1
EXHIBIT 13
OTTAWA FINANCIAL CORPORATION
1997 Report to Shareholders
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SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following financial data does not purport to be complete and is
qualified in its entirety by reference to the more detailed financial
information contained elsewhere herein.
December 31
1997 1996 (1) 1995 1994 1993
---------------------------------------------------------------------
(Dollars In Thousands except per share data)
Selected Financial Condition Data:
Total assets $ 885,817 $ 848,306 $ 370,305 $ 328,461 $ 266,555
Loans receivable, net 747,423 715,551 276,457 230,818 210,779
Securities 64,616 69,864 66,926 73,577 36,554
Deposits 654,560 622,492 243,220 231,321 221,865
Federal Home Loan Bank advances 145,458 139,170 43,241 13,579 14,181
Shareholders' Equity 76,363 76,917 79,560 78,593 26,527
Selected Operations Data:
Total interest income $ 64,726 $ 54,669 $ 25,579 $ 20,799 $ 20,253
Total interest expense 37,704 30,531 11,321 9,182 9,900
--------- --------- --------- --------- ---------
Net interest income 27,022 24,138 14,258 11,617 10,353
Provision for loan losses 660 564 160 170 450
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 26,362 23,574 14,098 11,447 9,903
Service charges and other fees 3,356 3,043 2,219 1,870 1,817
Gain on sales of loans 370 140 309 110 701
Other noninterest income (loss) 420 145 (435) (121) 135
--------- --------- --------- --------- ---------
Total noninterest income 4,146 3,328 2,093 1,859 2,653
Total noninterest expense (2) 18,708 21,844 10,651 8,999 7,885
--------- --------- --------- --------- ---------
Income before federal income tax expense and
cumulative effect of change in accounting principle 11,800 5,058 5,540 4,307 4,671
Income tax expense 4,273 1,964 1,911 1,308 1,550
--------- --------- --------- --------- ---------
Income before cumulative effect of change
in accounting principle 7,527 3,094 3,629 2,999 3,121
Cumulative effect of change in accounting principle -- -- -- -- (183)
--------- --------- --------- --------- ---------
Net income $ 7,527 $ 3,094 $ 3,629 $ 2,999 $ 2,938
========= ========= ========= ========= =========
Earnings per Common Share (3) $ 1.46 $ .56 $ .63 $ .23 NA
========= ========= ========= ========= =========
Earnings per Common Share Assuming Dilution (3) $ 1.34 $ .54 $ .63 $ .23 NA
========= ========= ========= ========= =========
Cash dividends declared per common share(3) $ .36 $ .31 $ .28 $ .06 NA
========= ========= ========= ========= =========
(1) Significant variation from prior years due primarily to the
acquisition of AFSB, in February 1996 (see Note 2 of the Notes
to the Consolidated Financial Statements).
(2) Noninterest expense for 1996 includes the one-time SAIF
assessment of $3.5 million (see Note 17 of the Notes to the
Consolidated Financial Statements).
(3) Weighted average common shares outstanding for 1997, 1996,
1995 and 1994 were 5,150,401, 5,552,911, 5,746,453 and
5,745,697, respectively. Weighted average common and dilutive
potential common shares outstanding for 1997, 1996, 1995 and
1994 were 5,609,060, 5,685,567, 5,781,256 and 5,745,697,
respectively All. Share and per share information has been
retroactively adjusted to reflect the 10% stock dividend paid
on September 30, 1997, and the adoption of Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings per
Share.
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December 31
1997 1996 1995 1994 1993
-------------------------------------------
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets .87% .41% 1.08% 1.03% 1.11%
SAIF adjusted (2) .72
Average interest rate spread during period 3.01 3.08 3.31 3.53 3.76
Net interest margin (1) 3.37 3.50 4.44 4.17 4.16
Ratio of operating expense to average total assets 2.15 3.06 3.16 3.14 2.97
SAIF adjusted (2) 2.56
Efficiency (3) 61.13 79.56 65.14 66.78 60.63
SAIF adjusted (2) 66.75
Return on equity 9.93 3.93 4.62 6.38 11.65
SAIF adjusted (2) 6.83
Quality Ratios:
Non-performing assets to total assets at end of period 0.36 0.36 0.76 0.36 0.29
Allowance for loan losses to non-performing loans 118.62 109.89 51.38 109.78 186.28
Allowance for loan losses to total loans receivable, net 0.44 0.44 0.45 0.48 0.45
Capital Ratios:
Equity to total assets at end of period 8.62 9.07 21.48 23.92 9.95
Average equity to average assets 8.73 9.09 22.62 16.15 9.50
Ratio of average interest-earning assets to average
interest-bearing liabilities 1.07x 1.10x 1.32x 1.19x 1.10x
Number of full service offices 26 26 13 13 10
(1) Net interest income divided by average interest-earning assets.
(2) Indicated ratios have been revised to remove the impact of the
one-time SAIF assessment of $3.5 million expensed in 1996 (see
Note 17 of the Notes to Consolidated Financial Statements).
(3) Ratio of non-interest expense to the total of net interest income
before provision for loan losses and noninterest income.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis should be read in conjunction
with the consolidated financial statements contained herein. This discussion
provides information about the consolidated financial condition and results of
operations of Ottawa Financial Corporation ("Company") and its wholly-owned
subsidiary, AmeriBank ("Bank").
GENERAL
1997 was the first full year of performance for the Company after its
acquisition of AmeriBank, Federal Savings Bank ("AFSB") in early 1996. Through
the acquisition of AFSB, the Company attained geographic expansion, product
diversification and expertise that, as anticipated, have had a very positive
impact on financial performance. In addition, the Company has better leveraged
its capital thereby improving return on equity and enhancing shareholder value.
Return on equity further improved in 1997 as the Company continued its
capital leveraging efforts both through additional asset growth and capital
management. As intended, assets grew at a reduced pace in 1997 compared to 1996
to continue to allow organized absorption of the growth. While assets continued
to grow, the Company was successful at maintaining its capital at a consistent
level through its stock repurchase program. Net income for the year improved
significantly compared to the prior year due primarily to the asset growth and
improvements in efficiency.
The Company, through its subsidiary, AmeriBank, serves Western Michigan
through 26 retail banking offices. The principal business of the Bank consists
of attracting retail deposits from the general public and investing those funds
in various types of loans including both owner-occupied and non-owner occupied
one- to four-family residential mortgage, construction, commercial, multi-family
real estate and consumer loans.
FINANCIAL CONDITION
The Company's total assets increased to $885.8 million at December 31,
1997 from $848.3 million at the same date in 1996. Most of this growth was in
loans which was funded primarily from the growth in deposits and, to a lesser
extent, from the proceeds received from the call and maturity of securities and
the increase in Federal Home Loan Bank Advances.
Securities decreased to $57.3 million at December 31, 1997 from $62.9
million at December 31, 1996. The decrease in securities was due primarily to
run-off through call and maturity, which was used to both replenish the
securities and fund loan portfolio growth.
Net loans receivable increased to $747.4 million at December 31, 1997,
from $715.6 million at December 31, 1996. Most of this growth was in new
originations of commercial and consumer loans. The total of non-real estate
commercial loans and consumer loans increased as a percent of total loans from
16% at the end of 1996 to 20% at the end of 1997. The experience in commercial
lending gained from AFSB has been instrumental in achieving the commercial loan
growth. Furthermore, the volume of residential mortgage loans originated for
sale increased from $9.8 million for the year ended December 31, 1996 to $45.4
million for 1997, resulting from a change in the method of pricing mortgage
loans to be sold. The Company moved from rate commitments based upon a sixty day
delivery period to a thirty day delivery period to Freddie Mac, resulting in
more competitive rates being offered to customers.
While the pace of loan growth during 1997 was not as significant as
that experienced during 1996, the increase in both net loans receivable and
origination of loans for sale reflects a continued healthy loan demand in
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the Bank's market area. The Bank was well-positioned with its loan products to
capitalize on this demand. The growth was achieved while maintaining rates
consistent with competitors and maintaining credit quality standards.
Deposits increased to $654.6 million at December 31, 1997 from $622.5
million at December 31, 1996. The primary area of growth was in certificates of
deposit and, to a lesser extent, money market savings accounts, all within the
Bank's market area. Most of the certificate of deposit growth was generated
through 10 to 24 month maturity products. The terms of the Bank's money market
accounts are unique and well-suited to the needs of the customers. As such,
these products have continued to experience healthy growth.
Federal Home Loan Bank ("FHLB") advances increased to $145.5 million at
December 31, 1997 from $139.2 million at December 31, 1996. The proceeds of
these advances, as well as the internal deposit growth discussed above, were
used to fund the loan portfolio growth.
The primary change in total shareholders' equity relates to the
offsetting of net income for the twelve months ended December 31 1997, by
quarterly cash dividends declared and additional repurchases of the Company's
outstanding shares of common stock. During 1997, 436,975 shares were repurchased
at an average price of $20.21 per share, which both completed the repurchase
plan approved in December 1996 and began a new repurchase plan approved in June
1997. Management believes that stock repurchases are an important part of
capital management and will use it as a supplement to asset growth in achieving
its desired capital levels as long as it is deemed to be accretive to the
Company's financial performance and does not jeopardize safe and sound capital
levels. As such, stock repurchase activity may diminish if growth in assets
increases.
On August 28, 1997, the Company declared a 10% stock dividend, paid on
September 30, 1997, which was the first stock dividend declared by the Company.
