1
EXHIBIT 13
SELECTED FINANCIAL HIGHLIGHTS D&N FINANCIAL CORPORATION
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1997 1996(2) 1995(2) 1994(2) 1993(2)
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(Dollars in thousands, except per share data)
FOR THE YEAR:
Net interest income $ 48,939 $ 42,763 $ 34,750 $ 23,786 $ 21,212
Provision for loan losses 1,350 1,100 2,400 100 --
Noninterest income(loss) 8,920 7,224 6,912 7,488 (21,536)
Net income (loss) 14,325 8,995 10,417 3,383 (66,642)(1)
Earnings (loss) per share
Basic 1.58 1.08 1.27 0.41 (13.69)
Diluted 1.53 1.01 1.24 0.41 (13.69)
Shares outstanding:
Basic 9,093,682 8,336,517 8,172,292 8,161,600 4,866,278
Diluted 9,364,874 8,906,109 8,403,028 8,185,146 4,945,579
Stock price range 14 57/64 - 26 3/4 10 29/32-16 9/64 6 19/32 -12 17/64 6 1/64-9 3/32 5 29/32 - 11 23/64
Cash dividends declared
per common share 0.10 -- -- -- --
AT YEAR END:
Total assets 1,815,315 1,473,054 1,228,497 1,128,732 1,080,131
Net loans receivable 1,300,959 1,055,876 952,359 821,875 646,709
Nonperforming assets 5,300 8,091 9,701 24,520 43,593
Mortgage-backed securities 358,296 251,256 127,709 151,293 171,983
Excess of cost over net assets of
association acquired __ -- -- 384 845
Mortgage servicing rights 2,136 1,443 1,113 968 9,870
Deposits 1,043,167 964,133 922,932 817,674 844,012
Borrowings 619,523 404,037 216,295 226,956 101,648
Stockholders' equity 98,082 86,121 71,979 58,325 56,887
Per share 10.78 9.38 8.75 7.15 6.97
Tangible stockholders' equity 97,184 85,110 70,855 58,264 57,049
Per share 10.68 9.27 8.62 7.14 6.99
Number of offices 48 48 46 41 38
SELECTED RATIOS:
Return on average assets 0.88% 0.67% 0.89% 0.31% (5.47)%
Return on average equity 15.75 11.58 16.01 5.97 (74.99)
Average equity to average assets 5.59 5.77 5.53 5.26 7.29
Net interest margin 3.08 3.26 3.04 2.31 1.95
General & administrative expenses
to average assets 2.01 2.34 2.44 2.48 2.30
Nonperforming assets to total assets 0.29 0.55 0.79 2.17 4.04
Allowance for loan losses to
nonperforming loans 275.72 166.77 122.21 46.38 38.21
Allowance for loan losses to total loans 0.80 1.03 1.05 1.01 1.76
Net loan charge-offs to average loans 0.15 0.01 0.07 0.43 0.59
Tangible capital ratio 6.55 5.11 5.41 5.05 4.89
Core capital ratio 6.55 5.11 5.41 5.09 4.97
Risk-based capital ratio 11.98 9.94 10.45 10.08 10.21
(1) Includes cumulative effect of change in accounting for goodwill of
($34,754,000).
(2) All per share amounts have been restated to include the effects of a 10%
stock dividend and adoption of SFAS 128 in 1997.
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2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
D&N Financial Corporation ("D&N" or "the Company") is a savings bank holding
company whose sole subsidiary is D&N Bank ("the Bank"). D&N's primary focus is
the delivery of retail financial services through its community banking offices
in Michigan and loan origination network in the Upper Midwest. This discussion
highlights important trends and events that have shaped the Company's financial
performance in 1997.
In 1997, D&N reported net income of $14.3 million, or $1.53 per diluted
share. Earnings in 1996, before one-time regulatory charges and the tax benefit
of a previous year's net operating loss, were $10.1 million or $1.14 per
diluted share. In 1995 the Company earned $10.4 million or $1.24 per diluted
share.
On December 31, 1997, the Company's balance sheet included total assets of
$1.82 billion, compared to $1.47 billion at the end of 1996. This 23% growth
reflected primarily the Bank's loan origination success, with $856 million of
new loans funded in 1997. Outstanding loan balances totaled $1.31 billion at
December 31, 1997, an increase of 23% during the year. Mortgage-backed
securities also increased by 43% to $358 million as the Bank securitized $86
million of its residential mortgage loan production with the Federal Home Loan
Mortgage Corporation ("FHLMC" or "Freddie Mac").
Equity and capital support for D&N's robust growth in 1997 came from the
retention of earnings, from the receipt, in December, 1996, of proceeds from
the exercise of warrants to purchase the Company's common stock, and from the
successful creation, in July, 1997, of a new Bank subsidiary, D&N Capital
Corporation ("DNCC"). DNCC is a Real Estate Investment Trust ("REIT") that
invests in residential and commercial real estate mortgages which it acquires
from the Bank. In addition to the $32 million equity investment that the Bank
made in DNCC, outside investors purchased preferred stock of the subsidiary for
$30.25 million. This preferred stock investment is included in the regulatory
capital accounts of D&N Bank.
In 1997, the Company made provisions for loan losses of $1.35 million, after
making provisions of $1.1 million and $2.4 million in 1996 and 1995,
respectively. At December 31, 1997, the allowance for loan losses was $10.5
million, or 0.80% of outstanding loans. D&N's portfolio of nonperforming assets
declined during 1997 by $2.8 million or 34% to $5.3 million. At December 31,
1997, the allowance for loan losses was 276% of the loans deemed to be
nonperforming. This ratio was 167% in 1996 and 122% in 1995.
Noninterest income from operations increased by 19.1% in 1997 after increasing
by 14.7% in 1996. The increases in loan related and deposit related fee income
experienced in 1996 and 1997 reflect the successful implementation of servicing
strategies designed to complement the Company's community banking focus.
D&N Bank incurred a one-time charge in 1996 as a result
of its mandated contribution to replenish the Federal Deposit Insurance
Corporation's ("FDIC") depleted Savings Association Insurance Fund ("SAIF").
The third quarter assessment was $5.5 million before consideration of its
impact on federal taxes, and was expected to reduce the Bank's annual deposit
insurance premiums by approximately $1.6 million.
Also during the third quarter of 1996, the Bank recognized adjustments to its
balance of deferred tax assets following the enactment in August of federal
legislation which resolved the recapture status of previously allowed
accelerated deductions for bad debts. Historically, thrift institutions such as
the Bank had been permitted to deduct a portion of their net income as bad debt
allowances. This practice was more advantageous than the specific-loss method
of deduction which was mandated for other classes of financial institutions.
The opportunity to use the percentage-of-income method expired in 1995,
but the status of previously accelerated deductions remained
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in question until the 1996 legislation was enacted. Notably, the presence of
unresolved prior deductions was felt to be a hindrance to evolution and
consolidation of the financial services industry because thrift institutions
that had recorded such accelerated deductions were required to repay them
before charter conversions or acquisitions by non-thrift institutions could be
approved. The new legislation required that accelerated deductions recorded
after 1987 would have to be repaid, but forgave that portion of institutions'
accelerated loan loss deductions that were recorded before 1988.
RESULTS OF OPERATIONS
NET INTEREST INCOME
The Company's primary source of earnings is its net interest income, defined as
the difference between the interest earned on its loans and investments and the
interest paid on its deposits and other liabilities. Interest income and
interest expense each increased in 1997 as the average size of the Company's
earning assets grew substantially. Interest income increased by $21.4 million,
or 20.5%, in 1997. The average yield on earning assets decreased by 4 basis
points to 7.91% in 1997, from 7.95% in 1996. In 1995, earning assets yielded
7.93%. Driving the interest income gains in 1997 was D&N's 21.1% increase in
average earning balances, which followed an increase of 14.7% in 1996 and
11.1% in 1995.
Interest expense increased by $15.2 million, or 24.7%, in 1997 as the average
balance of interest-bearing liabilities increased by 20.2%, and the average
rate paid on those liabilities increased by 19 basis points. In 1997,
interest-bearing liabilities had an average cost of 5.12%, compared to 4.93% in
1996 and 5.15% in 1995. Because the average yield on interest-earning assets
decreased and the average cost of interest-bearing liabilities increased in
1997, the Company's interest rate spread decreased from 3.02% in 1996 to 2.79%
in 1997. In 1995 the spread was 2.79%. Similarly, the Bank's net interest
margin, or ratio of net interest income to average interest-earning assets,
decreased from 3.26% in 1996 to 3.08% in 1997. In 1995 the net interest margin
was 3.04%. Average interest-earning assets exceeded average interest-bearing
liabilities by $88.7 million in 1997 compared to $64.5 million in 1996 and
$55.3 million in 1995.
Average balances of loans outstanding were higher in 1997 than 1996, as the
Company's loan originations increased significantly. Average balances of
mortgage-backed securities were also sharply higher reflecting loan
securitization efforts, while the investment securities category increased
modestly. Loans increased by $132 million, or 12%; mortgage-backed securities
increased by $120 million, or 82%; and investment securities increased by $24.2
million, or 23%. Average earning rates on investments and mortgage-backed
securities were lower in 1997 than 1996, while the average earning rate on the
loan portfolio increased. In 1997, loans earned an average yield of 8.25%
compared to 8.11% in 1996. Mortgage-backed securities earned an average of
7.15% in 1997, versus an average rate of 7.46% in 1996. Investment securities
earned 6.28% in 1997, down from 6.96% in 1996. Even though average loan yields
increased from the previous year, overall earning-asset performance decreased
slightly as a greater proportion of the earning-asset portfolio was comprised
of less profitable mortgage-backed security and investment assets in 1997 than
in 1996.
The average balances of loan assets and mortgage-backed securities also
increased from 1995 to 1996. In 1996, average investment balances fell,
reflecting the Company's application of surplus liquidity assets to fund loan
growth.
Average deposit balances increased 7.9% to $1.012 billion in 1997, from $938
million in 1996. The average cost of deposits increased 7 basis points, to
4.74%, in 1997, from 4.67% in 1996. From 1995 to 1996, average deposit balances
increased by $86 million, or 10.1%. In 1995, the average cost of deposits was
4.53%.
The average balance of borrowed funds increased by 57.7%, to $488 million in
1997, from $310 million in 1996. In 1995, the average balance of borrowed funds
was $236 million.
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MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.)
The following tables set forth the extent to which the Company's net interest
income has been affected by changes in average interest rates and average
balances of interest-earning assets and interest-bearing liabilities.
Years Ended December 31, 1997 and 1996
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Average balance (1) Average rate Interest Variance due to: (2)
------------------------------------------------------------------------------------------------
Increase
1997 1996 1997 1996 1997 1996 (Decrease) Volume Rate
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(Dollars in thousands)
Interest-earning assets:
Loans (3) $1,194,090 $1,062,108 8.25% 8.11% $98,560 $86,151 $12,409 $10,917 $ 1,492
Mortgage-backed securities (4) 267,010 146,560 7.15 7.46 19,085 10,930 8,155 8,627 (472)
Investments and deposits (4) 128,071 103,848 6.28 6.96 8,048 7,228 820 1,562 (742)
------------------------------------------------------------------------------------------------
1,589,171 1,312,516 7.91 7.95 125,693 104,309 21,384 21,106 278
------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits 1,012,237 938,484 4.74 4.67 47,961 43,859 4,102 3,469 633
Borrowings 488,251 309,516 5.90 5.71 28,793 17,687 11,106 10,294 812
------------------------------------------------------------------------------------------------
1,500,488 1,248,000 5.12 4.93 76,754 61,546 15,208 13,763 1,445
------------------------------------------------------------------------------------------------
Interest rate spread 2.79 3.02
Excess average earning assets $ 88,683 $64,516 7.91% 7.95%
================================================
Net interest margin 3.08% 3.26% $48,939 $42,763 $6,176 $7,343 $(1,167)
================================================================
Years Ended December 31, 1996 and 1995
------------------------------------------------------------------------------------------------
Average balance (1) Average rate Interest Variance due to: (2)
------------------------------------------------------------------------------------------------
1996 1995 1996 1995 1996 1995 Increase Volume Rate
(Decrease)
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(Dollars in thousands)
Interest-earning assets:
Loans (3) $1,062,108 $892,364 8.11% 8.13% $86,151 $72,550 $13,601 $13,767 $(166)
Mortgage-backed securities(4) 146,560 140,093 7.46 7.55 10,930 10,577 353 484 (131)
Investments and deposits (4) 103,848 111,476 6.96 6.85 7,228 7,638 (410) (525) 115
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1,312,516 1,143,933 7.95 7.93 104,309 90,765 13,544 13,726 (182)
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Interest-bearing liabilities:
Deposits 938,484 852,382 4.67 4.53 43,859 38,639 5,220 4,020 1,200
Borrowings 309,516 236,242 5.71 6.29 17,687 14,855 2,832 4,283 (1,451)
Interest rate instruments -- -- -- 0.23 -- 2,521 (2,521) -- (2,521)
-----------------------------------------------------------------------------------------------
1,248,000 1,088,624 4.93 5.15 61,546 56,015 5,531 8,303 (2,772)
-----------------------------------------------------------------------------------------------
Interest rate spread 3.02 2.79
Excess average earning assets $ 64,516 $55,309 7.95% 7.93%
================================================
Net interest margin 3.26% 3.04% $42,763 $34,750 $8,013 $5,423 $2,590
===============================================================
(1) Based on average daily balances.
