The same amounts for
2001 were $75.6 million and $263.2 million, respectively.
At December 31, 2002, Citizens also had outstanding mandatory forward
commitments to sell $175.5 million of residential mortgage loans which hedged
the year end balance of mortgage loans held for sale and our commitments to fund
residential mortgage loan applications with agreed upon rates. These outstanding
forward commitments to sell mortgage loans are expected to settle in the first
quarter of 2003 with no material gain or loss. Citizens' policy to hedge its
market rate risk with mandatory forward commitments has been highly effective
and has not generated any material gains or losses.
Citizens and its subsidiaries are parties to litigation arising in the ordinary
course of business. Management believes that the aggregate liability, if any,
resulting from these proceedings would not have a material effect on Citizens'
consolidated financial position or results of operations.
NOTE 18. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS 107, "Disclosure About Fair
Value of Financial Instruments". Where quoted market prices are not available,
as is the case for a significant portion of Citizens' financial instruments, the
fair values are based on estimates using present value or other valuation
techniques. These techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. Accordingly, the
derived fair value estimates presented herein cannot be substantiated by
comparison to independent markets and are not necessarily indicative of the
amounts Citizens could realize in a current market exchange.
In addition, the fair value estimates are based on existing on- and off-balance
sheet financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that are not
considered financial instruments. For example, Citizens has a substantial trust
department that contributes net fee income annually. The trust department is not
considered a financial instrument and its value has not been incorporated into
the fair value estimates. Other significant assets and liabilities that are not
considered financial assets or liabilities include Citizens' brokerage network,
net deferred tax asset, premises and equipment, goodwill and deposit based
intangibles. In addition, tax ramifications related to the recognition of
unrealized gains and losses such as those within the investment securities
portfolio can also have a significant effect on estimated fair values and have
not been
85
considered in the estimates. Accordingly, the aggregate fair value amounts do
not represent the underlying value of Citizens.
The estimated fair values of Citizens' financial instruments follow:
DECEMBER 31, 2002 December 31, 2001
-------------------------- --------------------------
CARRYING ESTIMATED Carrying Estimated
(in millions) AMOUNT FAIR VALUE Amount Fair Value
- ---------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and money market investments $ 243.2 $ 243.2 $ 228.8 $ 228.8
Investment securities 1,457.3 1,457.3 1,297.7 1,297.7
Net loans (1) 5,483.8 5,671.5 5,842.1 5,965.8
Financial liabilities:
Deposits 5,936.9 5,983.9 5,965.1 6,008.6
Short-term borrowings 302.4 302.5 314.4 314.6
Long-term debt 599.3 618.8 629.1 648.0
Off-balance sheet financial instrument liabilities:
Loan commitments -- 3.9 -- 3.2
Standby and commercial letters of credit -- 0.9 -- 0.7
=====================================================================================================================
(1) Includes mortgage loans held for sale
The various methods and assumptions used by Citizens in estimating fair value
for its financial instruments are set forth below:
CASH AND MONEY MARKET INVESTMENTS: The carrying amounts reported in the balance
sheet for cash and money market investments approximate those assets' fair
values because they mature within six months and do not present unanticipated
credit concerns.
INVESTMENT SECURITIES: The carrying amounts reported in the balance sheet for
investment securities approximate those assets' fair values as all investment
securities are classified as available for sale. SFAS 115 requires securities
carried in the available for sale category to be carried at fair value - see
Note 5. The fair values are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
LOANS RECEIVABLE: Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as commercial,
commercial real estate, residential mortgage, and home equity and other
consumer. Each loan category is further segmented into fixed and variable-rate
interest types and for certain categories by performing and nonperforming. For
performing variable-rate loans that reprice frequently (within twelve months)
and with no significant change in credit risk, fair values are based on carrying
values. Similarly, for credit card loans with no significant credit concerns and
average interest rates approximating current market origination rates, the
carrying amount is a reasonable estimate of fair value. Fair values of other
loans (e.g., fixed-rate commercial, commercial real estate, residential mortgage
and consumer loans) are estimated by discounting the future cash flows using
interest rates currently being offered by Citizens for loans with similar terms
and remaining maturities (new loan rates). Management believes the risk factor
embedded in the new loan rates adequately represents the credit risk within the
portfolios. Fair values for nonperforming loans are estimated after giving
consideration to credit risk and estimated cash flows and discount rates based
on available market and specific borrower information. The carrying amount of
accrued interest for all loan types approximates its fair value.