The stock dividend was paid from the Company's treasury shares and was accounted
for at the market value of $25.00 per share on the record date. The balance of
treasury shares was reduced at cost using the average cost method. The Company
has not reduced the amount of the cash dividends as a result of the stock
dividend. All share and per share amounts have been retroactively adjusted to
reflect this stock dividend.
RESULTS OF OPERATIONS
Comparison of 1997 to 1996
Net income. Net income for 1997 was $7.5 million, compared to $3.1
million for 1996. The results of operations for 1996 include the one-time SAIF
assessment of $3.5 million relating to legislation signed into law on September
30, 1996 to recapitalize the Savings Association Insurance Fund ("SAIF"). Net
income for the year ended December 31, 1996, without the SAIF assessment, would
have been $5.4 million. On a SAIF adjusted basis, net income increased $2.1
million, or 39%, for the year ended December 31, 1997 compared to 1996. This
increase was achieved primarily through growth in net interest income and to a
lesser extent in improvements in efficiency.
Earnings per common share assuming dilution ("EPS") for 1997 was $1.34
compared to $.54 for the prior year. If the effect of the one-time SAIF
assessment was removed from earnings, EPS would have been $.95 for 1996. On a
SAIF adjusted basis, EPS increased 41% for the year ended December 31, 1997
compared to 1996. In addition to the improvement in net interest income, EPS was
positively impacted by the Company's stock repurchase activity.
In 1996 the Company introduced a measure it refers to as "cash" or
"tangible" earnings per share. Due to significant differences in methods of
accounting for business combinations, the concept of cash or tangible earnings
per share provides comparability between companies using different methods.
Amortization of goodwill and core deposit intangibles, which are non-cash
components of net income, are added back to earnings in computing cash or
tangible earnings per share. Further, Employee Stock Ownership Plan ("ESOP") and
Management Recognition Plan ("MRP") expenses are added back as these items also
do not involve actual current period cash outflow. Cash
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or tangible earnings per share also serves as an alternative measure for
determining the rate of growth in regulatory (tangible) capital. Since the
amortization of goodwill, core deposit intangibles, ESOP and MRP does not reduce
tangible capital, these items are added back to earnings in evaluating tangible
capital growth. The Company's "cash" or "tangible" earnings per share assuming
dilution under this method was $1.74 for the year ended December 31, 1997,
compared to a SAIF adjusted tangible EPS of $1.09 for 1996, showing a 60%
improvement. The calculations of cash or tangible earnings per share were
specifically formulated by the Company and may not be comparable to similarly
titled measures reported by other companies. This measure is not intended to
reflect cash flow per share.
Net income for the year ended December 31, 1997 yielded a return on
average equity ("ROE") of 9.93%, representing a 45% improvement over the SAIF
adjusted ROE achieved for the same period in 1996 of 6.83%. The increase in the
ROE is primarily attributable to the improved earnings resulting from the
positive impact of capital leveraging experienced during 1996 and 1997. The
capital leveraging was achieved mostly through growth in assets and, to a lesser
extent, through the stock repurchase activity.
Net Interest Income. The Company's net income is primarily dependent
upon net interest income. Net interest income is a function of the difference
("margin") between the average yield earned on loans and investment securities
and the average rate paid on deposits and other borrowings, as well as relative
amounts of such assets and liabilities. The interest margin is affected by
economic and competitive factors that influence interest rates, loan demand and
deposit flows.
Net interest income increased $2.9 million on a tax equivalent basis
for the year ended December 31, 1997 as compared to the same period in 1996. The
increase in net interest income is attributable to the positive impact of volume
increases caused by the AFSB acquisition and internal growth experienced during
1996 and 1997. While net interest income increased, there was a decline in the
net interest spread, from 3.08% to 3.01%, and net interest margin, from 3.50% to
3.37%, for the year ended December 31, 1997 compared to the same period in 1996,
respectively. The yield on total interest-earning assets improved primarily due
to an increase in the loan portfolio as a percent of total interest-earning
assets, as well as a general rise in the rates of interest-earning assets.
Offsetting this improvement in the yield on interest-earning assets was the
increase in the cost of interest-bearing liabilities, resulting in a decline in
the net interest spread. The cost of interest-bearing liabilities increased
primarily due to an increase in FHLB advances as a percent of total
interest-bearing liabilities and, to a lesser extent, a shift in mix from lower
costing demand deposit and savings accounts to higher costing money market
demand and savings accounts, as well as a general rise in the rates of
interest-bearing liabilities. The reduction in net interest margin was partially
the result of this spread decline, but also the result of the Company becoming
more leveraged through acquisition and internal growth. This increase in
leveraging is reflected in the ratio of average interest-earnings assets to
average interest-bearing liabilities, which declined to 1.07x for the twelve
months ended December 31, 1997 compared to 1.10x for the same period in 1996.
Management's strategy during 1998 will be to continue to grow the
Bank's loan portfolio and alter the composition to increase the Bank's
percentage of higher yielding commercial and consumer loans in relation to the
total loan portfolio. It is anticipated this shift may have a positive impact to
net interest income and the overall yield on interest-earning assets, but may
also result in additional provisions for loan losses as a result of the greater
inherent risks associated with commercial and consumer lending compared to
residential mortgage lending. Interest rate spreads on the growth likely will
tighten due to the current interest rate environment and the cost of funding
sources.
AVERAGE BALANCES, INTEREST RATES AND YIELDS
The following tables present for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. All average balances are daily average
balances.
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Year Ended December 31
----------------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate
----------------------------------------------------------------------------
Interest-Earning Assets:
Loans receivable (1) (2) $732,927 $59,994 8.19 % $605,563 $49,036 8.10 %
Securities (2) 56,635 3,787 6.68 75,850 5,037 6.64
Other interest-earning assets 15,754 1,071 6.80 11,378 733 6.44
-------- ------- -------- -------
Total interest-earning assets (1) 805,316 64,852 8.05 692,791 54,806 7.91
Interest-Bearing Liabilities:
Demand and NOW deposits 149,909 5,823 3.89 127,574 4,518 3.54
Savings deposits 65,678 1,551 2.37 68,590 1,735 2.53
Certificate accounts 393,757 22,024 5.61 341,795 18,803 5.50
FHLB advances 140,746 8,293 5.91 94,269 5,451 5.78
Other interest-bearing
liabilities 184 13 7.07 248 24 9.68
-------- -- -------- -------
Total interest- bearing liabilities 750,274 37,704 5.04 632,476 30,531 4.83
------- -------- -------
Net interest income $27,148 $24,275
======= =======
Net interest rate spread 3.01 % 3.08 %
==== ====
Net earning assets $55,042 $60,315
======== ========
Net yield on average
interest-earning assets 3.37 % 3.50 %
==== ====
Average interest-earning
assets to average interest-
bearing liabilities 1.07 x 1.10 x
==== ====
Year Ended December 31
--------------------------------------
1995
--------------------------------------
Average Interest
Outstanding Earned/ Yield/
Balance Paid Rate
--------------------------------------
Interest-Earning Assets:
Loans receivable (1) (2) $249,742 $ 20,827 8.35 %
Securities (2) 64,320 4,259 6.56
Other interest-earning assets 6,631 493 7.43
-------- --------
Total interest-earning assets (1) 320,693 25,579 7.96
Interest-Bearing Liabilities:
Demand and NOW deposits 44,641 1,169 2.62
Savings deposits 47,451 1,165 2.46
Certificate accounts 132,349 7,705 5.82
FHLB advances 18,251 1,234 6.76
Other interest-bearing
liabilities 557 48 8.71
-------- --------
Total interest- bearing liabilities 243,249 11,321 4.65
-------- --------
Net interest income
$14,258
=======
Net interest rate spread 3.31 %
====
Net earning assets $77,444
=======
Net yield on average
interest-earning assets 4.44 %
====
Average interest-earning
assets to average interest-
bearing liabilities 1.32 x
====
- -----------------------
(1) Calculated net of deferred loan fees, loan discounts, loans in process
and allowance for loan losses.
(2) Tax-exempt interest on loans and securities has been converted to a
fully-taxable equivalent basis.
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RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume). For purposes
of this table, changes attributable to both rate and volume which cannot be
segregated have been allocated proportionately to the change due to volume and
the change due to rate.
Year Ended December 31
1997 vs. 1996 1996 vs. 1995
-------------------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
Due To Total Increase Due To Total Increase
Volume Rate (Decrease) Volume Rate (Decrease)
--------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-earning assets:
Loans receivable $ 10,420 $ 538 $ 10,958 $ 28,795 $ (586) $ 28,209
Securities (1,285) 35 (1,250) 766 12 778
Other interest-earning assets 296 42 338 295 (55) 240
-------- -------- -------- -------- -------- --------
Total interest-earning assets 9,431 615 10,046 29,856 (629) 29,227
Interest-bearing liabilities:
Demand and NOW deposits $ 840 $ 465 $ 1,305 $ 2,815 $ 534 $ 3,349
Savings deposits (72) (112) (184) 534 36 570
Certificate accounts 2,902 319 3,221 11,498 (400) 11,098
FHLB advances 2,737 105 2,842 4,369 (152) 4,217
Other interest-bearing liabilities (5) (6) (11) (31) 7 (24)
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities 6,402 771 7,173 19,185 25 19,210
-------- -------- -------- -------- -------- --------
Net interest income $ 3,029 $ (156) $ 2,873 $ 10,671 $ (604) $ 10,017
======== ======== ======== ======== ======== ========
Provision for Loan Losses. The provision for loan losses is a result of
management's periodic analysis of the adequacy of the allowance for loan losses.