(2) Changes to interest income and interest expense attributable to changes in
both rate and volume have been attributed proportionately to the change due
to rate and the change due to volume.
(3) Loans on nonaccrual are included in the average balances shown above. The
variance due to rate includes the effect of such loans because no interest
is earned on such loans.
(4) Average rates on mortgage-backed and investment securities available for
sale are based on historical amortized cost balances.
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In 1995, D&N's interest expense included the net costs of interest rate hedging
instruments. During 1995, contracts written in the 1980s to exchange fixed
interest payments for variable receipts ("swap contracts") resulted in net
charges to interest expense of $2.5 million. The swap contracts, originally
executed as hedges against rising interest rates, have expired, with the final
contract maturing in November of 1995.
NONINTEREST INCOME
D&N's noninterest income includes recurring fees from loan and deposit-related
activities, recurring income from the marketing of assets that are originated
for sale, and non-recurring gains and losses from events such as securities
sales and sales of non-earning and depreciated assets. D&N's loan and
deposit-related fee income totaled $6.0 million in 1997, up $461,000 or 8.3%
from 1996, reflecting primarily the Bank's growing core deposit base and the
initiation of fees for non-customer usage of the Bank's automatic teller
machine network. In 1997, net loan servicing and administrative fees were
unchanged from 1996 at $1.9 million. Deposit-related fees, on the other hand,
increased by 12.7% in 1997.
Gains on sales of loans totaled $1.7 million in 1997, up from $1.0 million in
1996. In 1997, $103 million of D&N's residential mortgages were sold to
secondary market investors, compared to $66.1 million in 1996. In each year,
D&N Bank retained the rights to service all of these loans. Other income
increased from $470,000 in 1996 to $657,000 in 1997 as D&N Bank's subsidiary,
Quincy Insurance Agency, continued to successfully expand its offerings of
annuities and investment products.
NONINTEREST EXPENSE
General and administrative expenses totaled $32.6 million in 1997. In 1996,
this category included $1.4 million of non-recurring costs associated with the
Bank's merger with Macomb Federal Saving Bank. When merger-related costs are
excluded from the 1996 total, general and administrative expenses were up in
1997 by $2.5 million, or 8.2%, following an increase of $1.5 million, or 5.1%
in 1996. These increases reflect the costs of D&N's expanding retail delivery
network, and the variable-based compensation consequences of sharply higher
loan production levels.
In 1997, net recoveries on sales of other real estate owned ("OREO") exceeded
operating costs for such properties by $81,000. In 1996, noninterest expense
included $71,000 of net operating costs related to OREO. In 1995, net
recoveries on sales of OREO properties exceeded operating costs resulting in a
credit in this category of $1.0 million.
In 1995, D&N's noninterest expense included amortization costs for goodwill
associated with the Company's 1982 merger with First Federal Savings and Loan
Association of Flint, Michigan.
In 1997, D&N's FDIC insurance premium was $658,000, or $1.76 million less than
the adjusted total for 1996. Excluding that year's SAIF recapitalization
assessment of $5.5 million, deposit insurance premiums in 1996 were $2.4
million. Similarly, the 1995 premium was $2.4 million.
INCOME TAXES
The Company's effective income tax rates were 35.09% in 1997, 3.74% in 1996 and
(19.16)% in 1995. The tax rates in 1996 and 1995 were effected by reductions in
each year of a portion of the valuation allowance for deferred tax assets
provided in prior years, when the Company incurred substantial net operating
losses. The valuation allowance was eliminated as of December 31, 1996.
FINANCIAL CONDITION
BALANCE SHEET TRENDS
At December 31, 1997, D&N's assets totaled $1.82 billion, an increase of $342
million, or 23%, from the previous year end. The Company's balance sheet growth
has been fueled by substantial loan production and increased capitalization.
In 1997, net loans receivable increased by $245 million, or 23%, reflecting
continued strong demand for the Company's consumer and commercial loan
products. Balances of mortgage-backed securities increased $107 million, or
43%, as a consequence of the securitization of $86 million of the Bank's
residential mortgage loan production and purchases of collateralized mortgage
obligations ("CMOs"). All of the servicing rights for sold and securitized
mortgages were retained, resulting in an increase in the balances of loans
serviced for others from $415 million to $519 million during the year.
The Company's liabilities increased by 22%, or $302 million, to $1.69 billion
at December 31, 1997, compared to $1.39 billion at the end of 1996. Overall
deposit balances
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MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.)
increased by 8.2%, or $79.0 million, while core deposits experienced an 8.3%
increase from $346.1 million at December 31, 1996, to $374.8 million at year-
end 1997. Borrowed funds increased by 53%, or $215 million, in 1997, while
advance payments by borrowers and investors held in escrow increased from $11.8
million to $17.6 million.
In 1997, D&N's common stockholders' equity rose from $86.1 million to $98.1
million. Profitable operations contributed $14.3 million to the Company's
retained earnings while the proceeds from the exercise of options and
accompanying tax benefits added $1.2 million to the equity accounts. Cash
dividends and purchases of Treasury Stock returned $3.8 million to shareholders
in 1997. An additional source of equity in 1997 was $1.5 million of
market-value in excess of book-value attributable to investment and
mortgage-backed securities held for sale. In accordance with the provisions of
the Statement of Financial Accounting Standards ("SFAS") 115, "Accounting for
Certain Investments in Debt and Equity Securities", unrealized gains such as
these are recorded in the stockholders' equity section of the Company's
Statement of Financial Condition, but are not recognized through the Statement
of Operations.
Under its federal charter, the Bank must maintain adequate levels of capital to
assure the safety and soundness of its operations. At December 31, 1997, the
Bank had a tangible capital ratio of 6.55%, a core capital ratio of 6.55%, and
a risk-based capital ratio of 11.98%. D&N Bank's ratios continue to exceed the
levels specified in the Financial Institutions Reform, Recovery and Enforcement
Act ("FIRREA" or "the Act") as minimally acceptable standards. At the close of
1997, those minimum standards were tangible capital of 1.50%, core capital of
3.0% (with a proposed regulation which would raise the core capital requirement
to between 4.00% and 5.00%), and risk-based capital of 8.00%.
The Bank's primary regulator, the Office of Thrift Supervision ("OTS"), prompt
corrective action regulations establish five capital categories for thrift
institutions: well capitalized, adequately capitalized, undercapitalized,
severely undercapitalized and critically undercapitalized. These categories are
determined for the supervisory purposes of Section 38 of the Federal Deposit
Insurance Act (which establishes a system of mandatory and discretionary
supervisory actions which generally become more severe as capital levels
decline) and may not necessarily constitute an accurate measure of the Bank's
current overall financial condition or its future prospects. A thrift generally
will be considered "well capitalized" if it has a core capital (or leverage)
ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0% and
a total risk-based capital ratio of at least 10.0%. A thrift generally will be
considered "adequately capitalized" if it has a core capital (or leverage)
ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0%, and
a total risk-based capital ratio of at least 8.0%. The Bank's core (or
leverage), Tier 1 risk-based and total risk-based capital ratios at December
31, 1997 of 6.55%, 11.02% and 11.98%, respectively, exceeded the capital ratios
established for "well capitalized" institutions.
The OTS issued rules adding an interest rate risk component to the total
capital that certain rate-sensitive institutions must maintain. The rule
requires the OTS to measure an institution's interest rate risk as the
percentage change in market value of its portfolio resulting from a
hypothetical 200 basis point shift in interest rates. At December 31, 1997,
D&N's level of interest rate risk was such that no additional capital was
required.
LIQUIDITY AND CAPITAL RESOURCES
The OTS also requires that institutions maintain liquid assets in the form of
cash, U.S. Government securities, mortgage-backed securities and other
qualifying assets, in amounts equal to at least 4% of net withdrawable accounts
and borrowed funds payable in one year or less. For the month of December 1997,
the Bank's average
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liquidity ratio was 13.9%, up from the December 1996 ratio of 6.61%.
Borrowing capacity can be viewed as a supplemental source of liquidity for the
Bank. D&N's government bond and mortgage-backed securities portfolios include
high quality investment securities which are readily acceptable as collateral
for additional borrowed funds, obtainable from either the FHLB system or from
other financial institutions. Also, much of the Bank's residential mortgage
loan portfolio would be acceptable as collateral to support new advances from
the FHLB. In the aggregate, by virtue of its inventory of unpledged security
and mortgage loan collateral, D&N had approximately $187 million of unused
borrowing capacity at December 31, 1997.
Loan Portfolio
The following table categorizes the Bank's loans receivable for the past five
years:
DECEMBER 31
--------------------------------------------------------
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands)
Residential mortgages $ 703,580 $ 600,923 $597,892 $526,572 $387,252
Mortgages on income-producing property 81,830 85,619 89,176 115,162 131,372
Construction loans 56,446 39,673 41,056 19,900 12,558
Consumer loans 449,551 339,268 239,459 170,939 134,644
Commercial loans 38,435 12,345 7,769 4,748 --
Allowance for losses (10,549) (11,042) (10,081) (8,349) (11,570)
Discounts, deferrals and other (18,334) (10,910) (12,912) (7,097) (7,547)
-----------------------------------------------------------
$1,300,959 $1,055,876 $952,359 $821,875 $646,709
===========================================================
D&N's investment in loans increased by $245 million, or 23%, in 1997. Consumer
loans and commercial loans experienced the most significant percentage
increases, while residential mortgages grew at a more modest rate. The Bank's
investment in mortgages on income-producing properties decreased for the seventh
consecutive year while the year-end balance of construction loans was up
markedly from the previous year. Consumer loans increased by $110 million, or
33% in 1997. Commercial loans increased by $26 million, or 211%, while
residential mortgage loans increased during the year by $103 million, or 17%.
Mortgages on income-producing properties decreased by $3.8 million, or 4.4%,
while construction loan balances increased by $16.8 million, or 42.3%. At the
end of 1997, 47% of the Company's loan balances were in consumer or
business-related loans, compared to a 44% weighting at the end of 1996. D&N
originated $622 million of loans in 1997, up $103 million, or 19.8% from $519
million originated in 1996. Consumer loan production totaled $324 million in
1997, up by $52.1 million, or 19.2%, from 1996. Aggregate mortgage production in
1997 was $261 million, an increase of $33 million, or 14.4%, from 1996.
Construction lending accounted for $54.0 million of this total, up 26% from
$42.9 million in 1996. Supplementing the Company's mortgage production was $235
million of purchased loans in 1997, up from $148 million in 1996.
CREDIT RISK MANAGEMENT AND PROVISION
FOR LOSSES ON LOANS AND OTHER ASSETS
At December 31, 1997, the Company's nonperforming assets totaled $5.3 million,
down from $8.1 million at the end of the previous year and $9.7 million at the
end of 1995. The 1997 balance was comprised of $3.8 million of nonperforming
loans and $1.5 million of other real estate owned ("OREO"). At the end of 1997,
nonperforming loans comprised just 0.29% of the loan portfolio, and the
allowance for loan losses stood at 276% of the total balances of nonperforming
loans.
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MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.)
The following table traces the Company's nonperforming asset experience for the
last five years.
December 31
------------------------------------------
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------
(Dollars in thousands)
Nonaccruing loans $3,552 $6,621 $8,225 $17,995 $30,102
Accruing loans delinquent more than 90 days 274 -- 24 5 13
Restructured loans -- -- -- -- 166
-------------------------------------------
Total nonperforming loans 3,826 6,621 8,249 18,000 30,281
Other real estate owned (OREO) 1,474 1,470 1,452 6,520 13,312
-------------------------------------------
Total nonperforming assets $5,300 $8,091 $9,701 $24,520 $43,593
===========================================
Nonperforming loans as a percentage
of total loans 0.29% 0.62% 0.86% 2.17% 4.60%
===========================================
Nonperforming assets as a percentage
of total assets 0.29% 0.55% 0.79% 2.17% 4.04%
===========================================
Allowance for loan losses as a percentage of
nonperforming loans 275.72% 166.77% 122.21% 46.38% 38.21%
===========================================
Allowances for loan and OREO losses as a
percentage of nonperforming assets 199.04% 136.47% 105.29% 35.40% 28.03%
===========================================
Allowances for losses on the loan portfolio totaled $10.5 million at December
31, 1997. Losses of $2.18 million were charged off and $340,000 was recovered,
as new provisions for loan losses of $1.35 million were recorded during
the year. At year-end, the allowance for loan losses represented .80% of the
total outstanding loan portfolio balance.
The following table details the changes in the Company's allowance for loan
losses for the last five years.