DEPOSIT LIABILITIES: Under SFAS 107, the fair value of demand deposits (e.g.,
interest and noninterest checking, passbook savings and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for certificates
of deposit are based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for certificates of
similar remaining maturities.
86
SHORT-TERM BORROWINGS: The carrying amounts of federal funds purchased,
securities sold under agreement to repurchase and other short-term borrowings
approximate their fair values.
LONG-TERM DEBT: The carrying value of Citizens' variable-rate long-term debt
approximates its fair value. The fair value of fixed-rate long-term debt is
estimated using discounted cash flow analyses, based on Citizens' current
incremental borrowing rates for similar types of borrowing arrangements.
LOAN COMMITMENTS AND LETTERS OF CREDIT: The fair value of loan commitments and
letter of credit guarantees is based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the counterparties' credit standing.
NOTE 19. LINES OF BUSINESS
The financial performance of Citizens is monitored by an internal profitability
measurement system, which provides line of business results and key performance
measures. The profitability measurement system is based on internal management
methodologies designed to produce consistent results and reflect the underlying
economics of the businesses. The development and application of these
methodologies is a dynamic process. Accordingly, these measurement tools and
assumptions may be revised periodically to reflect methodological, product,
and/or management organizational changes. Further, these policies measure
financial results that support the strategic objectives and internal
organizational structure of Citizens. Consequently, the information presented is
not necessarily comparable with similar information for other institutions.
Beginning in 2002, all activities formerly housed in our F&M business line were
integrated into our other lines of business: Commercial Banking, Retail Banking,
Financial Services and Other and the three major business lines were renamed
Business Banking, Consumer Banking and Wealth Management, respectively. The
activities of the renamed business lines remained the same. The former F&M
business line provided a full range of consumer and commercial banking services
to individuals, and commercial and agricultural businesses, in Wisconsin and
Iowa through a network of branch locations. Products and services offered
included deposit accounts; commercial, commercial mortgage, agricultural, small
business, residential mortgage and consumer loans; financial planning and trust;
brokerage, insurance, ATM, credit card and cash management services
A description of each business line, selected financial performance and the
methodologies used to measure financial performance are presented below.
Financial information for the year 2001 has been restated to reflect the new
organizational structure. As it was impractical to restate all amounts in 2000,
current and prior year financial information is presented under both the "old"
and "new" organizational structure.
BUSINESS BANKING: Business Banking provides a full range of credit and related
financial services to middle market corporate, small business, government and
leasing clients. Products and services offered include commercial loans,
commercial mortgages, small business loans, letters of credit, deposit accounts,
cash management and international trade services.
CONSUMER BANKING: Consumer Banking includes consumer lending and deposit
gathering, electronic banking and residential mortgage loan origination and
servicing. This line of business offers a variety of retail financial products
and services including deposit accounts, direct and indirect installment loans,
debit and credit cards, home equity lines of credit, residential mortgage loans,
fixed and variable annuities and ATM network services.
WEALTH MANAGEMENT: Wealth Management provides commercial and retail clients with
private banking, trust and investment, retirement plan, and brokerage and
insurance services. Private banking focuses on high net-worth customers and
offers a broad array of asset management, estate settlement and administration,
deposit and credit products. Trust and investment includes personal trust and
planning services, investment management services, estate settlement,
administration and advises the Golden Oak family of mutual funds. Retirement
plan services focus on investment management and fiduciary activities with
special emphasis on 401(k) plans. The brokerage and insurance businesses deliver
Citizens' retail mutual funds, other securities, variable and fixed annuities,
personal disability and life insurance products and discounted brokerage
services.
87
OTHER: All other includes activities that are not directly attributable to one
of the major lines of business. Included in this category is the parent company;
Citizens' Treasury unit, including the securities portfolio, wholesale funding
and asset liability management activities; inter-company eliminations; and the
economic impact of certain assets, capital and support functions not
specifically identifiable with the four primary lines of business.