The provision was $660,000 and $564,000 for 1997 and 1996, respectively. The
Company's ratio of non-performing assets, consisting of loans 90 days or more
delinquent and foreclosed assets, to total assets was .36% as of both December
31, 1997 and 1996. The Company's ratio of allowance for loan losses to total
loans receivable was .44% as of both December 31, 1997 and 1996. The increase in
provision was primarily for the purpose of growing the allowance for loan loss
balance to keep pace with loan growth as the credit risk profile of the
Company's loan portfolio has not changed dramatically. The Company anticipates
that it will increase its allowance for loan loss balance in future periods to
prepare for the higher risk of loss associated with management's intention to
continue to increase the commercial and consumer loan portfolios.
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The allowance is maintained by management at a level considered
adequate to cover possible loans that are currently anticipated based on past
loss experience, general economic conditions, information about specific
borrower situations, including their financial position and collateral values,
and other factors and estimates, which are subject to change over time. Although
the level of non-performing assets is considered in establishing the allowance
for loan losses balance, variations in non-performing loans have not been
meaningful based on the Company's past loss experience and, as such, have not
had a significant impact on the overall level of the allowance for loan losses.
The Company maintains its allowance for loan losses at a level which it
considered to be adequate to provide for potential losses, however, there can be
no assurance that future losses will not exceed estimated amounts or that
additional provisions for loan losses will not be required in future periods. In
addition, the Company's determination as to the amount of its allowance for loan
losses is subject to review by the Financial Institutions Bureau ("FIB") and the
Federal Deposit Insurance Corporation (the "FDIC") as part of their examination
process, which may require the establishment of additional general or specific
allowances based upon their judgment of the information available to them at the
time of their examination.
Non Interest Income. Non interest income for 1997 was $4.1 million
compared to $3.3 million for 1996. The increase is primarily attributable to an
increase in deposit account service fees. During the third quarter of 1997, fee
structures were modified to achieve more consistency between AmeriBank and AFSB.
The primary areas of change related to assessing fees on savings accounts that
fell below a minimum balance and checking accounts for which cancelled checks
were returned to customers with monthly bank statements. Due to the nature of
the fee assessments, customer behavior may change and the level of fee income
may diminish from 1997. The increase in deposit account service fees was
complimented by increases in gains on sales of mortgage loans and gains on sales
of equity securities.
Non Interest Expense. Non interest expense decreased from $21.8 million
for 1996 to $18.7 million for 1997. The decrease in non-interest expense was due
to the one-time SAIF assessment in 1996, as well as decreases in FDIC deposit
insurance, data processing and professional services, offset by an increase in
compensation and benefits.
Legislation was signed into law on September 30, 1996, to recapitalize
the Savings Association Insurance Fund, requiring the Bank to pay a one-time
special assessment of $3.5 million. The decrease in the FDIC deposit insurance
reflects the lower charge of 6.5 cents per $100 of domestic deposits in 1997
versus the 23 cents per $100 of domestic deposits in 1996. The 6.5 cent
assessment in 1997 is entirely for debt service of the Financing Corporation
(FICO), established to help pay for the costs of the 1988 recapitalization of
the industry, as the Company's rate of deposit insurance assessment was zero for
1997.
The Company underwent an electronic data processing ("EDP") conversion
in 1996. The new EDP system is more technologically advanced, thereby
positioning the Company to better meet the needs of its customers. The EDP
conversion itself required substantial outside consulting services, resulting in
approximately $400,000 of non-recurring expenses during 1996. During 1997, the
Company has experienced economies of operations reflected in lower levels of
data processing and other noninterest expenses and experienced cost savings as a
result of reduced contracted services.
The increase in compensation and benefits is due in part to a greater
number of full-time equivalent employees and an increase in ESOP expense
attributable to the higher market price of the Company's stock during 1997.
The Company's efficiency ratio, defined generally as noninterest
expense divided by the sum of net interest income and noninterest income,
decreased from a SAIF adjusted ratio of 66.75% for the year ended December 31,
1996, to 61.13% for the same period in 1997. This ratio demonstrates that the
Company's ability to generate revenues on its noninterest expense dollars has
improved.
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Income Tax Expense. Income tax expense for 1997 was $4.3 million
compared to $2.0 million for 1996. The higher federal tax expense is primarily
due to a higher level of pre-tax income and to a lesser extent, a full twelve
months of goodwill amortization, which is not deductible for tax purposes, in
1997 compared to ten and one half months of amortization in 1996 based upon the
date of the merger consummation.
Year 2000 Readiness. Management has devoted substantial effort to
analyzing and preparing for the readiness of its computer applications for the
Year 2000. A Year 2000 Action Plan has been developed by the Bank's Technology
Committee which outlines the Bank's process for preparing itself for Year 2000
issues. The more significant components of this action plan are as follows:
- Statement of purpose of action plan
- Identify areas of risk in software, internal hardware, service provider
systems, large commercial borrowers and vendor contracts
- Perform initial testing
- Establish preliminary budget based on initial testing
- Establish priority order and time-line
- Complete comprehensive testing
- Develop contingency plan
- Obtain third party review of Year 2000 readiness
Significant progress has been made during 1997 in identifying areas of
risk and initially gauging the level of risk by obtaining third party
certifications from software vendors and performing initial testing of both
hardware and software. Management feels its largest area of risk is with the
service bureau that provides data processing for the Bank's most significant
computer system applications. Management actively monitors the service bureau's
Year 2000 progress and testing. For all areas, test facilities are being
established in 1998 to accomplish the more comprehensive testing.
It is expected that the largest expenditure relative to Year 2000
readiness will be in the man-hours required to verify system compliance and
correct deficiencies. Based upon currently available information, management
presently anticipates that the costs of addressing the Year 2000 will not have a
significantly adverse impact on the Company's future financial condition and
results of operations. The costs associated with Year 2000 readiness are based
on management's best estimates. There can be no guarantee that these estimates
will be achieved and actual results could differ from those anticipated.
Specific factors that might cause differences include, but are not limited to,
the ability of other companies on which the Company's systems rely to modify or
convert their systems to be Year 2000 compliant, the ability to locate and
correct all relevant computer codes, and similar uncertainties. As testing
continues and more progress is made, management will continuously assess the
materiality of its Year 2000 costs.
Comparison of 1996 to 1995
Net income. Net income for 1996 was $3.1 million, compared to $3.6
million for 1995. The results of operations include the impact of AFSB since the
close of the acquisition on February 13, 1996. The acquisition resulted in
significant earnings growth, however, the increase was more than offset by the
one-time SAIF assessment of $3.5 million to cause the overall decrease in net
income. Net income, without the SAIF assessment, would have been $5.4 million
for 1996, an increase of $1.8 million over 1995.
Additionally, the net effect of the amortization of the purchase
accounting adjustments and goodwill that was generated in the acquisition of
AFSB had a small positive impact on the net income for the year ended December
31, 1996. The most significant purchase accounting adjustment relates to
deposits, for which an increase in value of approximately $3.9 million was
recorded. This adjustment is being amortized over approximately 4.5 years,
resulting in a positive impact to income through the year 2000. Offsetting this
positive impact to income is
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the amortization of goodwill which is being amortized using the straight-line
method over a period of 15 years. The net overall effect was an increase to
income, after taxes, during 1996 and a decrease to income, after taxes,
thereafter. The increase to net income for 1996 was $39,000.
EPS for 1996 was $.54 compared to $.63 for the prior year. If the
effect of the one-time SAIF assessment was removed from earnings, EPS would have
been $.95 for 1996. The Company's "cash" or "tangible" earnings per share was
$.75 for the year ended December 31, 1996, compared to $.77 for 1995.
Net Interest Income. Net interest income increased $10.0 million on a
tax equivalent basis for the year ended December 31, 1996 as compared to 1995,
reflecting increased income as a result of the acquisition of AFSB and internal
growth, partially offset by increased interest expense on deposits and
borrowings as a result of increases in balances and the cost associated with
such liabilities since the acquisition. The net interest margin decreased from
4.44% for the year ended December 31, 1995 to 3.50% for the year ended December
31, 1996. The reduction in net interest margin was primarily the result of the
liquidation of interest-earning securities to fund the acquisition of AFSB and
the lower net interest margin of the AFSB portfolio, which had a net interest
margin of 2.62% at December 31, 1995. The acquisition of AFSB decreased the
percentage of total average interest-earning assets to total average
interest-bearing liabilities to 110% at December 31, 1996 from 132% at December
31, 1995. This decrease also contributed to the decline in net interest margin.
Provision for Loan Losses. The provision was $564,000 and $160,000 for
1996 and 1995, respectively. The increase in provision was primarily for the
purpose of growing the allowance for loan loss balance to keep pace with loan
growth. The ratio of allowance to total loans was .44% and .45% as of December
31, 1996, and 1995, respectively. Since most of the loan portfolio growth in
1996 was in one-to-four family residential mortgages, the risk profile of the
Bank's portfolio did not change dramatically, therefore provisions to merely
keep pace with loan growth were appropriate.
Non Interest Income. Non interest income for 1996 was $3.3 million
compared to $2.1 million for 1995. The overall increase was primarily due to the
contribution to non-interest income from the acquisition of AFSB. AFSB's
non-interest income was generally lower than the Bank's due to the composition
of AFSB's deposit portfolio for generating service charge income. As such,
deposit service charges did not increase at a ratio consistent with the increase
in deposits from acquisition.