Year Ended December 31
---------------------------------------------
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of period $11,042 $10,081 $ 8,349 $11,570 $15,611
Charge-offs:
Residential mortgages 290 314 169 110 1,136
Mortgages on income-producing property 277 -- 1,019 3,109 2,584
Commercial loans -- -- -- -- --
Consumer loans 1,616 1,216 999 773 681
--------------------------------------------
2,183 1,530 2,187 3,992 4,401
Recoveries:
Residential mortgages -- 3 917 9 25
Mortgages on income-producing property -- 1,098 245 300 8
Commercial loans -- -- -- -- --
Consumer loans 340 290 357 362 327
--------------------------------------------
340 1,391 1,519 671 360
Net charge-offs 1,843 139 668 3,321 4,041
Provision charged to operations 1,350 1,100 2,400 100 --
--------------------------------------------
Balance at end of period $10,549 $11,042 $10,081 $ 8,349 $11,570
============================================
Net charge-offs as a percentage of
average loans 0.15% 0.01% 0.07% 0.43% 0.59%
============================================
Allowance for loan losses as a percentage of
total loans 0.80% 1.03% 1.05% 1.01% 1.76%
============================================
At the end of 1997, $5.4 million of the allowance for loan losses was allocated
to the commercial real estate mortgage portfolio while $4.2 million of the
allowance was allocated to the consumer loan portfolio.
18
9
The following table summarizes the allocation of the allowance for loan losses
among the Company's assets in each of the past five years.
December 31
------------------------------------------------------------------------------
1997 1996 1995
------------------------------------------------------------------------------
Percentage of Percentage of Percentage of
Amount loans to total Amount loans to total Amount loans to total
- -----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Residential mortgages $ 569 54% $ 859 57% $ 1,170 63%
Mortgages on income-producing property 5,386 9% 6,314 10% 6,115 11%
Commercial loans 400 3% 400 1% 400 1%
Consumer loans 4,194 34% 3,469 32% 2,396 25%
-------------------------------------------------------------------------------
$10,549 100% $11,042 100% $10,081 100%
===============================================================================
----------------------------------------------
1994 1993
----------------------------------------------
Percentage of Percentage of
Amount loans to total Amount loans to total
- --------------------------------------------------------------------------------------
(Dollars in thousands)
Residential mortgages $ 813 63% $ 429 60%
Mortgages on income-producing property 6,423 17% 9,617 19%
Commercial loans -- -- -- --
Consumer loans 1,113 20% 1,524 21%
----------------------------------------------
$8,349 100% $11,570 100%
==============================================
ANALYSIS OF CASH FLOWS
The Company's balances of cash and cash equivalents increased from $12.8
million to $20.5 million in 1997. During the year, $326 million of cash was
provided from financing activities, primarily from expanded borrowings and
increases in customers' deposit balances. Investing activities utilized $378
million of available cash and cash equivalents as loan purchases,
mortgage-backed security purchases, and purchases of investment securities
exceeded repayments in these categories. Operating activities provided $59.2
million of net cash in 1997.
ASSET/LIABILITY MANAGEMENT
The Company's objectives for the management of assets and liabilities include
achieving and maintaining adequate and stable levels of both net interest
income and market value for the Company's net assets. The level of net interest
income that can be attained is enhanced by assuming credit, liquidity and
interest rate risks and by striving to keep nonearning asset balances to a
minimum. Net interest income and market value of portfolio equity ("MVPE")
stability is enhanced across various interest rate scenarios by properly
matching maturity structures of assets and liabilities.
The Company employs various tools, including gap analysis, duration analysis
and simulation analysis, to assess the sensitivity of its net interest income
and MVPE to changes in interest rates. D&N's cumulative gap analysis for
December 31, 1997 is found on the following page.
19
10
Management's Discussion And Analysis (cont.)
For each maturity category in the table below, the difference between
interest-earning assets and interest-bearing liabilities reflects an imbalance
between repricing opportunities for the two sides of the balance sheet. The
consequence of a negative cumulative gap at the end of one year suggests that,
if interest rates were to fall, the Company's earnings stream would be enhanced
as more liability balances would reprice to lower rates than would asset
balances. Similarly, the negative cumulative gap suggests that if interest
rates were to rise, liability costs would increase more quickly than asset
yields, placing negative pressure on earnings.
With a cumulative one-year gap of (13.19)%, D&N's balance sheet is liability
sensitive. At year-end, however, 42.0% of the Bank's loan portfolio carried
variable or adjustable interest rates, and a growing proportion of the
fixed-rate loan portfolio was comprised of relatively shorter-term consumer
installment loans.
The balances presented in the table below reflect contractual repricings for
certificates of deposit. Certain demand deposit accounts and regular savings
accounts, however, have been classified as repricing beyond one year. While
these accounts are subject to immediate withdrawal, experience has shown them
to be relatively rate insensitive. If these accounts were included in the 0-3
month category, the gap in that time frame would be negative $376 million and
the cumulative gap at twelve months would be negative $426 million.
Maturity
----------------------------------------------------------
0 to 3 4 to 12 1 to 5 Over 5
Months Months Years Years Total
- ----------------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets:
Cash and due from banks/others $ 20,497 $ -- $ -- $ -- $ 20,497
Investment securities 15,000 52,000 10,000 25,636 102,636
Mortgage-backed certificates 21,835 45,297 174,009 117,155 358,296
Net loans receivable 286,029 385,524 602,582 26,824 1,300,959
Other assets 8,791 1,934 3,831 18,371 32,927
-----------------------------------------------------------
TOTAL ASSETS $ 352,152 $ 484,755 $790,422 $187,986 $1,815,315
===========================================================
Liabilities:
Deposits $ 232,098 $ 430,244 $264,633 $116,192 $1,043,167
FHLB advances and other borrowed money 285,317 128,675 204,528 1,003 619,523
Escrow funds -- -- -- 17,585 17,585
Other liabilities -- -- -- 8,239 8,239
-----------------------------------------------------------
TOTAL LIABILITIES 517,415 558,919 469,161 143,019 1,688,514
===========================================================
Preferred Stock of Subsidiary -- -- -- 28,719 28,719
Stockholders' Equity:
Common stock -- -- -- 92 92
Additional paid-in capital -- -- -- 76,694 76,694
Retained earnings and other -- -- -- 22,877 22,877
Treasury stock -- -- -- (1,581) (1,581)
-----------------------------------------------------------
TOTAL LIABILITIES AND EQUITY $ 517,415 $ 558,919 $469,161 $269,820 $1,815,315
===========================================================
Reprice difference $(165,263) $ (74,164) $321,261 $(81,834)
Cumulative gap $(165,263) $(239,427) $ 81,834 $ --
Percent of total assets (9.10)% (13.19)% 4.51% --
20
11
The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 1997.
Maturity
----------------------------------------------------------------------------------------
Total
1998 1999 2000 2001 2002 Thereafter Fair Value
----------------------------------------------------------------------------------------
(Dollars in thousands)
Interest sensitive assets:
Loans receivable:
Real estate mortgages $ 222,294 $152,151 $130,218 $ 88,281 $ 66,332 $187,366 $ 846,642
Average interest rate 8.15% 8.02% 7.94% 8.00% 8.06% 7.80% 7.99%
Non-real estate commercial 11,580 6,308 7,037 5,956 3,905 2,920 37,706
Average interest rate 9.55% 9.42% 9.38% 9.36% 9.21% 9.16% 9.40%
Consumer 167,875 115,973 77,333 50,261 25,269 12,565 449,276
Average interest rate 9.17% 8.99% 9.03% 9.10% 9.28% 8.95% 9.08%
Mortgage-backed securities 49,301 41,754 36,370 31,796 27,918 170,383 357,522
Average interest rate 7.30% 7.21% 7.26% 7.28% 7.35% 7.09% 7.19%
Investment securities
and interest bearing deposits 61,994 4,040 4 4 -- 39,765 105,807
Average interest rate 5.95% 5.74% 4.80% 4.90% -- 7.85% 6.38%
Mortgage servicing assets 358 305 259 220 187 1,060 2,389
-------------------------------------------------------------------------------------
Total interest sensitive assets $ 513,402 $320,531 $257,221 $176,518 $ 123,611 $414,059 $1,799,342
=====================================================================================
Interest sensitive liabilities:
Deposits:
NOW accounts $ 23,287 $ 12,588 $ 7,553 $ 3,776 $ 3,147 $ 12,588 $ 62,939
Average interest rate 1.51% 1.51% 1.51% 1.51% 1.51% 1.51% 1.51%
Savings deposits 27,694 22,816 16,302 12,229 8,156 75,922 163,119
Average interest rate 2.92% 2.99% 3.04% 3.08% 3.16% 3.33% 3.16%
Money-market accounts 72,928 6,462 3,693 2,769 1,846 4,616 92,314
Average interest rate 4.02% 4.02% 4.02% 4.02% 4.02% 4.02% 4.02%
Certificates of deposit 534,960 78,868 25,766 10,007 8,066 15,647 673,314
Average interest rate 5.86% 6.28% 6.20% 5.93% 6.22% 5.96% 5.93%
Borrowings:
Securities sold under
agreements to repurchase 149,092 -- -- -- -- -- 149,092
Average interest rate 5.80% -- -- -- -- -- 5.80%
FHLB Advances and
Other borrowed money 215,167 180,767 71,231 621 534 4,169 472,489
Average interest rate 5.86% 6.01% 5.96% 10.04% 10.04% 8.75% 5.97%
-------------------------------------------------------------------------------------
Total interest sensitive
liabilities $1,023,128 $301,501 $124,545 $ 29,402 $ 21,749 $112,942 $1,613,267
=====================================================================================
Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon
contractual maturity, projected repayments and prepayments of principal. The
prepayment assumptions are based on the Company's own historical experience.
The assumptions used to present deposit balances are essentially the same as
those used in the gap analysis. The actual maturities of these instruments
could vary substantially if future prepayments differ from the Company's
historical experience.
21
12
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.)
SIGNIFICANT LITIGATION
In 1989, the Financial Institutions Reform, Recovery and Enforcement Act
("FIRREA" or "the Act") was passed, significantly altering the regulatory
environment in which depository institutions in general, and the Company in
particular, would subsequently operate. A provision of the Act provided for the
elimination, over time, of one form of regulatory capital that many
institutions, including D&N Bank, had utilized in their capital structures. The
phased elimination of supervisory goodwill, an intangible asset previously
created when companies such as D&N acquired weaker institutions, resulted in
many of the affected companies experiencing capital shortfalls. In D&N's case,
$42 million of unamortized supervisory goodwill was permitted to be counted as
regulatory capital in 1989 at the time of the Act's passage, while $37 million
remained in 1993 when its phase-out as qualifying capital was complete. The loss
of this significant portion of D&N's regulatory capital base precipitated
drastic changes in the Company's strategic plans, including the 56% shrinkage of
the balance sheet from $2.3 billion in 1988 to $1.0 billion in 1993, the closure
of the Company's national network of mortgage origination offices, the
elimination of many jobs, and the cessation of stockholder dividends.
A number of institutions, including D&N Bank, that were adversely affected by
the FIRREA legislation subsequently initiated legal actions against the United
States Government. The institutions have claimed that the inducements offered
by federal regulatory agencies to acquire weakened or insolvent thrifts
constituted contractual agreements that the goodwill created through the
acquisition transactions would qualify as regulatory capital. FIRREA's mandated
phase-out of regulatory capital treatment for supervisory goodwill, then, has
been alleged to be a breach of a contract right. The United States Court of
Federal Claims has registered approximately 120 similar cases, including D&N's,
which seek damages for such breach.
Early cases were bifurcated into questions of liability and damages, with the
trial courts reasoning that, until the question of the government's liability
was unequivocally established, efforts to determine damages or to develop
damage theories were potentially irrelevant. Three early cases have proceeded
through the Court of Claims, and after consolidation, through the Federal
Circuit of the United States Court of Appeals, and the United States Supreme
Court. In July of 1996, the Supreme Court found generally that the United
States was liable for damages under a theory of contractual breach, and that
claims of governmental immunity were not applicable in these cases. The cases
were remanded to the Court of Claims where arguments concerning the extent of
damages began in 1997.
In consideration of the complexities of the pending litigation, the similarity
of issues in the various cases, and the potential magnitude of the damage
amounts that might ultimately be awarded, the Court of Claims has issued a case
management order on the remaining cases, in essence creating an orderly
procedure for these lawsuits, including D&N's suit, to proceed. Estimation of
potential liability or damages from this action is speculative at this time.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
130, "Reporting Comprehensive Income", and SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains, and losses) in a full set of general-purpose
financial statements. SFAS 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements. It also requires companies to report selected information
about operating segments in interim financial reports issued to shareholders.
These standards will be adopted effective January 1, 1998 and are not expected
to have any material effect on the Company's financial statements.
22
13
OTHER ITEMS
D&N utilizes various electronic computer systems for the delivery of its
financial services products such as deposit accounts and loans, for the
maintenance of its financial and other business records, and for general
management purposes. Some of these systems include legacy procedures that may
have been designed and historic data that may have been stored in such a manner
that inconsistencies or failures might occur when dates from the new millennium
are considered. Commonly known as the Year 2000 problem, a myriad of related
potential computing difficulties face entities that rely extensively upon
computer systems. D&N's major computer systems include deposit accounts,
commercial lending, consumer lending, financial control, and sales platform
support applications provided by M&I Data Services, Inc.; mortgage lending
applications provided by ALLTEL Information Services, Inc. and FiTech, Inc.; and
internally maintained micro-computer and network systems which support
management functions and communications. D&N is working closely with its data
services vendors to ascertain that their applications, upon which the Bank
relies, will be certifiable as compliant by the end of 1998.