The accounting policies on the individual business units are the same as those
of Citizens described in Note 1 to the Consolidated Financial Statements. Funds
transfer pricing is used in the determination of net interest income by
assigning a cost for funds used or credit for funds provided to assets and
liabilities within each business unit. Assets and liabilities are match-funded
based on their maturity, prepayment and/or repricing characteristics. As a
result, the Business, Consumer and Wealth Management units are largely insulated
from changes in interest rates. Changes in net interest income due to changes in
interest rates are reported in Citizens' Treasury unit. Under the "old"
organizational structure, changes in net interest income due to changes in
interest rates for F&M are included in the operating income of F&M. Noninterest
income and expenses directly attributable to a line of business are assigned to
that business. Expenses for centrally provided services are allocated to the
business lines as follows: product processing and technology expenditures are
allocated based on standard unit costs applied to actual volume measurements;
corporate overhead is allocated based on the ratio of a line of business'
noninterest expenses to total noninterest expenses incurred by all business
lines. The provision for loan losses was allocated in an amount based primarily
upon the actual net charge-offs of each respective line of business, adjusted
for loan growth and changes in risk profile. Selected segment information is
included in the following table.
LINE OF BUSINESS INFORMATION: NEW ORGANIZATIONAL STRUCTURE
Business Consumer Wealth
(in thousands) Banking Banking Mgmt Other Total
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS SUMMARY - 2002
Net interest income (taxable equivalent) $ 140,926 $ 152,398 $ 273 $ 22,655 $ 316,252
Provision for loan losses 108,002 13,590 -- (1,392) 120,200
--------- --------- --------- --------- ---------
Net interest income after provision 32,924 138,808 273 24,047 196,052
Noninterest income 17,179 58,524 23,881 2,192 101,776
Noninterest expense 69,555 140,098 17,563 32,167 259,383
--------- --------- --------- --------- ---------
Income (loss) before income taxes (19,452) 57,234 6,591 (5,928) 38,445
Income tax expense (taxable equivalent) (6,804) 20,034 2,307 (2,130) 13,407
--------- --------- --------- --------- ---------
Net income (loss) $ (12,648) $ 37,200 $ 4,284 $ (3,798) $ 25,038
========= ========= ========= ========= =========
AVERAGE ASSETS (IN MILLIONS) $ 3,364 $ 2,692 $ 7 $ 1,506 $ 7,569
========= ========= ========= ========= =========
================================================================================================================================
EARNINGS SUMMARY - 2001
Net interest income (taxable equivalent) $ 139,766 $ 166,312 $ 1,232 $ 15,506 $ 322,816
Provision for loan losses 17,380 8,881 -- 146 26,407
--------- --------- --------- --------- ---------
Net interest income after provision 122,386 157,431 1,232 15,360 296,409
Noninterest income 16,429 62,305 25,050 13,697 117,481
Noninterest expense 67,267 146,578 16,823 20,515 251,183
--------- --------- --------- --------- ---------
Income before income taxes 71,548 73,158 9,459 8,542 162,707
Income tax expense (taxable equivalent) 25,047 25,605 3,311 4,087 58,050
--------- --------- --------- --------- ---------
Net income $ 46,501 $ 47,553 $ 6,148 $ 4,455 $ 104,657
========= ========= ========= ========= =========
AVERAGE ASSETS (IN MILLIONS) $ 3,461 $ 3,075 $ 11 $ 1,389 $ 7,936
========= ========= ========= ========= =========
================================================================================================================================
88
LINE OF BUSINESS INFORMATION: OLD ORGANIZATIONAL STRUCTURE
Commercial Retail Financial
(in thousands) Banking Banking Services F&M Other Total
- --------------------------------------------------------------------------------------------------------------------------
EARNINGS SUMMARY - 2002
Net interest income (taxable equivalent) $ 95,208 $ 117,970 $ 235 $ 86,324 $ 16,515 $ 316,252
Provision for loan losses 68,067 9,237 -- 45,637 (2,741) 120,200
--------- --------- --------- --------- --------- ---------
Net interest income after provision 27,141 108,733 235 40,687 19,256 196,052
Noninterest income 14,730 43,605 22,603 19,456 1,382 101,776
Noninterest expense 37,483 100,802 15,964 82,149 22,985 259,383
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 4,388 51,536 6,874 (22,006) (2,347) 38,445
Income tax expense (taxable equivalent) 1,535 18,040 2,406 (7,980) (594) 13,407
--------- --------- --------- --------- --------- ---------