Non Interest Expense. Non interest expense increased from $10.7 million
for 1995 to $21.8 million for 1996. The increase in non-interest expense was due
to the one-time SAIF assessment, the addition of non-interest expenses of AFSB,
an increase in compensation and benefit expenses primarily related to the ESOP
and the MRP, amortization of acquisition intangibles of $1.1 million, and
general increases in other expenses. There was very little overlap of market
areas served by AFSB versus the Bank. As such, the opportunity for merger
related cost savings was limited. However, the advantage of a contiguous market
merger is the opportunity for growth in the respective markets, which the Bank
achieved during 1996.
The one-time special SAIF assessment significantly affected the
Company's efficiency ratio. This ratio for the year ended December 31, 1996 was
79.56%. After removing the impact of the SAIF assessment, the efficiency ratio
for the same period was 66.75%. Consistent with the concept of "cash earnings
per share," if the non-cash item goodwill amortization was removed from
non-interest expense, SAIF and goodwill adjusted efficiency would be 62.82% for
the year ended December 31, 1996, showing improvement over the prior year ratio
of 65.14% computed on the same basis.
Increased costs were experienced as a result of the Company's
electronic data processing ("EDP") conversion in 1996. In addition, the EDP
conversion itself required substantial outside consulting services. A portion of
the increase in professional services in 1996 from 1995 relates to the support
required in the EDP conversion. The outside consulting cost for the conversion
is a non-recurring expense.
12
Income Tax Expense. Income tax expense for 1996 was $2.0 million
compared to $1.9 million for 1995. The effective tax rate for 1996 was 38.8%
compared to 34.5% for 1995. The primary reason for the increase in effective
rate was due to the amortization of goodwill, which is not deductible for tax
purposes.
ASSET/LIABILITY MANAGEMENT
The Company's balance sheet consists of investments in interest-earning
assets (primarily loans and investment securities) which are primarily funded by
interest-bearing liabilities (deposits and borrowings). Such financial
instruments have varying levels of sensitivity to changes in market interest
rates resulting in market risk. Other than loans which are originated and held
for sale, all of the financial instruments of the Company are for other than
trading purposes.
The Bank is subject to interest rate risk to the extent that its
interest-bearing liabilities with short and intermediate-term maturities reprice
more rapidly, or on a different basis, than its interest-earning assets.
Management works to reduce its exposure to interest rate risk. Significant
effort has been made to reduce the duration and average life of the Bank's
interest-earning assets. The Bank continues to emphasize adjustable rate
mortgages and is attempting to grow its consumer and commercial portfolios which
are shorter term in nature than the mortgage portfolio. In addition, all
long-term, fixed rate mortgages are underwritten in accordance with Federal Home
Loan Mortgage Corporation ("FHLMC") guidelines thereby allowing the flexibility
of sale of the assets into the secondary market. Currently all 30-year fixed
rate loans are sold as they are originated. With its funding sources, management
has attempted to reduce the impact of interest rate changes by emphasizing
non-interest bearing products, longer term certificates of deposit and use of
fixed rate, term advances from the FHLB.
Management measures the Bank's interest rate risk by computing
estimated changes in net interest income and the net portfolio value ("NPV") of
its cash flows from assets, liabilities and off-balance sheet items in the event
of a range of assumed changes in market interest rates. The Bank's exposure to
interest rates is reviewed on a quarterly basis by senior management and the
Board of Directors. Exposure to interest rate risk is measured with the use of
interest rate sensitivity analysis to determine the change in NPV in the event
of hypothetical changes in interest rates. If estimated changes to NPV and net
interest income are not within the limits established by the Board, the Board
may direct management to adjust the Bank's asset and liability mix to bring
interest rate risk within Board approved limits.
NPV represents the market value of portfolio equity and is equal to the
market value of assets minus the market value of liabilities, with adjustments
made for off-balance sheet items. This analysis assesses the risk of loss in
market risk sensitive instruments in the event of sudden and sustained 1% to 4%
increases and decreases in market interest rates. The Bank's Board of Directors
has adopted an interest rate risk policy which establishes maximum decreases in
NPV in the event of sudden and sustained 1% to 4% increases or decreases in
market interest rates. The table below presents the Bank's projected change in
NPV and net interest income ("NII") for the various rate shock levels at
December 31, 1997.
13
Net Portfolio Value Net Interest Income
------------------- --------------------
Change in
Interest Rate Board Limit $ Amount % Change $ Amount % Change
(Basis Points) % Change in NPV in NPV in NII in NII
- ------------------------------------------------------------------------------------------------------------
+400 -50 % $42,260 -48 % $17,370 -31 %
+300 -40 54,990 -33 19,803 -22
+200 -35 64,479 -21 21,699 -14
+100 -30 73,263 -11 23,518 -7
0 --- 81,958 --- 25,286 ---
-100 -10 90,649 11 27,101 7
-200 -15 96,085 17 28,488 13
-300 -20 106,833 30 29,521 17
-400 -40 115,250 41 29,823 18
As illustrated in the table, NPV is more sensitive to rising rates than
declining rates. This occurs principally because, as rates rise, the market
value of fixed-rate loans declines due to both the rate increase and slowing
prepayments. When rates decline, the Bank does not experience a significant rise
in market value for these loans because borrowers prepay at relatively high
rates. The value of the Bank's deposits and borrowings changes in approximately
the same proportion in rising or falling rate scenarios.
As with any method of measuring interest rate risk, certain
shortcomings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets, such as adjustable-rate mortgage loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. In the event of a change in interest rates, expected
rates of prepayments on loans, decay rates of deposits and early withdrawals
from certificates could likely deviate significantly from those assumed in
calculating the table. Finally, the ability of many borrowers to service their
debt may decrease in the event of a significant interest rate increase.
In addition, the above table may not properly reflect the impact of
general interest rate movements on the Company's net interest income because the
repricing of certain categories of assets and liabilities are subject to
competitive and other pressures beyond the Company's control.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's principal sources of funds are deposits, principal and
interest payments on loans, sale of loans, maturities of securities, securities
available for sale and borrowings, primarily FHLB advances. The Bank has
classified all of the securities held in portfolio as available for sale,
thereby increasing the Bank's flexibility with respect to such securities. While
scheduled loan repayments and maturing investments are relatively predictable,
deposit flows and loan prepayments are more influenced by interest rates,
general economic conditions and competition.
Liquidity management is both a daily and long-term responsibility of
management. The Bank maintains a level of liquidity consistent with management's
assessment of expected loan demand, loan sales, deposit flows, yields available
on interest-earning deposits and investment securities, and the objectives of
its
14
asset/liability management program. Excess liquidity is invested generally in
interest-earning overnight deposits of the FHLB of Indianapolis. Other
investments include U.S. Treasury and federal agency securities, collateralized
mortgage obligations, mortgage and other asset-backed securities, municipal
bonds and corporate debt securities. When overnight deposits with the FHLB are
drawn to low levels to maintain liquidity, management will generally borrow
funds through the FHLB's advances program instead of selling its investment
securities.
Advances from the FHLB of Indianapolis increased only $6.3 million
during 1997 while assets grew by $37.5 million. As such, deposits were the
primary source of funds for this asset growth and there was very little pressure
on liquidity. FHLB advances totaled $145.5 million as of December 31, 1997. A
substantial portion of these advances will come due in 1998. The Bank may choose
to renew or pay off these advances depending upon its liquidity needs at that
time.
The Company also has a need for, and sources of, liquidity. Dividends
from the Bank are its primary source of liquidity, subject to certain regulatory
constraints (see Note 13 of the Notes to Consolidated Financial Statements). The
Company has modest operating costs and the dividends paid on common stock are
discretionary.
The Bank is subject to three capital to asset requirements in
accordance with OTS regulations. See Note 12 of the Notes to Consolidated
Financial Statements for information on the Bank's capital requirements.
ACCOUNTING AND REGULATORY STANDARDS
For accounting standards, see "Future Accounting Changes" in Note 1 of
the Notes to Consolidated Financial Statements.