D&N has determined that its internally maintained systems, consisting primarily
of a Lotus Notes server array and various workstation-based business suite
software, are Year 2000 compliant as currently installed.
Costs associated with addressing the Year 2000 issue as it affects D&N's
externally vended applications, is implicitly included in the contractual
arrangements for those applications. Accordingly, D&N's duty is to monitor the
progress of its vendors toward the attainment of compliance and to test for
compliance. Where progress is acceptable and timely compliance is deemed
likely, no material costs of addressing the Year 2000 issue are imputable to
D&N. At this time, D&N deems the progress attained by each of its service
bureau vendors to achieve Year 2000 compliance in a timely fashion to be
acceptable. Accordingly, the potential cost of addressing the Year 2000 issue
is not expected to be material to D&N's business, operations or financial
condition.
The operations of D&N Financial Corporation, and the financial services
industry generally, are influenced by many factors, including the interest rate
environment, competition, legislative and regulatory developments and general
economic conditions.
Except for the historical information contained in this
report, certain statements made herein are forward-looking statements that
involve risks and uncertainties and are subject to various factors that could
cause actual results to differ materially from these statements. Factors that
might cause such a difference include, but are not limited to: regional and
national economic conditions, substantial changes in levels of market interest
rates, credit and other risks of lending and investment activities and
competitive and regulatory factors.
23
14
REPORT OF INDEPENDENT AUDITORS
[COOPERS & LYBRAND LETTERHEAD]
BOARD OF DIRECTORS AND STOCKHOLDERS
D&N FINANCIAL CORPORATION
We have audited the Consolidated Statements of Condition of D&N Financial
Corporation and Subsidiary as of December 31, 1997 and 1996, and the related
Consolidated Statements of Income, Stockholders' Equity and Cash Flows for each
of the three years in the period ending December 31, 1997. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of D&N Financial
Corporation and Subsidiary at December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ending December 31, 1997, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
Detroit, Michigan
January 22, 1998
24
15
CONSOLIDATED STATEMENTS OF CONDITION
D&N FINANCIAL CORPORATION
December 31
--------------------------------
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
ASSETS
Cash and due from banks $ 16,239 $ 2,847
Federal funds sold 300 8,600
Interest-bearing deposits in other banks 3,958 1,342
-------------------------------
Total cash and cash equivalents 20,497 12,789
Investment securities
(market value of $56,594,000 in 1997 and $60,783,000 in 1996) 56,524 60,739
Investment securities available for sale (at market value) 46,112 59,038
Mortgage-backed securities
(market value of $199,525,000 in 1997 and $213,304,000 in 1996) 198,050 214,690
Mortgage-backed securities available for sale (at market value) 160,246 36,566
Loans receivable (including loans held for sale of $5,275,000 in 1997
and $5,218,000 in 1996) 1,311,508 1,066,918
Allowance for loan losses (10,549) (11,042)
-------------------------------
Net loans receivable 1,300,959 1,055,876
Other real estate owned, net 1,474 1,470
Federal income taxes 1,129 6,002
Office properties and equipment, net 16,621 15,764
Other assets 13,703 10,120
-------------------------------
$ 1,815,315 $ 1,473,054
LIABILITIES ===============================
Checking and NOW accounts $ 119,412 $ 107,550
Money market accounts 92,314 89,321
Savings deposits 163,119 149,226
Time deposits 667,204 617,102
Accrued interest 1,118 934
-------------------------------
Total deposits 1,043,167 964,133
Securities sold under agreements to repurchase 149,092 58,040
FHLB advances and other borrowed money 470,431 345,997
Advance payments by borrowers and investors held in escrow 17,585 11,808
Other liabilities 8,239 6,955
-------------------------------
Total liabilities 1,688,514 1,386,933
PREFERRED STOCK OF SUBSIDIARY 28,719 --
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value per share (1,000,000 shares authorized; none issued)
Common stock, $.01 par value per share (shares authorized - 25,000,000; -- --
shares outstanding - 9,197,224 in 1997 and 8,370,494 in 1996) 92 84
Additional paid-in capital 77,025 55,452
-------------------------------
Total paid-in capital 77,117 55,536
Retained earnings - substantially restricted 21,042 29,568
Less: Cost of treasury stock (98,129 shares in 1997 and 22,339 in 1996) (1,581) (226)
Unrealized holding gains on debt securities available for sale, net of tax 1,504 1,243
-------------------------------
Total stockholders' equity 98,082 86,121
-------------------------------
$ 1,815,315 $ 1,473,054
===============================
See Notes to Consolidated Financial Statements.
25
16
CONSOLIDATED STATEMENTS OF CONDITION
D&N FINANCIAL CORPORATION
Year Ended December 31
-------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share)
INTEREST INCOME
Loans $ 98,560 $ 86,151 $ 72,550
Mortgage-backed securities 19,085 10,930 10,577
Investments and deposits 8,048 7,228 7,638
--------------------------------------------
Total interest income 125,693 104,309 90,765
INTEREST EXPENSE
Deposits 47,961 43,859 38,639
Securities sold under agreements to repurchase 5,571 2,193 1,450
FHLB advances and other borrowed money 23,222 15,494 13,405
Interest rate instruments -- -- 2,521
--------------------------------------------
Total interest expense 76,754 61,546 56,015
--------------------------------------------
Net interest income 48,939 42,763 34,750
Provision for loan losses 1,350 1,100 2,400
--------------------------------------------
Net interest income after provision for loan losses 47,589 41,663 32,350
NONINTEREST INCOME
Loan servicing and administrative fees, net 1,916 1,914 1,882
Deposit related fees 4,080 3,621 3,147
Gain on sale of loans held for sale 1,728 1,031 882
Other income 657 470 222
--------------------------------------------
8,381 7,036 6,133
Gain (loss) on investment securities available for sale -- 188 (120)
Gain on loans and mortgage-backed securities available for sale 539 -- 899
--------------------------------------------
Total noninterest income 8,920 7,224 6,912
NONINTEREST EXPENSE
Compensation and benefits 17,881 16,881 15,732
Occupancy 3,110 2,834 2,273
Other expense 11,655 11,863 10,713
--------------------------------------------
General and administrative expense 32,646 31,578 28,718
Other real estate owned, net (81) 71 (999)
Amortization of intangibles -- -- 370
FDIC insurance 658 7,894 2,431
--------------------------------------------
Total noninterest expense 33,223 39,543 30,520
--------------------------------------------
Income before income tax expense 23,286 9,344 8,742
Federal income tax expense (credit) 7,743 349 (1,675)
--------------------------------------------
Income before preferred stock dividends 15,543 8,995 10,417
Preferred stock dividend of subsidiary 1,218 -- --
--------------------------------------------
NET INCOME $ 14,325 $ 8,995 $ 10,417
============================================
Earnings per share:
Basic $ 1.58 $ 1.08 $ 1.27
============================================
Diluted $ 1.53 $ 1.01 $ 1.24
============================================
See Notes to Consolidated Financial Statements.
26
17
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
D&N FINANCIAL CORPORATION
Unrealized
Holding
Treasury Gains (Losses)
Additional Stock & Leveraged on Securities Total
Common Paid-In Retained Treasury ESOP Available Stockholders'
Stock Capital Earnings Warrants Debt for Sale Equity
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Balance December 31, 1994 $ 74 $ 49,591 $ 10,156 $ (213) $ (99) $ (1,184) $ 58,325
Net income -- -- 10,417 -- -- -- 10,417
Issuance of common stock
upon exercise of stock options
and warrants - 60,886 shares 1 345 -- -- -- -- 346
Purchase of 11,000 warrants -- -- -- (44) -- -- (44)
Reduction of leveraged ESOP debt -- -- -- -- 36 -- 36
Change in value of securities
available for sale -- -- -- -- -- 2,899 2,899
-------------------------------------------------------------------------------
Balance December 31, 1995 $ 75 $ 49,936 $ 20,573 $ (257) $ (63) $ 1,715 $ 71,979
Net income -- -- 8,995 -- -- -- 8,995
Issuance of common stock upon
exercise of stock options and
warrants - 960,508 shares 9 9,046 -- -- -- -- 9,055
Purchase of treasury stock
and warrants -- -- -- (3,499) -- -- (3,499)
Reissuance of 256,251
treasury shares -- (3,530) -- 3,530 -- -- --
Reduction of leveraged ESOP debt -- -- -- -- 63 -- 63
Change in value of securities
available for sale -- -- -- -- -- (472) (472)
-------------------------------------------------------------------------------
Balance December 31, 1996 $ 84 $ 55,452 $ 29,568 $ (226) $ -- $ 1,243 $ 86,121
Net income -- -- 14,325 -- -- -- 14,325
Cash dividends, common stock
($0.10 per share) -- -- (826) -- -- -- (826)
10% common stock dividend, at
fair market value 8 22,017 (22,025) -- -- -- --
Issuance of common stock upon
exercise of stock options -
98,681 shares -- 1,196 -- -- -- -- 1,196
Purchase of treasury stock -- -- -- (2,995) -- -- (2,995)
Reissuance of 98,681 treasury shares -- (1,640) -- 1,640 -- -- --
Change in value of securities
available for sale -- -- -- -- -- 261 261
-------------------------------------------------------------------------------
Balance December 31, 1997 $ 92 $ 77,025 $ 21,042 $ (1,581) $ -- $ 1,504 $ 98,082
===============================================================================
See Notes to Consolidated Financial Statements.
27
18
CONSOLIDATED FINANCIAL STATEMENTS
D&N FINANCIAL CORPORATION
Year Ended December 31
-----------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 14,325 $ 8,995 $ 10,417
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,350 1,100 2,400
Depreciation & amortization of office properties & equipment . . 1,987 1,954 1,843
Amortization of net discounts on purchased
loans and securities (925) (73) (2,395)
Originations and purchases of loans held for sale (47,928) (56,132) (91,203)
Proceeds from sales of loans held for sale 89,889 73,658 75,928
(Gain)loss on investment securities available for sale -- (188) 120
Gain on loans and mortgage-backed securities available for sale (539) -- (899)
Amortization and writedowns of mortgage servicing rights 543 300 476
Other 519 (2,635) (7,888)
-----------------------------------------
Net cash provided (used) by operating activities 59,221 26,979 (11,201)
INVESTING ACTIVITIES
Proceeds from sales of investment securities available for sale 20 298 10,070
Proceeds from maturities of investment securities 202,066 83,970 44,025
Purchases of investment securities to be held to maturity (184,903) (107,012) (60,309)
Proceeds from sales of mortgage-backed securities available for sale 24,094 -- 4,145
Proceeds from sales of loans -- -- 33,535
Principal collected on mortgage-backed securities 64,150 54,951 22,077
Purchases of mortgage-backed securities (107,400) (58,661) --
Loans purchased (234,886) (148,405) (103,524)
Net change in loans receivable (137,882) (94,006) (43,299)
(Increase) decrease in other real estate owned (4) (151) 4,871
Purchases of office properties and equipment (2,824) (2,868) (2,333)
-----------------------------------------
Net cash used by investing activities (377,569) (271,884) (90,742)
FINANCING ACTIVITIES
Increase in time deposits 50,102 23,058 94,581
Increase in other deposits 28,748 18,666 10,510
Proceeds from notes payable, securities sold under agreements
to repurchase and other borrowed money 513,052 309,040 203,000
Payments on maturity of notes payable, securities sold under
agreements to repurchase and other borrowed money (297,717) (121,482) (213,851)
Net change in advance payments by borrowers and investors
held in escrow 5,777 479 (4,022)
Common stock cash dividend (826) -- --
Net proceeds from issuance of stock 1,196 9,055 346
Purchases of treasury stock/warrants (2,995) (3,499) (44)
Proceeds from issuance of subsidiary preferred stock 28,719 -- --
Reduction of leveraged ESOP debt -- (63) (36)
-----------------------------------------
Net cash provided by financing activities 326,056 235,254 90,484
-----------------------------------------
Increase (decrease) in cash and cash equivalents 7,708 (9,651) (11,459)
Cash and cash equivalents at beginning of year 12,789 22,440 33,899
-----------------------------------------
Cash and cash equivalents at end of year $ 20,497 $ 12,789 $ 22,440
=========================================
Supplemental disclosures of cash flow information:
Interest paid $ 75,416 $ 61,689 $ 60,222
Income taxes paid $ 2,027 $ 299 $ 397
Noncash investing activities:
Transfer of loans to other real estate owned $ 961 $ 3,373 $ 1,936
Securitization of loans into mortgage-backed securities $ 86,066 $ 119,717 $ --
See Notes to Consolidated Financial Statements.
28
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
D&N FINANCIAL CORPORATION DECEMBER 31, 1997
NOTE A: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
D&N Financial Corporation ("the Company") is a financial services holding
company whose sole subsidiary is D&N Bank ("the Bank"), a federally-chartered
stock savings bank. D&N Financial Corporation's primary business is the delivery
of financial services to consumers and businesses through its network of 48
community banking and financial services offices in Michigan.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts and transactions of the Company and the Bank and the Bank's
wholly-owned subsidiaries. Significant intercompany accounts and transactions
have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates and assumptions.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents represent short-term highly
liquid investments with original maturities of three months or less and include
cash, demand deposits in other banks and interest-bearing deposits in other
banks.