Net income (loss) $ 2,853 $ 33,496 $ 4,468 $ (14,026) $ (1,753) $ 25,038
========= ========= ========= ========= ========= =========
AVERAGE ASSETS (IN MILLIONS) $ 2,225 $ 2,146 $ 7 $ 2,351 $ 840 $ 7,569
========= ========= ========= ========= ========= =========
==========================================================================================================================
EARNINGS SUMMARY - 2001
Net interest income (taxable equivalent) $ 92,714 $ 125,418 $ 1,140 $ 94,000 $ 9,544 $ 322,816
Provision for loan losses 6,949 7,046 -- 13,033 (621) 26,407
--------- --------- --------- --------- --------- ---------
Net interest income after provision 85,765 118,372 1,140 80,967 10,165 296,409
Noninterest income 13,777 48,527 23,139 20,119 11,919 117,481
Noninterest expense 44,584 104,732 14,267 70,580 17,020 251,183
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 54,958 62,167 10,012 30,506 5,064 162,707
Income tax expense (taxable equivalent) 19,235 21,758 3,504 10,441 3,112 58,050
--------- --------- --------- --------- --------- ---------
Net income (loss) $ 35,723 $ 40,409 $ 6,508 $ 20,065 $ 1,952 $ 104,657
========= ========= ========= ========= ========= =========
AVERAGE ASSETS (IN MILLIONS) $ 2,128 $ 2,804 $ 9 $ 2,633 $ 363 $ 7,936
========= ========= ========= ========= ========= =========
==========================================================================================================================
EARNINGS SUMMARY - 2000
Net interest income (taxable equivalent) $ 91,718 $ 132,582 $ 1,330 $ 104,177 $ (857) $ 328,950
Provision for loan losses 6,044 10,278 -- 4,103 558 20,983
--------- --------- --------- --------- --------- ---------
Net interest income after provision 85,674 122,304 1,330 100,074 (1,415) 307,967
Noninterest income 12,352 31,914 26,618 16,633 2,827 90,344
Noninterest expense 42,965 102,834 18,174 76,739 17,050 257,762
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 55,061 51,384 9,774 39,968 (15,638) 140,549
Income tax expense (taxable equivalent) 19,272 17,983 3,420 14,001 (4,787) 49,889
--------- --------- --------- --------- --------- ---------
Net income (loss) $ 35,789 $ 33,401 $ 6,354 $ 25,967 $ (10,851) $ 90,660
========= ========= ========= ========= ========= =========
AVERAGE ASSETS (IN MILLIONS) $ 2,025 $ 2,596 $ 17 $ 2,745 $ 690 $ 8,073
========= ========= ========= ========= ========= =========
==========================================================================================================================
NOTE 20. REGULATORY MATTERS
The Federal Reserve Bank requires Citizens' banking subsidiaries to maintain
certain noninterest-bearing deposits. These reserve balances vary depending upon
the level of client deposits in the subsidiary banks. During 2002 and 2001, the
average reserve balances were $35.3 million and $41.9 million, respectively.
The banking subsidiaries are also subject to limitations under banking laws on
extensions of credit to members of the affiliate group and on dividends that can
be paid to Citizens. Generally extensions of credit are limited to 10% to any
one affiliate and 20% in aggregate to all affiliates of a subsidiary bank's
capital and surplus (net assets) as defined. Unless prior regulatory approval is
obtained, dividends declared in any calendar year may not exceed the retained
net profit, as defined, of that year plus the retained net profit of the
preceding two years. As of January 1, 2003, due to the net loss recorded in the
third quarter of 2002, Citizens' banking subsidiaries are temporarily unable to
pay dividends
89
without further regulatory approval.
Citizens and its banking subsidiaries are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, specific
capital guidelines must be met that involve quantitative measures of the assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Citizens and its banking subsidiaries to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier 1 capital to
risk-weighted assets (as defined in the regulations), and of Tier 1 capital to
average assets (as defined). Management believes, as of December 31, 2002, that
Citizens and its banking subsidiaries meet all capital adequacy requirements to
which it is subject.
As of December 31, 2002, the most recent notification from the Federal Reserve
Board categorized Citizens and its banking subsidiaries as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized Citizens and its banking subsidiaries must maintain minimum
total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the table. There are no conditions or events since that notification that
management believes would result in a change.