- - - - - - - - - - - -
When used in this Annual Report, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements are subject to certain risks and uncertainties -
including, changes in economic conditions in the Company's market area, changes
in policies by regulatory agencies, fluctuations in interest rates, demand for
loans in the Company's market area and competition, that could cause actual
results to differ materially from historical performance and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake - and specifically disclaims any
obligation - to publicly release the result of any revisions which may be made
to any forward-looking statements to reflect events or circumstances after the
date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
15
OTTAWA FINANCIAL CORPORATION
Holland, Michigan
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS .................................. II-2
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS - December 31, 1997 and 1996 ...... II-3
CONSOLIDATED STATEMENTS OF INCOME for the
years ended December 31, 1997, 1996 and 1995 ................. II-4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'
EQUITY for the years ended December 31, 1997, 1996 and 1995 .. II-5
CONSOLIDATED STATEMENTS OF CASH FLOWS for
the years ended December 31, 1997, 1996 and 1995 ............. II-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .................... II-10
II-1
16
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Ottawa Financial Corporation
Holland, Michigan
We have audited the accompanying consolidated balance sheets of Ottawa
Financial Corporation as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Ottawa Financial
Corporation as of December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
February 20, 1998
II-2
17
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
1997 1996
----------- -----------
(Dollars in thousands except share data)
ASSETS
Cash and due from financial institutions $ 25,437 $ 20,253
Interest-bearing demand deposits in other
financial institutions 7,087 2,548
----------- -----------
Total cash and cash equivalents 32,524 22,801
Securities available for sale 57,308 62,906
Loans held for sale 1,955
Loans receivable, net of allowance for loan losses of
$3,293 in 1997 and $3,129 in 1996 747,423 715,551
Federal Home Loan Bank stock 7,308 6,958
Accrued interest receivable
Loans 3,859 3,893
Securities 669 798
Premises and equipment, net 15,030 14,534
Acquisition intangibles 14,248 15,474
Other assets 5,493 5,391
----------- -----------
Total assets $ 885,817 $ 848,306
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits $ 654,560 $622,492
Federal funds purchased 2,000
Federal Home Loan Bank advances 145,458 139,170
Advances from borrowers for taxes or insurance 917 270
Accrued expenses and other liabilities 8,519 7,457
----------- -----------
Total liabilities 809,454 771,389
Commitments and contingent liabilities
Shareholders' equity
Preferred stock, $.01 par value: 5,000,000 shares
authorized, none outstanding
Common stock, $.01 par value: 10,000,000 shares
authorized; 6,012,997 and 5,962,534 issued 60 60
at December 31, 1997 and 1996
Additional paid-in capital 67,381 61,049
Retained earnings, substantially restricted 23,386 32,672
Net unrealized gain (loss) on securities available for sale,
net of tax of $32 and $(41) for December 31,
1997 and 1996, respectively 62 (79)
Employee Stock Ownership Plan (ESOP)
(unallocated shares) (2,323) (2,806)
Management recognition and retention plan (MRP)
(unearned shares) (1,502) (1,977)
Less cost of common stock in treasury - 699,913 and 782,866
shares at December 31, 1997 and 1996, respectively (10,701) (12,002)
----------- -----------
Total shareholders' equity 76,363 76,917
----------- -----------
Total liabilities and shareholders' equity $ 885,817 $ 848,306
=========== ===========
See accompanying notes to consolidated financial statements.
II-3
18
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
(Dollars in thousands except share data)
Interest income
Loans $ 59,948 $ 48,991 $ 20,827
Securities 3,707 4,945 4,259
Other 1,071 733 493
--------- ---------- -----------
64,726 54,669 25,579
Interest expense
Deposits 29,398 25,056 10,038
Federal Home Loan Bank advances 8,293 5,451 1,234
Other 13 24 49
--------- ---------- -----------
37,704 30,531 11,321
--------- ---------- -----------
NET INTEREST INCOME 27,022 24,138 14,258
Provision for loan losses 660 564 160
--------- ---------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 26,362 23,574 14,098
Noninterest income
Service charges and other fees 3,039 2,755 2,047
Mortgage servicing fees 317 287 172
Gain on sale of mortgage loans 370 141 71
Gain on sale of student loans 238
Gain (loss) on securities 143 5 (398)
Other 277 140 (37)
--------- ---------- -----------
4,146 3,328 2,093
Noninterest expense
Compensation and benefits 10,356 8,945 5,439
Occupancy 1,316 1,112 688
Furniture, fixtures and equipment 1,056 781 596
Advertising 276 364 148
FDIC deposit insurance premium 324 1,235 534
SAIF assessment 3,510
State single business tax 357 338 222
Data processing 891 939 604
Deposit account ancillary 359 489 658
Professional services 379 697 191
Acquisition intangibles amortization 1,226 1,081
Other 2,168 2,353 1,571
--------- ---------- -----------
18,708 21,844 10,651
--------- ---------- -----------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 11,800 5,058 5,540
Federal income tax expense 4,273 1,964 1,911
--------- ---------- -----------
NET INCOME $ 7,527 $ 3,094 $ 3,629
========= ========== ===========
Earnings per common share $ 1.46 $ .56 $ .63
====== ====== =======
Earnings per common share assuming
dilution $ 1.34 $ .54 $ .63
====== ====== =======
See accompanying notes to consolidated financial statements.
II-4
19
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1997, 1996 and 1995
Net Unrealized
Gain (Loss)
on Securities
Additional Available
Common Paid-in Retained for Sale,
Stock Capital Earnings Net of Tax
------ ---------- -------------- --------------
(Dollars in thousands except share data)
BALANCE - JANUARY 1, 1995 $ 57 $ 54,804 $ 29,248 $ (1,715)
Net income for the year ended
December 31, 1995 3,629
49,749 shares committed to be
released under employee stock
ownership plan 194
Issuance of 201,213 shares of
common stock for management
recognition plan 2 2,664
Shares earned under management
recognition and retention plan
Acquisition of 306,000 treasury
shares, at cost (Note 13)
Cash dividend - $.28 per share (1,600)
Change in unrealized gain (loss)
on securities available for
sale, net of tax of ($654) 2,106
------ ---------- ------------ ------------
BALANCE - DECEMBER 31, 1995 59 57,662 31,277 391
Unallocated Total
ESOP Unearned Treasury Shareholders'
Shares MRP Shares Stock Equity
-------------- ---------- -------- -------------
(Dollars in thousands except share data)
BALANCE - JANUARY 1, 1995 $ (3,799) $ 78,595
Net income for the year ended
December 31, 1995 3,629
49,749 shares committed to be
released under employee stock
ownership plan 497 691
Issuance of 201,213 shares of
common stock for management
recognition plan $ (2,666)
Shares earned under management
recognition and retention plan 355 355
Acquisition of 306,000 treasury
shares, at cost (Note 13) $ (4,215) (4,215)
Cash dividend - $.28 per share (1,600)
Change in unrealized gain (loss)
on securities available for
sale, net of tax of ($654) 2,106
---------- ---------- -------- ----------
BALANCE - DECEMBER 31, 1995 (3,302) (2,311) (4,215) 79,561
(Continued)
II-5
20
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1997, 1996 and 1995
Net Unrealized
Gain (Loss)
on Securities
Additional Available
Common Paid-in Retained for Sale,
Stock Capital Earnings Net of Tax
------ ---------- -------- --------------
Net income for the year ended
December 31, 1996 3,094
Cost of warrants and options related
to the acquisition of AmeriBank 2,306
125,696 shares issued upon
exercise of stock options 1 507
49,607 shares committed to be released
under employee stock ownership plan 332
Issuance of 15,000 shares of common
stock for management recognition plan 242
Shares earned under management
recognition and retention plan
Acquisition of 476,866 treasury
shares, at cost (Note 13)
Cash dividend - $.31 per share (1,699)
Change in unrealized gain (loss)
on securities available for
sale, net of tax of $242 (470)
------ ---------- -------- --------------
BALANCE - DECEMBER 31, 1996 60 61,049 32,672 (79)
Unallocated Total
ESOP Unearned Treasury Shareholders'
Shares MRP Shares Stock Equity
----------- ---------- -------- -------------
Net income for the year ended
December 31, 1996 3,094
Cost of warrants and options related
to the acquisition of AmeriBank 2,306
125,696 shares issued upon
exercise of stock options 508
49,607 shares committed to be released
under employee stock ownership plan 496 828
Issuance of 15,000 shares of common
stock for management recognition plan (242)
Shares earned under management
recognition and retention plan 576 576
Acquisition of 476,866 treasury
shares, at cost (Note 13) (7,787) (7,787)
Cash dividend - $.31 per share (1,699)
Change in unrealized gain (loss)
on securities available for
sale, net of tax of $242 (470)
----------- ---------- -------- -------------
BALANCE - DECEMBER 31, 1996 (2,806) (1,977) (12,002) 76,917
(Continued)
II-6
21
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1997, 1996 and 1995
Net Unrealized
Gain (Loss)
on Securities
Additional Available
Common Paid-in Retained for Sale,
Stock Capital Earnings Net of Tax
------ ---------- -------- --------------
Net income for the year ended
December 31, 1997 7,527
22,367 shares issued upon
exercise of stock options 258
30,430 shares issued upon
exercise of stock warrants 502
51,907 shares committed to be released
under employee stock ownership plan 654
Issuance of 9,418 shares of common
stock for management recognition plan 249
Shares earned under management
recognition and retention plan
11,752 shares forfeited under management
recognition and retention plan (152)
Acquisition of 436,975 treasury
shares, at cost (Note 13)
Cash dividend - $.36 per share (1,858)
10% Stock dividend 4,821 (14,955)
Change in unrealized gain (loss)
on securities available for
sale, net of tax of $73 141
------ ---------- -------- --------------
BALANCE - DECEMBER 31, 1997 $ 60 $ 67,381 $23,386 $ 62
====== ========== ======== ==============
Unallocated Total
ESOP Unearned Treasury Shareholders'
Shares MRP Shares Stock Equity
----------- ---------- -------- -------------
Net income for the year ended
December 31, 1997 7,527
22,367 shares issued upon
exercise of stock options 258
30,430 shares issued upon
exercise of stock warrants 502
51,907 shares committed to be released
under employee stock ownership plan 483 1,137
Issuance of 9,418 shares of common
stock for management recognition plan (249)
Shares earned under management
recognition and retention plan 572 572
11,752 shares forfeited under management
recognition and retention plan 152
Acquisition of 436,975 treasury
shares, at cost (Note 13) (8,833) (8,833)
Cash dividend - $.36 per share (1,858)
10% Stock dividend 10,134
Change in unrealized gain (loss)
on securities available for
sale, net of tax of $73 141
-------- ----------- -------- ----------
BALANCE - DECEMBER 31, 1997 $ (2,323) $ (1,502) $(10,701) $ 76,363
======== ========== ======== ==========
See accompanying notes to consolidated financial statements.