INVESTMENT CLASSIFICATIONS: Securities are classified as either held to maturity
(amortized cost), trading (fair value, with unrealized gains and losses reported
in income), or available for sale (fair value, with unrealized gains and losses
reported directly in equity, net of taxes).
INVESTMENT AND MORTGAGE-BACKED SECURITIES: Investment and mortgage-backed
securities which the Company has the ability and the intent to hold until
maturity are stated at amortized cost. Investment and mortgage-backed securities
available for sale are carried at fair value. Fair value adjustments are
included in stockholders' equity, net of tax. Gains or losses realized on the
sale of investment and mortgage-backed securities are determined by the specific
identification method and are included in securities gains (losses). Interest
income is adjusted using the level-yield method for amortization of premiums and
accretion of discounts.
MORTGAGE DERIVATIVE PRODUCTS: The Bank's interest only certificates are
classified as available for sale and are recorded at fair value. Fair value
adjustments are included in stockholders' equity and are classified on the
Statements of Condition with mortgage-backed securities.
ALLOWANCE FOR LOAN LOSSES: A loan is considered impaired, based on current
information and events, if it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
is generally based on the present value of expected future cash flows discounted
at the historical effective interest rate, except that all collateral-dependent
loans are measured for impairment based on the fair value of the collateral.
The allowance for possible losses on loans is maintained at a level believed
adequate by management to absorb potential losses from impaired loans as well as
losses from the remainder of the portfolio. Management's determination of the
level of the allowance is based upon evaluation of the portfolio, past
experience, current economic conditions, size and composition of the portfolio,
collateral location and values, cash flow positions, industry concentrations,
delinquencies and other relevant factors.
MORTGAGE LOANS HELD FOR SALE: The Bank enters into commitments to originate and
does originate mortgage loans for sale to investors and in the secondary market.
Loans held for sale are carried at the lower of cost or market value, determined
on an aggregate basis. Commitment fees are amortized either over the commitment
period or the combined commitment and loan period depending upon the probability
of performance under the commitment.
INTEREST ON LOANS: Interest on loans is credited to income when earned. An
allowance for interest on loans is provided when management considers the
collection of these loans doubtful and the accrual of interest is usually
suspended when a loan becomes more than 90 days past due.
LOAN FEES: Loan origination and commitment fees and certain direct loan
origination costs are deferred and recognized over the lives of the related
loans as an adjustment of the yields using the level-yield method.
29
20
OTHER REAL ESTATE OWNED: Real estate acquired through foreclosure and similar
proceedings is recorded at estimated fair value of the property, less cost to
dispose of, at the acquisition date. Operating expenses of such properties, net
of any income, are charged to expense.
DEPRECIATION: Provisions for depreciation are computed using the straight-line
method over the estimated useful lives of office properties and equipment, as
follows: buildings - 40 years; leasehold improvements - life of lease; furniture
and fixtures - 15 years; and computers - 3 years.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The Company enters into sales of
investment and mortgage-backed securities under agreements to repurchase the
same or essentially identical securities. The agreements are short-term and are
accounted for as secured borrowings. The obligations to repurchase securities
sold are reflected as a liability and the securities which collateralize the
agreements are reflected as an asset in the Consolidated Statements of
Condition.
CAPITALIZED MORTGAGE SERVICING RIGHTS: The Company services mortgage loans for
investors. Fees earned for and in connection with this activity are recognized
as income when the related mortgage payments are received. Mortgage servicing
costs are charged to expense as incurred.
As the Company acquires mortgage servicing rights through either the purchase or
origination of mortgage loans and sells or securitizes those loans with
servicing rights retained, it must allocate the total cost of the mortgage loans
to the mortgage servicing rights and the loans (without the mortgage servicing
rights) based on their relative fair values. Capitalized mortgage servicing
rights are reported in other assets. The capitalized cost of mortgage servicing
rights is amortized in proportion to, and over the period of, estimated net
servicing income (servicing revenue in excess of servicing costs), into
noninterest income.
Capitalized mortgage servicing rights are periodically assessed for impairment
based on the fair value of those rights calculated on a discounted basis. This
assessment is performed on a disaggregate basis, stratified by mortgage type,
term and rate. Identified impairments are recognized through a valuation
allowance.
As permitted by Statement of Financial Accounting Standards ("SFAS") 122,
"Accounting For Mortgage Servicing Rights", the Company adopted the provisions
of the Statement effective July 1, 1995. The effect of adopting SFAS 122 was to
increase net income for the year ended December 31, 1995 by $621,000 or $0.07
per share. The Company later adopted SFAS 125, "Accounting For Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities", effective
January 1, 1997, which had no material effect on the financial statements.
INCOME TAXES: The Company uses the liability method in accounting for income
taxes. Under this method, deferred income taxes result from temporary
differences between the tax bases of assets and liabilities and the bases
reported in the consolidated financial statements. The deferred taxes are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
PER SHARE DATA: The Company adopted SFAS 128 "Earnings per Share", for the year
ended December 31, 1997. The earnings per share for the years 1996 and 1995 have
been restated to comply with these standards.
Basic earnings per share is calculated by dividing net income by the average
number of shares outstanding during the applicable period.
The Company had stock options and warrants which are considered to be
potentially dilutive to common stock. Diluted earnings per share is calculated
by dividing net income by the average number of shares outstanding during the
applicable period adjusted for these potentially dilutive options and warrants.
30
21
The following table sets forth the computation of per share earnings as provided
in SFAS 128, and illustrates the dilutive effect of options and warrants
outstanding.
Year Ending December 31
------------------------------------------------------------------------------
1997 1996 1995
------------------------------------------------------------------------------
Earnings Earnings Earnings
Shares Per Share Shares Per Share Shares Per Share
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share earnings)
Basic EPS: 9,094 $ 1.58 8,337 $ 1.08 8,172 $ 1.27
Net dilutive effect of:
Stock options outstanding 271 (0.05) 167 (0.02) 134 (0.02)
Warrants outstanding -- -- 402 (0.05) 97 (0.01)
-----------------------------------------------------------------------------
Diluted EPS: 9,365 $ 1.53 8,906 $ 1.01 8,403 $ 1.24
=============================================================================
Options to purchase 107,800 shares of common stock at $19.26 to $24.37 per share
were outstanding at December 31, 1997. These options were not included in the
computation of diluted earnings per share, because the exercise prices were
greater than the average annual market price of the comon stock in 1997.
RECLASSIFICATIONS: Certain amounts in previously issued consolidated financial
statements have been reclassified to conform with the current year presentation.
All per share amounts have been restated to include the effects of a 10% stock
dividend and adoption of SFAS 128 in 1997.
NOTE B: BUSINESS COMBINATION
On April 10, 1996, Macomb Federal Savings Bank ("Macomb") was merged into the
Company. The Company issued 716,497 shares of common stock and cash in lieu of
fractional shares for all of the outstanding shares of Macomb. At the time of
the merger, Macomb had assets and stockholders' equity (unaudited) of
$41,932,000 and $6,268,000, respectively. The merger was accounted for as a
pooling-of-interests and accordingly, the financial statements have been
restated to include the results of Macomb.
A reconciliation of previously reported net interest income and net income is as
follows:
Three Months Ended Twelve Months Ended
March 31, 1996 December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars In thousands)
Net interest income (as previously reported) $ 9,465 $ 33,632
Macomb Federal Savings Bank - net interest income 217 1,118
---------------------------------------
Total net interest income $ 9,682 $ 34,750
=======================================
Net income (as previously reported) 3,497 10,140
Macomb Federal Savings Bank - net income (9) 277
---------------------------------------
Total net income $ 3,488 $ 10,417
=======================================
A reconciliation of per share income is as follows:
Three Months Ended Twelve Months Ended
March 31, 1996 December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share:
Net income (as previously reported) $ 0.47 $ 1.37
Macomb Federal Savings Bank (0.05) (0.10)
---------------------------------------
Basic earnings per share $ 0.42 $ 1.27
Diluted earnings per share: =======================================
Net income (as previously reported) $ 0.44 $ 1.33
Macomb Federal Savings Bank (0.04) (0.09)
---------------------------------------
Diluted earnings per share $ 0.40 $ 1.24
=======================================
31
22
NOTE C: NEW BANK SUBSIDIARY
D&N Capital Corporation ("D&N Capital") is a Delaware corporation incorporated
on March 18, 1997 for the purpose of acquiring and holding real estate assets
and is a Real Estate Investment Trust ("REIT"). All shares of common stock of
D&N Capital are owned by D&N Bank.
On July 17, 1997, D&N Capital sold 1.21 million shares of its 9.0% noncumulative
preferred stock, Series A with a liquidation preference of $25.00 per share
(totaling $30,250,000). As part of this transaction, D&N Capital received
$28,719,000 in net proceeds, after offering costs of $1,531,000. The Series A
Preferred Shares are generally not redeemable prior to July 1, 2002. On or after
July 1, 2002, the Series A Preferred Shares may be redeemed for cash at the
option of the Bank, in whole or in part, at a redemption price of $25.00 per
share.
The preferred shares are treated as Tier-1 Capital by the Bank, and are traded
on Nasdaq as DNFCP. During 1997, D&N Capital declared and paid preferred
dividends totaling $1,217,563.
NOTE E: INVESTMENT SECURITIES
Investment securities consisted of the following:
NOTE D: RESTRICTIONS ON CASH AND
NONINTEREST-BEARING BALANCES
The Company is required to maintain reserve balances with the Federal Reserve
Bank. The average amounts of those reserve balances for the years ended December
31, 1997 and December 31, 1996 were $452,000 and $418,000, respectively.
December 31
--------------------------------------------------------------
1997 1996
--------------------------------------------------------------
Book Market Book Market
Value Value Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
U.S. Treasury securities $ 33,299 $ 33,369 $ 40,737 $ 40,781
Investment in Federal Home Loan Bank stock 23,200 23,200 19,959 19,959
Other securities 25 25 43 43
--------------------------------------------------------------
Held to maturity 56,524 56,594 60,739 60,783
U.S. Treasury securities 44,764 44,860 57,996 58,000
Municipal bonds 148 148 -- --
Other securities 1,088 1,104 1,032 1,038
Valuation allowances 112 -- 10 --
--------------------------------------------------------------
Available for sale 46,112 46,112 59,038 59,038
--------------------------------------------------------------
$102,636 $102,706 $119,777 $119,821
==============================================================
32
23
An analysis of gross unrealized gains and losses is as follows:
December 31
----------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Held to maturity
U.S. Treasury securities $ 70 $ -- $ 79 $ (35)
------------------------------------------------------------------
70 -- 79 (35)
Available for sale
U.S. Treasury securities 97 (1) 31 (27)
Other securities 16 -- 6 --
------------------------------------------------------------------
113 (1) 37 (27)
------------------------------------------------------------------
$ 183 $ (1) $ 116 $ (62)
==================================================================
There were no sales of investment securities during 1997. Proceeds from sales of
investment securities available for sale during 1996 were $298,000. Gross gains
of $188,000 were realized on those sales. Proceeds from sales of investment
securities available for sale during 1995 were $10,070,000. Gross losses of
$120,000 were realized on those sales.
The book value and market value of investment securities at December 31, 1997,
by contractual maturity, were as follows:
Less than one year 1 - 5 Years
------------------------------------------------------------------------
Book Market Avg. Book Market Avg.
Value Value Yield Value Value Yield
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
U.S. Treasury securities held to maturity $33,299 $33,369 5.95% $ -- $ -- --%
U.S. Treasury securities available for sale 34,560 34,618 5.94 10,204 10,242 6.04
-------------------------------------------------------------------------
$67,859 $67,987 5.95% $10,204 $ 10,242 6.04%
==========================================================================
NOTE F: MORTGAGE-BACKED SECURITIES
Mortgage-backed securities consisted of the following:
December 31
-----------------------------------------------------------------
1997 1996
-----------------------------------------------------------------
Book Market Book Market
Value Value Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Government agency securities $ 112,156 $ 113,253 $ 127,677 $ 126,576
Collateralized mortgage obligations 84,788 84,987 85,755 85,311
Accrued interest receivable 1,285 1,285 1,417 1,417
Net discounts (179) -- (159) --
--------------------------------------------------------------------
Held to maturity 198,050 199,525 214,690 213,304
Government agency securities 86,658 88,145 18,815 19,255
Collateralized mortgage obligations 69,104 69,715 14,767 15,005
Interest-only certificates 378 1,422 639 2,023
Accrued interest receivable 964 964 283 283
Net premiums 940 -- 160 --
Valuation allowances 2,202 -- 1,902 --
--------------------------------------------------------------------
Available for sale 160,246 160,246 36,566 36,566
--------------------------------------------------------------------
$ 358,296 $ 359,771 $ 251,256 $ 249,870
====================================================================
Mortgage-backed securities with a carrying value of $20,851,000 are specifically
pledged as collateral for advances from the Federal Home Loan Bank of
Indianapolis and other borrowings.