RISK BASED CAPITAL REQUIREMENTS
For Capital
Actual Adequacy Purposes
------------------- -------------------------------
(in thousands) Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------
CITIZENS BANKING CORPORATION
AS OF DECEMBER 31, 2002:
Total Capital to risk weighted assets(1) $ 606,133 10.4% $ 464,714 > than or = 8.0%
Tier 1 Capital to risk weighted assets(1) 533,066 9.2 232,357 > than or = 4.0
Tier 1 Leverage(2) 533,066 7.2 296,413 > than or = 4.0
As of December 31, 2001:
Total Capital to risk weighted assets(1) $ 669,332 11.1% $ 481,512 > than or = 8.0%
Tier 1 Capital to risk weighted assets(1) 594,033 9.9 240,756 > than or = 4.0
Tier 1 Leverage(2) 594,033 7.8 304,854 > than or = 4.0
CITIZENS BANK
AS OF DECEMBER 31, 2002:
Total Capital to risk weighted assets(1) $ 427,868 10.6% $ 323,496 > than or = 8.0%
Tier 1 Capital to risk weighted assets(1) 377,195 9.3 161,748 > than or = 4.0
Tier 1 Leverage(2) 377,195 7.6 199,460 > than or = 4.0
As of December 31, 2001:
Total Capital to risk weighted assets(1) $ 425,456 10.4% $ 327,353 > than or = 8.0%
Tier 1 Capital to risk weighted assets(1) 374,294 9.2 163,676 > than or = 4.0
Tier 1 Leverage(2) 374,294 7.5 199,801 > than or = 4.0
=====================================================================================================
To Be Well Capitalized
Under Prompt Corrective
Action Provisions
(in thousands) Amount Ratio
- ------------------------------------------------------------------------------
CITIZENS BANKING CORPORATION
AS OF DECEMBER 31, 2002:
Total Capital to risk weighted assets(1) $ 580,892 > than or = 10.0%
Tier 1 Capital to risk weighted assets(1) 348,535 > than or = 6.0
Tier 1 Leverage(2) 370,517 > than or = 5.0
As of December 31, 2001:
Total Capital to risk weighted assets(1) $ 601,889 > than or = 10.0%
Tier 1 Capital to risk weighted assets(1) 361,134 > than or = 6.0
Tier 1 Leverage(2) 381,068 > than or = 5.0
CITIZENS BANK
AS OF DECEMBER 31, 2002:
Total Capital to risk weighted assets(1) $ 404,370 > than or = 10.0%
Tier 1 Capital to risk weighted assets(1) 242,622 > than or = 6.0
Tier 1 Leverage(2) 249,325 > than or = 5.0
As of December 31, 2001:
Total Capital to risk weighted assets(1) $ 409,191 > than or = 10.0%
Tier 1 Capital to risk weighted assets(1) 245,515 > than or = 6.0
Tier 1 Leverage(2) 249,751 > than or = 5.0
=============================================================================
(1) Total Capital is comprised of Tier 1 Capital plus a portion of the allowance
for loan losses. Tier 1 Capital consists of total equity less unrealized
gains and losses accumulated in other comprehensive income, certain
intangible assets and adjustments related to the valuation of mortgage
servicing assets.
(2) Tier 1 Capital to quarterly average assets
90
NOTE 21. CITIZENS BANKING CORPORATION (PARENT ONLY) STATEMENTS
BALANCE SHEETS
CITIZENS BANKING CORPORATION (PARENT ONLY)
December 31,
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
ASSETS
Cash $ 5 $ 5
Money market investments 3,166 2,969
Investment securities 83 73
Investment in subsidiaries - principally banks 682,010 719,422
Goodwill - net 265 265
Other assets 3,850 5,349
-------- --------
TOTAL ASSETS $689,379 $728,083
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term revolving credit $ 30,000 $ 30,000
Other liabilities 8,910 619
-------- --------
Total liabilities 38,910 30,619
Shareholders' equity 650,469 697,464
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $689,379 $728,083
======== ========
================================================================================
STATEMENTS OF INCOME
CITIZENS BANKING CORPORATION (PARENT ONLY)
Year Ended December 31,
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------
INCOME
Dividends from subsidiaries - principally banks $ 90,500 $ 107,400 $ 79,400
Interest from bank subsidiary --- 32 18
Service fees from bank subsidiaries 10,887 9,435 9,517
Equity security gain --- 11,017 ---
Other 703 890 646
--------- --------- ---------
Total 102,090 128,774 89,581
--------- --------- ---------
EXPENSES
Interest 710 1,904 3,099
Amortization of goodwill --- 796 796
Salaries and employee benefits 14,352 9,955 9,333
Service fees paid to bank subsidiaries 1,168 1,265 1,215
Special charge 1,434 --- (211)
Other noninterest expense 3,042 3,888 1,884
--------- --------- ---------
Total 20,706 17,808 16,116
--------- --------- ---------
Income before income taxes and
equity in undistributed earnings of subsidiaries 81,384 110,966 73,465
Income tax benefit 3,465 (1,197) 2,727
Equity in undistributed earnings of subsidiaries (59,811) (5,112) 14,468
--------- --------- ---------
NET INCOME $ 25,038 $ 104,657 $ 90,660
========= ========= =========