II-7
22
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $7,527 $3,094 $3,629
Adjustments to reconcile net income
to net cash from operating activities
Depreciation 1,079 844 445
Net amortization of security premiums
and discounts 314 332 (7)
Amortization of intangible assets 1,226 1,081
Provision for loan losses 660 564 160
Other than temporary loss on securities
available for sale 267
(Gain) loss on sales of securities (143) (5) 131
Loss on limited partnership investment 82 112 67
ESOP expense 1,137 828 691
MRP expense 572 576 355
Origination of loans for sale (45,354) (9,833) (4,707)
Proceeds from sales of loans originated
for sale 43,531 9,973 4,778
Gain on sales of loans (370) (140) (309)
Changes in assets and liabilities
Other assets (94) (302) (1,139)
Other liabilities 1,062 775 211
-------- ---------- --------
Net cash from operating activities 11,229 7,899 4,572
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of AFSB (23,534)
Purchases of securities available for sale (30,092) (14,016) (21,731)
Proceeds from calls and maturities of
securities available for sale 26,381 27,789 13,580
Proceeds from sales of securities
available for sale 2,324 25,371 11,509
Purchases of securities held to maturity (634)
Proceeds from calls and maturities of
securities held to maturity 5,151
Purchases of FHLB stock (350) (3,112) (130)
Principal payments on mortgage-backed
certificates 7,028 4,191 1,210
Purchases of loans (6,039) (27,027) (986)
Proceeds from sales of student loans 7,032
Loan originations and principal
payments on loans (26,255) (117,970) (51,810)
Premises and equipment expenditures, net (1,575) (2,985) (1,580)
-------- ---------- --------
Net cash used in investing activities (28,578) (131,293) (38,389)
(Continued)
II-8
23
OTTAWA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
(Dollars in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits $32,068 $46,248 $11,898
Net increase (decrease) in
Federal funds purchased (2,000) 2,000
Proceeds from FHLB advances 67,000 112,500 38,000
Repayment of FHLB advances (60,712) (21,461) (8,338)
Net increase (decrease) in advances from
borrowers for taxes and insurance 647 18 (819)
Proceeds from exercise of stock options 258 508
Proceeds from exercise of stock warrants 502
Cash dividends paid (1,858) (1,699) (1,600)
Purchase of treasury shares (8,833) (7,787) (4,215)
-------- --------- -------
Net cash from financing activities 27,072 130,327 34,926
-------- --------- -------
Net change in cash and cash equivalents 9,723 6,933 1,109
Cash and cash equivalents at beginning of year 22,801 15,868 14,759
-------- --------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR $32,524 $22,801 $15,868
======== ========= =======
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $37,289 $29,194 $11,102
Income taxes 3,167 1,766 1,911
During 1995, securities with a carrying value of $6,562 and a fair value of
$6,560 were transferred from securities held to maturity to securities
available for sale.
See accompanying notes to consolidated financial statements.
II-9
24
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: Ottawa Financial
Corporation (the "Company") was organized as a thrift holding company in August
1994 to be the sole shareholder of Ottawa Savings Bank, FSB. During the third
quarter of 1996, Ottawa Savings Bank, FSB's name was changed to AmeriBank (the
"Bank"). The Bank is the sole shareholder of O.S. Services, Inc., Midwest
Investment Services and AmeriPlan Financial Services, Inc. The consolidated
financial statements include the accounts of the Company, the Bank and the
Bank's wholly-owned subsidiaries. All significant intercompany transactions
and balances have been eliminated in consolidation. The Bank's primary
services include accepting deposits and making commercial, mortgage and
installment loans at its 26 retail banking offices (including one drive-up
facility) in Ottawa, Muskegon, Kent, Oceana, Newaygo and Allegan counties in
the Western part of Michigan's lower peninsula. Substantially all of the
Company's revenue arises from lending and investment activities. The
operations of O.S. Services and Midwest Investment Services include investing
in the stock of MMLIC Life Insurance Company and participating as a limited
partner in affordable housing projects. O.S. Services and Midwest Investment
Services were merged effective December 31, 1997. The name of the combined
organization is O.S. Services, Inc., and the operations remain the same as
before the merger. AmeriPlan Financial Services was established in December
1997. Its operations consist of sales of investment products, including mutual
funds and annuities and offering discount brokerage services.
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, disclosure of contingent assets
and liabilities at the date of the financial statements, and the reported
amount of revenues and expenses during the reporting period. Actual results
could differ from those estimates. The primary estimates incorporated into the
Company's consolidated financial statements which are particularly susceptible
to change in the near term include the allowance for loan losses, the
realization of deferred tax assets, the determination and carrying value of
certain financial instruments, the determination and carrying value of impaired
loans, the determination of other-than-temporary reductions in the fair value
of securities, and the evaluation of impairment of mortgage servicing assets.
Concentration of Credit Risk: Loans are granted to, and deposits are obtained
from, customers primarily in the Western Michigan area as described above.
Substantially all loans are secured by specific items of collateral, including
residential real estate, commercial real estate and consumer assets. Other
financial instruments which potentially subject the Company to concentrations
of credit risk include deposit accounts in other financial institutions.
Consolidated Statements of Cash Flows: For purposes of the consolidated
statements of cash flows, cash equivalents include demand balances with
financial institutions and Federal funds sold for one-day periods. Cash flows
are reported net for short-term investment, loan and deposit transactions, and
short-term borrowings.
(Continued)
II-10
25
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities Available for Sale: Securities available for sale consist of those
securities which might be sold prior to maturity due to changes in interest
rates, prepayment risks, yield and availability of alternative investments,
liquidity needs or other factors. Securities classified as available for sale
are reported at their fair value and the related unrealized holding gain or
loss is reported, net of related income tax, as a separate component of
shareholders' equity, until realized.
Declines in the fair value of individual securities below cost, considered by
management to be other than temporary, are charged to earnings as a realized
loss.
Premiums and discounts on securities available for sale are recognized in
interest income using the level-yield method over the estimated life of the
security. Gains and losses on the sale of securities available for sale are
determined using the specific identification method.
Securities Held to Maturity: Securities for which management has the positive
intent and the Company has the ability to hold to maturity are reported at
cost, adjusted for premiums and discounts that are recognized in interest
income using the level-yield method over the period to maturity.
Loan Income: Interest on loans is accrued over the term of the loans based
upon the principal outstanding, using the interest method. Management reviews
loans delinquent 90 days or more to determine if the interest accrual should be
discontinued and the loan considered impaired. Under SFAS No. 114 as amended
by SFAS No. 118, the carrying values of impaired loans are periodically
adjusted to reflect cash payments, revised estimates of future cash flows, and
increases in the present value of expected cash flows due to the passage of
time. Cash payments representing interest income are reported as such. Other
cash payments are reported as reductions in carrying value, while increases or
decreases due to changes in estimates of future payments and due to the passage
of time are reported as adjustments to the provision for loan losses.
For loans originated for portfolio, loan fees are deferred, net of certain
direct loan origination costs. The net amount deferred is reported in the
consolidated balance sheets as a reduction of loans and is recognized as
interest income over the contractual term of the loan using the level-yield
method.
(Continued)
II-11
26
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Mortgage Banking Activities: Mortgage loans originated and intended for sale
in the secondary market are carried at the lower of cost or estimated aggregate
market value. Net unrealized losses are recognized in a valuation allowance by
charges to income. Mortgage loans are sold into the secondary market at market
prices, which includes consideration for normal servicing fees. Effective
January 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 122, Accounting for Mortgage Servicing Rights (SFAS No. 122).
The Statement requires capitalizing the rights to service originated or
purchased mortgage loans. Prior to the adoption of SFAS No. 122, loan
servicing fees were recognized when received and the related costs were
recognized when incurred. Beginning in 1996, the total cost of mortgage loans
purchased or originated with the intent to sell is allocated between the loan
servicing right and the mortgage loan without servicing, based on their
relative fair values. The capitalized cost of loan servicing rights is
amortized in proportion to, and over the period of, estimated net future
servicing revenue. The effect of adopting this Statement was not material to
the Company's consolidated financial position or results of operations during
1996.
Mortgage servicing rights are periodically evaluated for impairment by
stratifying them based on predominant risk characteristics of the underlying
serviced loans, such as loan type, term and note rate. Impairment represents
the excess of cost of an individual mortgage servicing rights stratum over its
fair value, and is recognized through a valuation allowance.
Allowance for Loan Losses: Because some loans may not be repaid in full, an
allowance for loan losses is maintained. Increases to the allowance are
recorded by a provision for loan losses charged to expense. Estimating the
risk of the loss and the amount of loss on any loan is necessarily subjective.
Accordingly, the allowance is maintained by management at a level considered
adequate to cover possible losses that are currently anticipated based on past
loss experience, general economic conditions, information about specific
borrower situations including their financial position and collateral values,
and other factors and estimates which are subject to change over time. While
management may periodically allocate portions of the allowance for specific
problem loan situations, including impaired loans discussed below, the whole
allowance is available for any loan charge-offs that occur. Loans are charged
off in whole or in part when management's estimate of the undiscounted cash
flows from the loan are less than the recorded investment in the loan, although
collection efforts may continue and future recoveries may occur.
(Continued)
II-12
27
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of
similar nature such as residential mortgage, consumer, and credit card loans,
and on an individual loan basis for other loans. If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported, net, at the
present value of estimated future cash flows using the loan's existing rate or
at the fair value of collateral if repayment is expected solely from the
collateral. Loans are evaluated for impairment when payments are delayed,
typically 90 days or more, or when it is probable that all principal and
interest amounts will not be collected according to the original terms of the
loan.