33
24
(Note F: continued...)
An analysis of gross unrealized gains and losses is as follows:
December 31
-----------------------------------------------------------------
1997 1996
-----------------------------------------------------------------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Government agency securities $ 1,238 $ (368) $ 764 $(2,119)
Collateralized mortgage obligations 675 (70) 294 (325)
-----------------------------------------------------------------
Held to maturity 1,913 (438) 1,058 (2,444)
Government agency securities 743 (1) 287 (11)
Collateralized mortgage obligations 424 (8) 270 (28)
Interest only certificates 1,044 -- 1,384 --
-----------------------------------------------------------------
Available for sale 2,211 (9) 1,941 (39)
-----------------------------------------------------------------
$ 4,124 $ (447) $ 2,999 $(2,483)
=================================================================
Proceeds from sales of mortgage-backed securities available for sale during 1997
were $30,154,000. Gross gains of $543,000 and gross losses of $4,000 were
realized on those sales. There were no sales of mortgage-backed securities
during 1996. Proceeds from sales of mortgage-backed securities available for
sale during 1995 were $4,145,000. Gross gains of $267,000 were realized on those
sales, and there were no losses.
The book value and market value of mortgage-backed securities at December 31,
1997, by contractual maturity, were as follows:
Held to Maturity Available For Sale
----------------------------------------------------------------------------------------
Book Market Average Book Market Average
Value Value Yield Value Value Yield
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Government agency securities
Less than one year $ -- $ -- --% $ -- $ -- -- %
One to five years 731 737 7.00 -- -- --
Five to ten years 1,530 1,542 7.14 -- -- --
After ten years 110,121 110,974 7.04 87,403 88,145 7.08
----------------------------------------------------------------------------------------
112,382 113,253 7.04 87,403 88,145 7.08
Collateralized mortgage obligations
Less than one year -- -- -- -- -- --
One to five years -- -- -- -- -- --
Five to ten years -- -- -- -- -- --
After ten years 84,383 84,987 6.98 69,298 69,715 6.95
----------------------------------------------------------------------------------------
84,383 84,987 6.98 69,298 69,715 6.95
Interest-only certificates
Less than one year -- -- -- -- -- --
One to five years -- -- -- -- -- --
Five to ten years -- -- -- 3 12 139.66
After ten years -- -- -- 375 1,410 132.90
----------------------------------------------------------------------------------------
-- -- -- 378 1,422 132.96
----------------------------------------------------------------------------------------
$ 196,765 $198,240 7.02% $157,079 $ 159,282 7.33%
========================================================================================
Mortgage-backed securities will mature according to the repayment
characteristics of the underlying mortgage loans which collateralize the
securities. Expected maturities for the mortgage-backed securities will differ
from contractual maturities because borrowers have the right to prepay.
The aggregate book value and aggregate market value of the securities of any one
issuer, other than U.S. Government agencies, did not exceed 10% of stockholders'
equity at December 31, 1997 or 1996.
34
25
NOTE G: LOANS RECEIVABLE
The carrying amounts and fair values of loans receivable consisted of the
following:
December 31
----------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Residential mortgages $ 694,902 $ 706,459 $ 592,712 $ 598,390
Residential mortgages held for sale 5,275 5,275 5,218 5,218
Mortgages on income producing property 81,304 79,007 84,983 79,704
Construction loans 56,176 55,901 39,535 39,404
Consumer loans 446,710 449,276 337,178 338,180
Commercial loans 38,164 37,706 12,262 11,959
Accrued interest receivable 7,311 7,311 5,940 5,940
----------------------------------------------------------------------
1,329,842 1,340,935 1,077,828 1,078,795
Less:
Discounts on purchased loans (2,356) -- (2,035) --
Allowance for loan losses 10,549 -- 11,042 --
Undisbursed portion of loan proceeds 20,315 -- 12,085 --
Deferred income 375 -- 860 --
----------------------------------------------------------------------
$ 1,300,959 $ 1,340,935 $ 1,055,876 $ 1,078,795
======================================================================
Credit is extended based on evaluation of the borrower's financial condition,
the value of the collateral and, in the case of income producing property, the
sufficiency of net cash flows from the property's operation to service the debt.
When loans are made to businesses, personal guarantees may also be required of
owners or partners.
Loans collateralized by income producing property are categorized as follows:
December 31
---------------------------
1997 1996
- -------------------------------------------------------------------------------
(Dollars in thousands)
Shopping centers $22,185 $23,582
Multi-family apartments 19,913 25,404
Motels/hotels 11,491 13,540
Offices 6,905 6,667
Nursing homes 5,291 5,528
Industrial 4,774 4,565
Condominium development 4,240 1,826
Mobile home parks 2,118 3,625
Other 4,387 246
-----------------------
$81,304 $84,983
=======================
35
26
(Note G: continued...)
Loans collateralized by income producing property categorized by state are as
follows:
December 31
-------------------------
1997 1996
- ----------------------------------------------------------------
(Dollars in thousands)
Michigan $65,697 $65,645
California 11,008 11,738
New York 805 2,037
Pennsylvania 405 607
Other 3,389 4,956
-------------------------
$81,304 $84,983
=========================
Changes in the allowance for loan losses are summarized as follows:
1997 1996 1995
- --------------------------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of year $ 11,042 $ 10,081 $ 8,349
Provisions for loan losses 1,350 1,100 2,400
Net charge-offs (1,843) (139) (668)
-------------------------------------
Balance at end of year $ 10,549 $ 11,042 $ 10,081
=====================================
At December 31, 1997 and 1996, the total recorded investment in impaired loans,
as defined by SFAS 114 "Accounting by Creditors for Impairment of a Loan", was
$4,779,000 and $7,241,000, respectively. In 1997 and 1996 the amount of the
recorded investment for which there is a related allowance for loan losses is
$145,000, and the amount of the recorded investment for which there is no
related allowance for loan losses is $4,634,000 and $7,096,000, respectively.
Interest income on impaired loans is recognized primarily on a cash basis.
During 1997 and 1996, the amount of interest income recognized on impaired loans
was insignificant.
Changes in capitalized mortgage servicing rights, included in other assets in
the Consolidated Statements of Condition, are summarized as follows:
1997 1996 1995
- ---------------------------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of year $ 1,443 $ 1,113 $ 968
Originations and acquisitions 1,236 630 621
Amortizations, sales, and writedowns (543) (300) (476)
-----------------------------------------
Balance at end of year $ 2,136 $ 1,443 $ 1,113
=========================================
Changes in the valuation allowance for mortgage servicing rights are summarized
as follows:
1997 1996 1995
- ---------------------------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of year $221 $291 $ --
Additions:
Purchased mortgage servicing rights 38 151 222
Originated mortgage servicing rights 154 55 77
--------------------------------------
Total additions 192 206 299
Reductions:
Purchased mortgage servicing rights 69 158 8
Originated mortgage servicing rights 23 118 --
--------------------------------------
Total reductions 92 276 8
--------------------------------------
Balance at end of year $321 $221 $291
======================================
36
27
At December 31, 1997, and 1996, the fair value of capitalized mortgage servicing
rights were $2,389,000 and $1,770,000, respectively. Loans serviced for others
amounted to $518,877,000, $415,156,000, and $278,051,000 at December 31, 1997,
1996 and 1995, respectively.
NOTE H: OTHER REAL ESTATE OWNED
Other real estate owned ("OREO") consisted of the following:
December 31
-----------------------
1997 1996
- ---------------------------------------------------------------------------------------
(Dollars in thousands)
Real estate acquired through foreclosure $ 742 $1,365
Real estate in judgment 732 105
-------------------
$1,474 $1,470
===================
Changes in the allowance for possible losses on OREO are summarized as follows:
1997 1996 1995
- -----------------------------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of year $-- $ 133 $ 330
Provision for losses -- -- 150
Net charge-offs -- (133) (347)
------------------------------
Balance at end of year $-- $ -- $ 133
==============================
The Company recorded writedowns of other real estate owned amounting to $75,000
during 1996. The Company did not record any writedowns of other real estate
owned in 1997 or 1995.
The Company recognized net gains on sale of OREO amounting to $132,000, $164,000
and $1,139,000 during 1997, 1996 and 1995, respectively.
NOTE I: OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows:
December 31
----------------------
1997 1996
- -----------------------------------------------------------------------
(Dollars in thousands)
Cost:
Land $ 2,565 $ 2,634
Buildings and improvements 17,653 17,174
Furniture and equipment 18,749 16,839
------------------------
38,967 36,647
Less accumulated depreciation 22,346 20,883
------------------------
$ 16,621 $ 15,764
========================
Depreciation and amortization expense was $1,987,000, $1,954,000 and $1,843,000
in 1997, 1996 and 1995, respectively.
Rental expense for leased properties and equipment was $1,150,000, $938,000 and
$643,000 in 1997, 1996 and 1995, respectively. The aggregate minimum annual
rental commitments under these leases are approximately $1,105,000 in 1998,
$955,000 in 1999, $877,000 in 2000, $787,000 in 2001, $605,000 in 2002 and
$1,266,000 thereafter.
37
28
NOTE J: DEPOSITS
The carrying amounts and fair values of deposits and the nominal rate of
interest paid were as follows:
December 31
---------------------------------------------------------------------------------------
1997 1996
---------------------------------------------------------------------------------------
Weighted Weighted
Carrying Fair Average Carrying Fair Average
Amount Value Rate Amount Value Rate
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Checking accounts $ 56,473 $ 56,473 --% $ 46,882 $ 46,882 --%
NOW accounts 62,939 62,939 1.51 60,668 60,668 1.52
Money market accounts 92,314 92,314 4.02 89,321 89,321 4.01
Savings deposits 163,119 163,119 3.16 149,226 149,226 2.82
Certificates of deposit 667,204 673,314 5.93 617,102 622,040 5.79
Accrued interest 1,118 1,118 -- 934 934 --
---------------------------------------------------------------------------------------
$1,043,167 $1,049,277 4.74% $ 964,133 $ 969,071 4.61%
=======================================================================================
Included in deposits are $144,426,000 and $107,386,000 of deposit accounts with
balances in excess of $100,000 as of December 31, 1997 and 1996, respectively.
Certificates of deposit had the following maturities at December 31, 1997:
Weighted
Amount Average Rate
- ----------------------------------------------------------------------------
(Dollars in thousands)
1998 $531,631 5.86%
1999 77,811 6.28
2000 25,230 6.20
2001 9,698 5.93
2002 and beyond 22,834 6.05
----------------------------------------
$667,204 5.93%
========================================
The average balance, interest expense and average rate on deposits were as
follows:
1997 1996 1995
---------------------------------------------------------------------------------------------
Average Interest Avg. Average Interest Avg. Average Interest Avg.
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------------------------------------------------------------------------------------------
(Dollars in thousands)
Checking accounts $ 47,680 $ -- --% $ 40,349 $ -- --% $ 36,886 $ -- --%
NOW and money
market accounts 152,615 4,547 2.98 146,863 4,490 3.06 137,867 4,261 3.09
Savings deposits 154,541 4,623 2.99 153,701 4,446 2.89 139,685 3,723 2.67
Certificates of deposit 657,401 38,791 5.90 597,571 34,923 5.84 537,944 30,655 5.70
----------------------------------------------------------------------------------------------
$1,012,237 $ 47,961 4.74% $938,484 $ 43,859 4.67% $ 852,382 $ 38,639 4.53%
==============================================================================================
38
29
NOTE K: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase, in which the Company will
repurchase identical securities, consisted of the following:
December 31
----------------------------------------------------
1997 1996
----------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Collateral pledged:
Mortgage-backed securities and Treasury notes with a book value including
accrued interest of $151,761,000 and a market value of $152,766,000 in
1997, and a book value including accrued interest of $59,835,000
and a market value of $59,750,000 in 1996. $149,092 $149,092 $58,040 $58,040
=====================================================
Securities sold under agreements to repurchase averaged $98,471,000 and
$40,095,000 during 1997 and 1996, respectively, and the maximum amounts
outstanding at any month-end during 1997 and 1996 were $181,055,000 and
$74,621,000, respectively.
The securities underlying the agreements were delivered to the dealers who
arranged the transactions. The dealers may have sold, loaned or otherwise
disposed of such securities to other parties in the normal course of their
operations, and have agreed to resell to the Company essentially identical
securities at the maturities of the agreements.