=========================================================================================
91
STATEMENTS OF CASH FLOWS
CITIZENS BANKING CORPORATION (PARENT ONLY)
Year Ended December 31,
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 25,038 $ 104,657 $ 90,660
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of goodwill --- 796 796
Equity security gain --- (11,017) ---
Equity in undistributed earnings of subsidiaries 59,811 5,112 (14,468)
Other 9,474 (1,525) (2,657)
---------- ----------- ----------
Net cash provided by operating activities 94,323 98,023 74,331
---------- ----------- ----------
INVESTING ACTIVITIES
Net (increase) decrease in money market investments (197) 4,947 (6,814)
Purchases of investment securities --- --- (19)
Proceeds from sales and maturities of investment securities --- --- 33
Proceeds from sale of NYCE stock --- 11,017 ---
---------- ----------- ----------
Net cash provided (used) by investing activities (197) 15,964 (6,800)
---------- ----------- ----------
FINANCING ACTIVITIES
Proceeds from short-term borrowings --- 6,000 6,000
Principal reductions in short-term borrowings --- (24,000) ---
Cash dividends paid (50,659) (50,158) (48,108)
Net change in deferred compensation, net of tax effect 267 --- ---
Proceeds from stock options exercised 6,562 12,662 1,879
Shares acquired for retirement (50,296) (58,491) (27,302)
---------- ----------- ----------
Net cash used by financing activities (94,126) (113,987) (67,531)
---------- ----------- ----------
Net increase in cash --- --- ---
Cash at beginning of year 5 5 5
---------- ----------- ----------
Cash at end of year $ 5 $ 5 $ 5
========== =========== ==========
=============================================================================================================
92
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
BOARD OF DIRECTORS CITIZENS BANKING CORPORATION
We have audited the accompanying consolidated balance sheets of Citizens Banking
Corporation and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform our
audits 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Citizens Banking
Corporation and subsidiaries at December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 7 to the consolidated financial statements, in 2002
Citizens Banking Corporation and subsidiaries changed their method of accounting
for goodwill and intangible assets.
[ERNST & YOUNG LLP]
Detroit, Michigan
January 16, 2003
93
REPORT OF MANAGEMENT
MANAGEMENT'S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
Management is responsible for the preparation of the consolidated financial
statements and all other financial information appearing in this Annual Report.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States.
SYSTEM OF INTERNAL CONTROLS
Citizens maintains a system of internal controls designed to provide reasonable
assurance that assets are safe-guarded and that the financial records are
reliable for preparing consolidated financial statements. The selection and
training of qualified personnel and the establishment and communication of
accounting and administrative policies and procedures are elements of this
control system. The effectiveness of the internal control system is monitored by
a program of internal audit and by independent certified public accountants
("independent auditors").
Management recognizes that the cost of a system of internal controls should not
exceed the benefits derived and that there are inherent limitations to be
considered in the potential effectiveness of any system. Management believes
Citizens' system provides the appropriate balance between costs of controls and
the related benefits.
AUDIT COMMITTEE OF THE BOARD
The Audit Committee of the Board of Directors, comprised entirely of outside
directors, recommends the independent auditors who are engaged upon approval by
the Board of Directors. The committee meets regularly with the internal auditor
and the independent auditors to review timing and scope of audits and review
audit reports. The internal auditor and the independent auditors have free
access to the Audit Committee.
INDEPENDENT AUDITORS
The consolidated financial statements in this Annual Report have been audited by
Citizens' independent auditors, Ernst & Young LLP, for the purpose of
determining that the consolidated financial statements are free of material
misstatement. Their audit considered Citizens' internal control structure to the
extent necessary to determine the scope of their auditing procedures.
Charles D. Christy William R. Hartman
Executive Vice President Chairman,
and Chief Financial Officer President and Chief Executive Officer
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