Premises and Equipment: Premises and equipment are stated at cost less
accumulated depreciation. Premises and related components are depreciated
using the straight-line method with useful lives ranging from 10 to 40 years
and furniture and equipment are depreciated using the straight-line method with
useful lives ranging from 3 to 10 years. Maintenance and repairs are charged
to expense and improvements are capitalized. The cost and accumulated
depreciation applicable to assets retired or otherwise disposed of are
eliminated from the accounts and the gain or loss on disposition is included in
noninterest income or expense. These assets are reviewed for impairment when
events indicate the carrying amount may not be recoverable.
Real Estate Owned: Real estate properties acquired through, or in lieu of,
loan foreclosure are initially recorded at fair value at the date of
foreclosure establishing a new cost basis. After foreclosure, valuations are
periodically performed by management and the real estate is carried at the
lower of cost or fair value minus estimated costs to sell. Revenue and
expenses from operations of real estate owned is included in other noninterest
expense.
(Continued)
II-13
28
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Acquisition Intangibles: Goodwill is the excess of purchase price over
identified net assets in business acquisitions. Goodwill is expensed on the
straight-line method over 15 years. Identified intangibles represent the value
of depositor relationships purchased and is expensed on the straight-line
method over 15 years. Goodwill and identified intangibles are assessed for
impairment based on estimated undiscounted cash flows, and written down if
necessary.
Income Taxes: Income tax expense is based on the amount of taxes due on the
tax return plus the change in deferred taxes computed based on the expected
future tax consequences of temporary differences between the carrying amounts
and tax bases of assets and liabilities, using enacted tax rates, adjusted for
allowances made for uncertainty regarding the realization of net tax assets.
Retirement Plans: The Company sponsors noncontributory defined benefit pension
and defined contribution profit sharing plans. The plans cover all employees
who have met certain age and service requirements. Benefits from the defined
benefit pension plan are based on years of service and the employee's
compensation. The funding policy for the defined benefit pension plan is to
contribute the minimum funding requirement calculated by consulting actuaries.
Profit sharing plan contributions are charged to expense annually.
Employee Stock Ownership Plan: The Employee Stock Ownership Plan (ESOP) is
accounted for in accordance with AICPA Statement of Position 93-6. The cost of
shares issued to the ESOP but not yet allocated to participants are presented
in the consolidated balance sheet as a reduction of shareholders' equity.
Compensation expense is recorded based on the market price of the shares as
they are committed to be released for allocation to participant accounts. The
difference between the market price and the cost of shares committed to be
released is recorded as an adjustment to paid in capital. Dividends on
allocated ESOP shares are recorded as a reduction of retained earnings;
dividends on unallocated ESOP shares are reflected as a reduction of debt and
accrued interest.
Shares are considered outstanding for earnings per share calculations as they
are committed to be released; unallocated shares are not considered
outstanding.
Preferred Stock: The Company is authorized to issue preferred stock from time
to time in one or more series subject to applicable provisions of law, and the
Board of Directors is authorized to fix the designations, powers, preferences
and relative participating, optional and other special rights of such shares,
including voting rights (which could be multiple or as a separate class) and
conversion rights. In the event of a proposed merger, tender offer or other
attempt to gain control of the Company that the Board does not approve, it
might be possible for the Board to authorize the issuance of a series of
preferred stock with rights and preferences that would impede the completion of
such a transaction. The Board of Directors has no present plans for the
issuance of any preferred stock.
(Continued)
II-14
29
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings Per Share: Earnings per common share and Earnings per common share
assuming dilution were computed under the provisions of Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which was adopted
retroactively beginning the fourth quarter of 1997. All prior amounts have
been restated to be comparable. Amounts reported as Earnings per Common Share
reflect the earnings available to common shareholders for the year divided by
the weighted average number of common shares outstanding during the year.
Common shares outstanding includes issued shares less shares held in the
treasury and unallocated shares held by the ESOP. Earnings per Common Share
Assuming Dilution includes the shares that would be outstanding assuming
exercise of dilutive stock options and warrants. All share and per share
information has been retroactively adjusted to reflect the 10% stock dividend
paid on September 30, 1997.
Future Accounting Changes: New accounting standards have been issued which
will require future reporting of comprehensive income (net income plus changes
in holding gain and losses on available for sale securities) and may require
redetermination of industry segment financial information.
Reclassifications: Certain amounts on the 1996 and 1995 consolidated financial
statements have been reclassified to conform with the 1997 presentation.
(Continued)
II-15
30
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - ACQUISITION
On February 13, 1996, the Company completed the acquisition of AmeriBank
Federal Savings Bank ("AFSB"), a federal savings bank headquartered in
Muskegon, Michigan. Under the terms of this transaction, the Company acquired
all of the outstanding stock of AFSB in exchange for approximately $30.4
million in cash and warrants to acquire 623,200 shares of Company stock at
$15.91 per share. The value of the warrants was determined to be approximately
$555,000. Further, options to acquire AFSB stock were converted to options to
acquire Company stock. The value of these options for purposes of determining
the total cost to the Company for the merger transaction was approximately $1.8
million. Accordingly, the total cost of the transaction considering cash,
warrants, and converted options was approximately $32.7 million.
The acquisition has been accounted for using the purchase method of accounting,
and, accordingly, the purchase price has been allocated to the assets purchased
and the liabilities assumed based upon the estimated fair values at the date
of acquisition. The excess of the purchase price over the fair values of the
net assets acquired was approximately $14.1 million and has been recorded as
goodwill, which is being amortized on a straight-line basis over 15 years. The
purchase accounting adjustments are being amortized under various methods and
over the lives of the corresponding assets and liabilities.
In conjunction with the acquisition, the fair values of significant assets and
liabilities assumed were as follows, stated in thousands of dollars:
Cash acquired net of cash paid for acquisition $ (23,534)
Securities 42,629
Loans 294,699
Premises and equipment 6,756
Acquisition intangibles 16,555
Deposits (333,024)
Other borrowings (4,890)
The consolidated statements of income reflect the operating results of AFSB
since the effective date of the acquisition. The following table presents
unaudited pro forma information as if the acquisition of AFSB had occurred at
the beginning of both 1996 and 1995. The pro forma information includes
adjustments for lost interest on funds paid to consummate the acquisition, the
amortization of intangibles arising from the transaction, the elimination of
acquisition related expenses, and the related income tax effects. The pro
forma financial information is not necessarily indicative of the results of
operations as they would have been had the transactions been effected on the
assumed dates.
(Continued)
II-16
31
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 -ACQUISITION (Continued)
1996 1995
---- ----
(Unaudited, Dollars in thousands except share data)
Interest income $ 57,609 $ 48,444
Interest expense 32,332 25,624
------------- -------------
NET INTEREST INCOME 25,277 22,820
Provision for loan losses 700 460
------------- -------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 24,577 22,360
Noninterest income 3,408 3,015
Noninterest expense 22,782 18,312
------------- -------------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 5,203 7,063
Federal income tax expense 2,050 2,664
------------- -------------
NET INCOME $ 3,153 $ 4,399
============= =============
Pro forma earnings per common share $.57 $.70
==== ====
Pro forma earnings per common share assuming dilution .55 .69
==== ====
In connection with the acquisition, the Company entered into an employment
agreement with one of its officers. For more information regarding the
employment agreement, see Note 12. Further, AFSB options rolled over into
163,402 options to acquire Company stock at a price equivalent to the original
AFSB exercise price, additional options to purchase 45,635 shares of common
stock were awarded and an additional 16,500 shares of common stock were awarded
under the Management Recognition Plan. For more discussion regarding the stock
options and awards, see Note 15.
All share and per share information has been retroactively adjusted to reflect
the 10% stock dividend paid on September 30, 1997.
(Continued)
II-17
32
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES
The amortized cost and fair values of securities available for sale at December
31, 1997 and 1996 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ----------- ----------- ---------
(Dollars in thousands)
1997
- ----
Debt securities
Obligations of U.S. Government
corporations and agencies $ 24,999 $ 65 $ 57 $ 25,007
Municipal obligations 1,846 12 2 1,856
Corporate 2,000 10 2,010
Asset-backed 28,369 169 103 28,435
--------- ----------- ----------- ---------
$ 57,214 $ 256 $ 162 $ 57,308
========= =========== =========== =========
(Continued)
II-18
33
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES (Continued)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ----------- ----------- -------
(Dollars in thousands)
1996
- ----
Equity securities $ 167 $ 129 $ 296
Debt securities
Obligations of U.S. Government
corporations and agencies 16,002 39 $ 81 15,960
Municipal obligations 4,666 43 2 4,707
Corporate 11,354 22 23 11,353
Asset-backed 30,837 83 330 30,590
--------- ----------- ----------- -------
62,859 187 436 62,610
--------- ----------- ----------- -------
$ 63,026 $ 316 $ 436 $62,906
========= =========== =========== =======
The amortized cost and fair value of securities available for sale at December
31, 1997, by contractual maturity, are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
------------------------
Amortized Fair
Cost Value
----------- -----------
(Dollars in thousands)
Due in one year or less $ 6,190 $ 6,164
Due after one year through five years 17,547 17,617
Due after five through ten years 5,108 5,092
----------- -----------
28,845 28,873
Asset-backed debt securities 28,369 28,435
----------- -----------
$ 57,214 $ 57,308
=========== ===========
Because of their variable payments, asset-backed securities are not reported by
a specific maturity grouping.