Agreements to repurchase as of December 31, 1997, are as follows:
Broker Borrowing Average Rate Maturity Date
- -------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Bear Stearns $ 26,755 5.80% January 1998
Federal National Mortgage Association 49,955 5.75 January 1998
Merrill Lynch 36,805 5.82 January 1998
Morgan Stanley 35,577 5.88 January 1998
--------------------------
$149,092 5.80%
==========================
NOTE L: FHLB ADVANCES AND OTHER BORROWED MONEY
The carrying amounts and fair values of Federal Home Loan Bank of Indianapolis
("FHLB") advances and other borrowed money consisted of the following:
December 31
-----------------------------------------------------------------------------------
1997 1996 1997 1996
-----------------------------------------------------------------------------------
Year of Weighted Weighted Carrying Fair Carrying Fair
Maturity Avg. Rate Avg. Rate Amount Value Amount Value
-------- --------- ------------------ ----- -------- ------
(Dollars in thousands)
Advances from FHLB:
Variable rate of interest:
5.47 - 6.80% 1997 --% 5.58% $ -- $ -- $206,000 $206,047
5.69 - 5.88 1998 5.76 -- 61,000 61,001 -- --
Fixed rate of interest:
5.20 - 5.42% 1997 -- 5.25 -- -- 45,000 44,977
5.47 - 5.98 1998 5.88 5.77 153,000 153,190 43,000 42,566
5.81 - 6.20 1999 5.99 5.84 179,000 179,927 43,000 42,233
5.85 - 5.97 2000 5.92 -- 70,000 70,509 -- --
4.00 2005 4.00 4.00 1,003 888 1,003 802
-----------------------------------------------------------------------------------
464,003 465,515 338,003 336,625
Other borrowed money:
Collateralized mortgage obligation 6,428 6,974 7,994 8,606
------------------------------------------
$ 470,431 $472,489 $345,997 $345,231
==========================================
39
30
(Note L: continued...)
The Company is required to maintain qualifying loans, investments and
mortgage-backed securities as collateral for the FHLB advances.
The collateralized mortgage obligation ("CMO") was issued through a special
purpose finance subsidiary established in 1986. The CMO is secured by
mortgage-backed securities with unpaid principal balances of $7,154,000 and
$9,160,000 at December 31, 1997 and December 31, 1996, respectively. The notes
underlying the obligations bear interest, payable quarterly, at rates varying
from 7.27% to 7.33%, with contractual maturity dates ranging from 2008 to 2010.
NOTE M: FEDERAL INCOME TAXES
Federal income tax expense (credit) consisted of the following:
1997 1996 1995
- -----------------------------------------------------------------------------------
(Dollars in thousands)
Current $4,634 $ -- $ 100
Deferred 3,109 3,228 3,959
Change in valuation allowance
for deferred tax assets -- (2,879) (5,734)
------------------------------------
$7,743 $ 349 $ (1,675)
====================================
Deferred income tax expense (credit) included in stockholders' equity related to
the change in unrealized holding gains (losses) on securities available for sale
for 1997, 1996 and 1995 amounted to $141,000, $(181,000), and $850,000,
respectively.
A reconciliation of the statutory federal income tax rate to the effective
income tax rate follows:
1997 1996 1995
- -----------------------------------------------------------------------------------
Statutory tax rate 35.0% 35.0% 35.0%
Effect of:
Change in valuation allowance
for deferred tax assets -- (30.8) (68.5)
Adjustment to net operating loss
carryforward -- -- 12.5
Other, net 0.1 (0.5) 1.9
-----------------------------------
Effective tax rate 35.1% 3.7% (19.1)%
===================================
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
the Company's deferred and other tax assets and liabilities are as follows:
December 31
------------------------------
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses $ 3,086 $ 3,036
Net deferral required by SFAS 91 79 229
Pension and other benefit obligations 700 695
Tax effect of net of operating loss carryforward -- 3,258
Other, net 398 381
------------------------------
Total deferred tax assets 4,263 7,599
Deferred tax liabilities:
Securities marked to market for tax purposes* (13) 289
Fixed assets 588 662
FHLB stock 1,075 1,075
Valuation adjustment on CMO residuals 1,431 1,408
Other, net 53 68
------------------------------
Total deferred tax liabilities 3,134 3,502
------------------------------
Total net deferred tax assets 1,129 4,097
Current income tax receivable due to net operating loss
carrybacks and other overpayments -- 1,905
------------------------------
Total net federal income tax assets $ 1,129 $ 6,002
==============================
* The amount shown is net of the $810,000 and $669,000 tax effect of SFAS 115
unrealized holding gains at December 31, 1997 and December 31, 1996,
respectively.
40
31
NOTE N: STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
OTS regulations governing the payment of dividends by savings institutions
provide that an institution may only pay dividends with regulatory approval.
Unlike the Bank, the Company is not subject to these regulatory restrictions on
the payment of dividends to its stockholders. However, the source of future
dividends may depend upon the payment of dividends from the Bank to the Company.
In December 1993, the Company issued 1,003,219 units in the shareholder rights
offering. Each unit consisted of three shares of common stock and one warrant.
Each warrant entitled the holder thereof to purchase one share of common stock
at an exercise price of $8.25 at any time no later than December 31, 1996.
During 1996, 1995 and 1994, 996,369, 2,553 and 390 warrants were exercised,
respectively. The warrant period ended with 3,907 warrants unexercised.
During 1996, the Company paid a one-time charge of $5.5 million pretax, ($3.6
million after tax) as the mandated contribution of D&N Bank, to replenish the
Federal Deposit Insurance Corporation's depleted Savings Association Insurance
Fund ("SAIF"). This charge is the result of federal legislation passed and
signed into law on September 30, 1996, which required all thrifts to pay a
one-time assessment to restore the SAIF fund to its statutory reserve level. The
assessment was 65.7 basis points (b.p.) of the institution's deposits as of
March 31, 1995.
Macomb had a leveraged Employee Stock Ownership Plan ("ESOP"), which was
terminated subsequent to the merger with the Company. The related ESOP debt was
paid in full in 1996.
On December 7, 1989, new capital standards were imposed on the thrift
industry as a result of the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA"). Regulatory standards impose the following
capital requirements: a risk-based capital standard expressed as a percent of
risk-adjusted assets, a leverage ratio of core capital to total adjusted
assets, and a tangible capital ratio expressed as a percent of total adjusted
assets. As of December 31, 1997, the Bank exceeded all regulatory capital
standards.
In December, 1996, D&N Financial Corporation's Board of Directors authorized a
program to acquire up to 440,000 shares of D&N Financial Corporation common
stock for the Company's treasury. In 1996, 257,222 shares were acquired and
256,251 were reissued as holders of D&N Financial Corporation Warrants (issued
in 1993) presented their maturing warrants for conversion to common stock. In
1997, the authorized program was completed when an additional 182,050 shares
were acquired for general corporate purposes, including the satisfaction of its
obligation to issue shares upon the exercise of employees' and directors' stock
options. By December 31, 1997, 98,681 of these shares had been reissued upon the
exercise of stock options.
On December 10, 1997, the Company declared a $.05 per share cash dividend and a
10% stock dividend. Both were paid on January 13, 1998, to holders of record on
December 23, 1997. The liability for the cash dividend is shown in Other
Liabilities on the accompanying financial statements. All per share data have
been adjusted to include the effect of the stock dividend.
The table below summarizes as of December 31, 1997, the Bank's capital
requirements under FIRREA and its actual capital ratios at that date.
Regulatory Bank Actual
Requirements Capital
-----------------------------------------------
Amount Percent Amount Percent
- ---------------------------------------------------------------------------------------------
(Dollars in thousands)
Risk-based capital $86,758 8.00% $129,878 11.98%
Core capital 54,742 3.00 119,474 6.55
Tangible capital 27,371 1.50 119,474 6.55
41
32
(Note N: continued...)
The FDIC Improvement Act of 1992 ("FDICIA") requires each federal banking agency
to implement prompt corrective actions for institutions that it regulates. The
OTS has adopted rules, based upon FDICIA's five capital tiers: well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized, and
critically undercapitalized. Under FDICIA, the OTS is required to take
supervisory action against institutions that are not deemed either "well
capitalized" or "adequately capitalized".
The rules generally provide that a savings institution is "well capitalized" if
its total risk-based capital ratio is 10% or greater, its ratio of core capital
to risk-based assets ("tier 1 risk-based capital") is 6% or greater, its core
capital ("leverage") ratio is 5% or greater, and the institution is not subject
to a capital directive. The Bank's tier 1 risk-based capital ratio at December
31, 1997 was 11.02%. At December 31, 1997, the Bank was considered well
capitalized.
NOTE O: EMPLOYEE BENEFIT PLANS
The Company sponsors an employee savings and investment plan in which all
employees may participate after completing a minimum of 1,000 hours in an
eligibility period. The plan allows participants to make contributions by salary
deductions equal to 15% or less of their salary pursuant to Section 401(k) of
the Internal Revenue Code. Employee contributions are matched by the Company at
the rate of 100 cents per dollar, up to 6% of the employee's salary. Employees
vest immediately in their own contributions and over a five-year period in the
Company's contributions. Employee contributions may be invested in a variety of
instruments, including the Company's common stock and the preferred stock of D&N
Capital Corporation. The Company's matching contribution is invested at the
direction of the participant. The Company's contributions to the plan were
$653,000, $621,000 and $273,000 in 1997, 1996, and 1995, respectively.
The Company terminated its noncontributory defined benefit retirement plan
during 1996, with all assets being distributed to participants. No gain or loss
was recorded on this transaction.
The following table sets forth the market value of assets and distribution
thereof on December 16, 1996 the date of distribution.
Before Effect of After
Termination Termination Termination
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets and obligations:
Accumulated benefit obligation $ (8,419) $ 8,419 $ --
Plan assets at fair value 11,238 (11,238) --
---------------------------------------------------
Excess assets $ 2,819 $ (2,819) $ --
===================================================
Benefits under the plan were based on years of service and the employee's
compensation during the last five years of employment.
Pension expense included the following components:
1997* 1996* 1995*
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Service cost-benefits earned during the period $ -- $ -- $ 620
Interest cost on projected benefit obligation -- -- 1,071
Return on plan assets -- -- (2,030)
Net amortization -- -- 512
--------------------------------------------------
$ -- $ -- $ 173
==================================================
*Benefits were frozen as of September 30, 1995; therefore, no cost or
amortization was subsequently recorded.
42
33
NOTE P: POSTRETIREMENT BENEFITS
The Company has a contributory unfunded benefit plan which provides
postretirement medical benefits to certain employees who have retired prior to
September 30, 1995. The Company is recognizing its accumulated postretirement
benefit obligation over a prospective 20-year period.
The following table sets forth the plan's status and amounts recognized in the
Company's Consolidated Statement of Condition.
December 31
----------------------------
1997 1996
- -------------------------------------------------------------------------------------
(Dollars in thousands)
Accumulated postretirement benefit obligation $ 1,187 $ 1,358
Unrecognized net loss (141) (233)
Unrecognized transition obligation (780) (829)
-----------------------------
Accrued postretirement benefit cost $ 266 $ 296
=============================
Postretirement benefit expense included the following components:
1997 1996 1995
- ---------------------------------------------------------------------------------------------
(Dollars in thousands)
Service cost $ -- $ -- $ --
Interest cost 84 97 99
Amortization of transition obligation 48 48 49
---------------------------------
$132 $ 145 $ 148
=================================
A weighted average discount rate of 7.25% in 1997 and 7.00% in 1996 was used in
determining the accumulated postretirement benefit obligation. The 1997 health
care trend rate was projected to be 9.0% for participants under the age of 65,
and this rate is assumed to trend downward until it reaches 5.5% and remains at
that level thereafter. This trend rate assumption does not have a significant
effect on the plan; therefore, a one percent change in the trend rate is not
material in the determination of the accumulated postretirement benefit
obligation or the ongoing expense.
43
34
NOTE Q: STOCK OPTION PLAN
The Company has stock option plans in which 1,487,000 shares of common stock
have been reserved for issuance as of December 31, 1997. Under the plans, the
exercise price of any option will not be less than the fair market value of the
common stock on the date of grant. The dates on which the options are first
exercisable is determined by the Stock Option Committee of the Board of
Directors and have generally vested over a two year period from the date of
grant. The term on any option may not exceed ten years from the date of grant.
The Company has elected to continue to measure compensation cost using the
intrinsic value method, in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, since
all options are granted at a fixed price not less than the fair market value of
the Company's common stock on the date of grant, no compensation cost has been
recognized for its stock option plans. Had stock option costs of these plans
been determined based on the fair value at the 1997, 1996 and 1995 grant dates
for awards under those plans consistent with the methodology of Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based
Compensation", the pro forma effects on the Company's net income and earnings
per share would be as follows:
1997 1996 1995
- ----------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share)
Net income (as reported) $ 14,325 $ 8,995 $10,417
Stock option compensation cost (761) (396) (74)
-----------------------------------------
Pro forma net income $ 13,564 $ 8,599 $10,343
=========================================
Basic earnings per share (as reported) $ 1.58 $ 1.08 $ 1.27
Stock option compensation cost (0.08) (0.05) (0.00)
-----------------------------------------
Pro forma basic earnings per share $ 1.50 $ 1.03 $ 1.27
=========================================
Diluted earnings per share (as reported) $ 1.53 $ 1.01 $ 1.24
Stock option compensation cost (0.08) (0.04) (0.01)
-----------------------------------------
Pro forma diluted earnings per share $ 1.45 $ 0.97 $ 1.23
=========================================
The fair value of each option grant in 1997, 1996 and 1995 was estimated
using the Black-Scholes option pricing model with the following assumptions
used:
1997 1996 1995
- -------------------------------------------------------------------------------------------------
Estimated weighted average fair value
per share of options granted $ 7.63 $ 4.61 $ 2.63
Assumptions:
Annualized dividend yield 0.8% -- --
Common-stock price volatility 32.5% 25.1% 25.1%
Weighted average risk-free rate of return 6.5% 5.9% 7.4%
Weighted average expected option term (in years) 5 5 4
44
35
The following table sets forth changes in options outstanding.
1997 1996 1995
------------------------------------------------------------------------------------
Weighted Weighted Weighted
Amount Avg. Price Amount Avg. Price Amount Avg. Price
- ---------------------------------------------------------------------------------------------------------------------------
Shares under option:
Outstanding at beginning of year 820,943 $ 9.31 653,956 $ 7.56 702,463 $7.43
Granted 261,087 19.55 315,929 12.26 82,368 7.28
Forfeited (34,003) 12.27 (21,836) 9.45 (4,432) 7.15
Canceled -- -- (6,353) 14.60 (68,365) 7.73
Exercised (98,681) 9.05 (120,753) 7.22 (58,078) 5.51
----------------------------------------------------------------------------------
Outstanding at end of year 949,346 12.07 820,943 9.31 653,956 7.56
----------------------------------------------------------------------------------
Exercisable at end of year 738,092 $ 11.25 590,858 $ 8.40 563,268 $7.64
----------------------------------------------------------------------------------
The following table sets forth details of options outstanding at December 31,
1997.
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual life Price Exercisable Price
- ----------------------------------------------------------------------------------------------------------
$ 5.45 - 7.62 366,737 5.2 Years $ 6.99 357,937 $ 7.03
10.17 - 12.05 262,122 7.0 Years 11.38 193,082 11.26
12.95 - 14.04 67,650 8.1 Years 13.92 52,250 13.89
16.36 - 24.38 252,837 9.5 Years 19.65 134,824 21.42
- ----------------------------------------------------------------------------------------------------------
$ 5.45 - 24.38 949,346 7.0 Years $ 11.82 738,093 $ 11.25
==========================================================================================================
45
36
NOTE R: LITIGATION
The Company is a defendant in a number of matters of litigation, substantially
all of which have arisen in the ordinary course of business. It is the opinion
of management that the resulting liabilities, if any, from these actions will
not materially affect the Consolidated Financial Statements.
D&N Bank is a plaintiff, like approximately 120 other institutions, in a
currently pending claim in the United States Court of Federal Claims seeking
substantial damages as a result of the 1989 Financial Institutions Reform,
Recovery and Enforcement Act's mandatory phase-out of the regulatory capital
treatment of supervisory goodwill. The ultimate outcome of these matters cannot
be ascertained at this time.
NOTE S: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk (in
the normal course of its business) to meet the financial needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments may include commitments to originate or purchase loans,
standby letters of credit, recourse arrangements on sold assets, and forward
commitments. The instruments involve, to varying degrees, elements of credit and
interest rate risk in addition to the amounts recognized in the Consolidated
Statements of Condition. The contract amounts of those instruments reflect the
extent of the Company's involvement in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters of
credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as for on-balance sheet instruments. For
forward commitments, the contract amounts do not represent exposure to credit
loss. The Company controls the credit risk of those instruments through credit
approvals, limits and monitoring procedures.
The following table sets forth financial instruments with off-balance sheet risk
and their contract amounts and fair values.
December 31
---------------------------------------------------
1997 1996
---------------------------------------------------
Contract Fair Contract Fair
Amount Value Amount Value
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Financial instruments whose contract amounts
represent credit risk:
Commitments to originate and purchase loans $78,710 $(787) $69,383 $(694)
Unused lines of credit 93,709 (937) 78,303 (783)
Standby letters of credit 3,907 (39) 367 (4)
Loans sold with recourse 2,155 (108) 3,004 (150)
Financial instruments whose contract amounts
exceed the amount of credit risk:
Forward commitments to sell loans 6,400 (64) 4,000 (40)
46
37
Commitments to originate loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn on, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's evaluation of the borrower's creditworthiness.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Additionally, the Company has
retained credit risk on certain residential and commercial mortgage loans sold
with recourse with outstanding balances at December 31, 1997 of $1,310,000 and
$845,000, respectively. These balances as of December 31, 1996 were $1,430,000
and $1,574,000, respectively. The maximum amount of loss to which the Company is
subject, under the recourse provisions, is $1,395,000 at December 31, 1997.
Management does not believe the recourse provisions subject the Company to any
material risk of loss. This credit risk is considered to be no more onerous than
that existing on similar loans in the Company's loan portfolio.
Forward commitments to sell loans are contracts the Company negotiates for the
purpose of reducing the market risk associated with rate lock agreements with
customers for new loan applications that have not yet been closed. In order to
fulfill a forward commitment, the Company typically exchanges through FNMA,
FHLMC or GNMA, its current production of loans for mortgage-backed securities
which are then delivered to a national securities firm at a future date at
prices or yields specified by the contracts. Risks may arise from the possible
inability of the Company to originate loans to fulfill the contracts, in which
case the Company would normally purchase securities in the open market to
deliver against the contracts.
NOTE T: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and
fair values of financial instruments at the dates indicated. SFAS 107,
"Disclosures about Fair Value of Financial Instruments", defines the fair value
of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale.
December 31
--------------------------------------------------------------------
1997 1996
--------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- ------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Cash and cash equivalents $ 20,497 $ 20,497 $ 12,789 $ 12,789
Investment securities (Note E) 102,636 102,706 119,777 119,821
Mortgage-backed securities (Note F) 358,296 359,771 251,256 249,870
Loans receivable (Note G) 1,300,959 1,340,935 1,055,876 1,078,795
Deposits (Note J) (1,043,167) (1,049,277) (964,133) (969,071)
Securities sold under agreement
to repurchase (Note K) (149,092) (149,092) (58,040) (58,040)
Debt (Note L) (470,431) (472,489) (345,997) (345,231)
Commitments to originate and
purchase loans (Note S) -- (787) -- (694)
Unused lines of credit (Note S) -- (937) -- (783)
Standby letters of credit (Note S) -- (39) -- (4)
Loans sold with recourse (Note S) -- (108) -- (150)
Forward commitments to sell loans (Note S) -- (64) -- (40)
47
38
(Note T: continued...)
ESTIMATION OF FAIR VALUES:
SFAS 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the Statement of Condition, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. SFAS 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
The carrying amounts reported in the Statement of Condition for cash and cash
equivalents approximate those assets' fair value. Fair values for investment
securities and mortgage-backed securities 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. Fair values for the
Company's loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. The carrying amount of accrued interest approximates
its fair value.
The fair values of checking and NOW accounts, money market accounts and savings
deposits are the amounts payable on demand at the reporting date. The fair value
for fixed-maturity time deposits is estimated using a discounted cash flow
analyses using the rates currently offered for deposits with similar remaining
maturities. The fair values of securities sold under agreement to repurchase and
the Company's debt are estimated using discounted cash flow analyses, based on
the Company's current incremental borrowing rates for debt with similar terms
and remaining maturities. Fair values for the Company's off-balance sheet
instruments (guarantees and credit commitments) are based on current settlement
or termination values and on fees currently charged to enter into similar
agreements, given the remaining terms of the agreements and the counterparties'
credit standing.
NOTE U: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Income
(Loss)
Before
Gain on Income Income
Net Provision Securities Tax Tax Net Stock Price
Interest Interest Interest For Loan & Other Expense Expense Income Earnings Per Share(2) Range(2)
Income Expense Income Losses Assets (Credit) (Credit) (Loss) Basic Diluted High Low
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share and stock price)
1st Quarter
1997 $ 28,335 $17,000 $11,335 $ 300 $ -- $ 5,075 $1,781 $ 3,294 $0.36 $0.35 16 15/16 14 57/64
1996 24,000 14,318 9,682 300 -- 2,689 (799) 3,488 0.42 0.40 12 1/2 10 29/32
2nd Quarter
1997 30,293 18,484 11,809 300 539 5,505 1,926 3,579 0.39 0.38 17 1/2 15 33/64
1996 25,426 14,886 10,540 300 188 2,824 (537) 3,361 0.40 0.38 12 47/64 10 29/32
3rd Quarter
1997 32,142 19,626 12,516 300 -- 6,262 2,003 3,722 0.41 0.40 19 49/64 16 13/16
1996 27,105 15,863 11,242 300 -- (1,127)(1) (42) (1,085)(1) (0.13) (0.12) 12 61/64 11 9/64
4th Quarter
1997 34,923 21,644 13,279 450 -- 6,444 2,033 3,730 0.41 0.40 26 3/4 19 13/64
1996 27,778 16,479 11,299 200 -- 4,958 1,727 3,231 0.38 0.36 16 9/64 12 1/2
Year
1997 125,693 76,754 48,939 1,350 539 23,286 7,743 14,325 1.58 1.53 26 3/4 14 57/64
1996 104,309 61,546 42,763 1,100 188 9,344 349 8,995 1.08 1.01 16 9/64 10 29/32
(1)Included in this loss is the one-time charge of $5.5 million to replenish the
Federal Deposit Insurance Corporation's Savings Association Insurance Fund
(see Note N).
(2)All per share amounts have been adjusted to include the effect of the 10%
stock dividend in 1997.
48
39
NOTE V: D&N FINANCIAL CORPORATION - PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF CONDITION
December 31
1997 1996
----------------------
(Dollars in thousands)
- ------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 2 $ 2
Amounts receivable from subsidiary 3,523 6,104
Investments in subsidiary 94,994 80,014
Other assets -- 65
--------------------------
$ 98,519 $ 86,185
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Dividends payable $ 414 $ --
Other liabilities 23 64
Stockholders' equity 98,082 86,121
--------------------------
$ 98,519 $ 86,185
==========================
CONDENSED STATEMENTS OF INCOME
Year Ended December 31
----------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest income from subsidiary $ 228 $ 64 $ 40
Equity in undistributed net income of subsidiary 14,388 9,378 10,618
Noninterest expense:
Compensation and benefits 10 13 9
Other 281 434 232
----------------------------------------
Total noninterest expense 291 447 241
----------------------------------------
Income before income tax expense 14,325 8,995 10,417
Federal income tax expense -- -- --
----------------------------------------
Net income $ 14,325 $ 8,995 $ 10,417
========================================
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Operating activities
Net income $ 14,325 $ 8,995 $ 10,417
Items not affecting cash:
Equity in undistributed net income of subsidiary (14,388) (9,378) (10,618)
Other 438 115 37
--------------------------------------
Net cash provided (used) by operating activities 375 (268) (164)
Investing activities
Change in intercompany receivable 2,581 (5,225) (102)
Financing activities
Proceeds from exercise of stock options 865 9,055 346
Purchases of treasury stock (2,995) (3,499) (44)
Common stock cash dividends (826) -- --
Payment of ESOP debt -- (63) (36)
--------------------------------------
Net cash provided (used) by financing activities (2,956) 5,493 266
Net change in cash and cash equivalents -- -- --
Cash and cash equivalents at beginning of year 2 2 2
--------------------------------------
Cash and cash equivalents at end of year $ 2 $ 2 $ 2
======================================
49
40
STOCKHOLDER INFORMATION
D&N FINANCIAL CORPORATION
400 Quincy Street
Hancock, Michigan 49930
(906) 482-2700
363 W. Big Beaver, Ste. 100
Troy, Michigan 48084
(248) 528-0704
COMMON STOCK
D&N's common stock is listed on The Nasdaq Stock Market under the symbol DNFC.
The stock quotations appear in major daily newspapers under the listing
D&N Fncl. At December 31, 1997, there were approximately 7,100 holders of
D&N common stock.
SHAREHOLDER ASSISTANCE
Shareholders with questions concerning their records, change of name, address
or ownership of stock and lost or stolen certificates may contact the transfer
agent:
Illinois Stock Transfer Company
223 West Jackson Blvd., Suite 1210
Chicago, Illinois 60606
(800) 757-5755
DIRECT INVESTMENT PLAN
Registered holders of D&N Financial Corporation common stock are eligible to
participate in the Company's Direct Investment Plan. The Plan provides a
convenient method for making direct cash investments for the purchase of
additional shares of D&N stock without fees or commissions. Purchases are made
on or about the first working day of each month on the open market. The minimum
investment is $25; the maximum is $12,000 annually. Cash investments must be
received by the transfer agent no less than five working days prior to month
end to be included in the monthly purchase.
FORM 10-K
The 1997 Annual Report and Form 10-K are available to shareholders at no
cost upon written request to the Company at the address above.
INVESTOR RELATIONS CONTACT
Analysts, investment professionals, shareholders and others seeking information
about the Company should contact Mary Jo Kristapovich, Director of
Investor Relations. She may be reached at the address above, by phone at (906)
487-6225 or by e-mail at mjkrist@portup.com.
ANNUAL MEETING
The 1998 Annual Meeting of Stockholders will be held on April 30, 1998 at 2
p.m. Eastern Daylight Time at the Franklin Square Inn in Houghton, Michigan.
OTHER COMPANY INFORMATION
To find out more about D&N--its history, management, products and
services--visit our web site at http://www.dn.portup.com.
INDEPENDENT AUDITORS
Coopers & Lybrand, L.L.P., Detroit, Michigan
52