Proceeds from sales of securities available for sale were $2,324,000 in 1997.
Losses of $11,000 and gains of $154,000 were realized on these sales. Proceeds
from sales of securities available for sale were $25,371,000 in 1996. Losses
of $21,000 and gains of $26,000 were realized on these sales. Proceeds from
sales of securities available for sale were $11,509,000 in 1995. Losses of
$137,000 and gains of $6,000 were realized on these sales.
(Continued)
II-19
34
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES (Continued)
A charge of $267,000 was recorded in 1995 to recognize other-than-temporary
losses on investments in certain mutual funds which held asset-backed
securities. These funds were classified as available for sale.
In accordance with the FASB Special Report, A Guide to Implementation of
Statement No. 115 on Accounting for Certain Investments in Debt and Equity
Securities, securities held to maturity with a carrying value of $6,562,000,
fair value of $6,560,000, unrealized gain of $13,000 and unrealized loss of
$14,000 were transferred to the available for sale classification on November
30, 1995. The transfer increased shareholders' equity by $1,000, which is net
of the related deferred tax asset of $584. The reclassification was made to
provide greater flexibility in managing liquidity and interest rate risk.
NOTE 4 - LOANS
Loans are classified as follows at December 31:
1997 1996
---- ----
(Dollars in thousands)
First mortgage loans (principally conventional)
Principal balances
Secured by one-to-four family residences $ 483,502 $ 516,935
Secured by other properties 73,810 77,008
Construction loans 71,145 33,823
--------- ----------
628,457 627,766
Less
Undisbursed portion of construction loans (25,787) (22,956)
Deferred fees and discounts (854) (1,238)
--------- ----------
601,816 603,572
Commercial loans
Principal balances 37,322 14,996
Consumer and other loans
Principal balances
Student loans 21 103
Home equity and second mortgage 55,960 49,396
Other 55,597 50,613
--------- ----------
111,578 100,112
--------- ----------
750,716 718,680
Allowance for loan losses (3,293) (3,129)
--------- ----------
$ 747,423 $ 715,551
========= ==========
(Continued)
II-20
35
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
An analysis of the allowance for loan losses follows:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Balance - beginning of year $ 3,129 $ 1,251 $ 1,118
Acquired balance 1,358
Provision 660 564 160
Recoveries 119 90 1
Loans charged-off (615) (134) (28)
----------- ----------- --------
Balance - end of year $ 3,293 $ 3,129 $ 1,251
=========== =========== ========
Information regarding impaired loans is as follows for the years ended December
31:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Average investment in impaired loans $ 1,354 $ 1,612 $ 415
Interest income recognized on impaired loans
including interest income recognized on cash basis 104 46 35
Interest income recognized on impaired loans on cash basis 4 5 --
Information regarding impaired loans at December 31 is as follows:
1997 1996
---- ----
(Dollars in thousands)
Balance of impaired loans $ 1,942 $ 1,173
Less portion for which no allowance for
loan losses is allocated (490) (492)
------------ ----------
Portion of impaired loan balance for which an
allowance for credit losses is allocated $ 1,452 $ 681
============ ==========
Portion of allowance for loan losses allocated
to the impaired loan balance $ 346 $ 185
(Continued)
II-21
36
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - SECONDARY MORTGAGE MARKET ACTIVITIES
The following summarizes the Company's secondary mortgage market activities:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Loans originated for resale $ 45,354 $ 9,833 $ 4,707
Proceeds from sales of loans
originated for resale 43,531 9,973 4,778
Gain on sales of mortgage loans 370 140 71
Mortgage loans serviced for others,
principally the Federal Home Loan
Mortgage Corporation 130,431 102,685 54,000
Custodial escrow balances maintained
in connection with the foregoing loan
servicing 238 230 480
Mortgage servicing fees 317 287 172
The carrying value of mortgage servicing rights, which approximates fair value,
was $650,000 at December 31, 1997.
Following is an analysis of the activity, in thousands, for mortgage servicing
rights for 1997 and 1996:
Balance at January 1, 1996 $ 0
Additions (acquired and originated) 489
Amortization (32)
---------------
Balance at December 31, 1996 $ 457
---------------
Additions 237
Amortization (44)
---------------
Balance at December 31, 1997 $ 650
===============
NOTE 7 - PREMISES AND EQUIPMENT
A summary of premises and equipment is as follows at December 31:
1997 1996
---- ----
(Dollars in thousands)
Land $ 3,675 $ 3,656
Buildings and improvements 11,336 10,210
Furniture and equipment 6,150 6,152
-------- -----------
21,161 20,018
Accumulated depreciation (6,131) (5,484)
-------- -----------
$ 15,030 $ 14,534
======== ===========
(Continued)
II-22
37
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - DEPOSITS
Deposits at December 31 are summarized as follows:
1997 1996
---- ----
(Dollars in thousands)
Noninterest-bearing $ 28,431 $ 25,487
NOW accounts and MMDAs 160,296 154,711
Passbook and statement savings 60,143 64,987
Certificates of deposit 405,690 377,307
--------------- ---------
$ 654,560 $ 622,492
=============== =========
At December 31, 1997, scheduled maturities of certificates of deposit, in
thousands, are as follows:
1998 $ 250,574
1999 114,024
2000 29,262
2001 3,798
2002 and thereafter 8,032
--------------------
$ 405,690
====================
The aggregate amount of demand, time and certificates of deposit with balances
of $100,000 or more was approximately $78,138,000 and $71,956,000 at December
31, 1997 and 1996, respectively.
NOTE 9 - BORROWINGS
Advances from the Federal Home Loan Bank of Indianapolis, collateralized by
mortgage loans under a blanket collateral agreement and Federal Home Loan Bank
stock, consist of the following at December 31:
Advance Range of Range of
Principal Terms Amount Maturities Interest Rates
--------------- ------- ---------- --------------
(Dollars in thousands)
1997
-----
Single-maturity fixed rate advances $ 96,500 February 1998 to 4.97% to 7.30%
December 2007
Putable advances 18,000 May 2000 to 5.55% to 5.90%
December 2002
Short-term variable rate advances 25,000 March 1998 to 5.72% to 5.88%
July 1998
Amortizable mortgage advances 5,958 June 1999 to 6.82% to 7.16%
------------------ May 2000
$ 145,458
==================
1996
-----
Single-maturity fixed rate advances $ 81,500 December 1997 to 4.97% to 7.30%
August 2000
Short-term variable rate advances 51,000 January 1997 to 5.32% to 5.56%
November 1997
Amortizable mortgage advances 6,670 June 1999 to 6.82% to 7.16%
May 2000
------------------
$ 139,170
==================
(Continued)
II-23
38
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - BORROWINGS (Continued)
Maturities of advances outstanding, in thousands, at December 31, 1997 are as
follows for the next five years:
1998 $ 70,500
1999 33,656
2000 19,302
2001 0
2002 17,000
2003 and thereafter 5,000
----------
$ 145,458
==========
Through February 20, 1998, an additional $16 million was borrowed from the
FHLB. Certain of the advances are subject to prepayment penalties according to
the provisions and conditions of the credit policy of the Federal Home Loan
Bank.
At December 31, 1997, the Company also had an unused line of credit with a
major bank totaling $15 million.
NOTE 10 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments consist of standby letters of credit, commitments
to make loans and fund loans in process. The Company's exposure to credit loss
in the event of nonperformance by the other party to these financial
instruments is represented by the contractual amount of these instruments. The
Company follows the same credit policy to make such commitments as is followed
for those loans recorded in the financial statements.
The contract amounts of these financial instruments are as follows at December
31:
1997 1996
----------- -----------
(Dollars in thousands)
Financial instruments whose contract
amount represents credit risk
Commitments to make loans $23,844 $12,540
Unused consumer lines of credit 33,729 33,748
Unused commercial lines of credit 9,930 7,551
Loans in process 25,787 24,886
Letters of credit 5,110 1,056
Since certain commitments to make loans and fund loans in process expire
without being used, the amount does not necessarily represent future cash
commitments. Commitment periods are generally for 30 to 120 days.
Approximately 43% and 69% of commitments to make loans and to fund loans in
process were made at fixed rates as of December 31, 1997 and 1996,
respectively. Rate ranges for these fixed rate commitments were 6.00% to 10.5%
and 6.125% to 10.5% as of December 31, 1997 and 1996, respectively. Lines of
credit are issued at variable market rates. No losses are anticipated as a
result of these transactions.
(Continued)
II-24
39
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements with three of its officers.
Under the terms of those agreements, certain events leading to separation from
the Company could result in cash payments aggregating approximately $1,958,000.
The Company and the Bank periodically become defendants in certain claims and
legal actions arising in the ordinary course of business. Currently, there are
no matters which are expected to have a material adverse effect on the
consolidated financial position of the Company.
NOTE 12 - RESTRICTIONS ON RETAINED EARNINGS AND CAPITAL
REQUIREMENTS
Effective July 25, 1997, AmeriBank, the Company's wholly-owned subsidiary,
completed its conversion to a Michigan chartered savings bank. As a state
chartered savings bank, AmeriBank's primary regulators are the Financial
Institutions Bureau of Michigan and the Federal Deposit Insurance Corporation.
The Bank is subject to regulatory capital requirements administered by these
regulatory agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain
off-balance sheet items calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments
by regulators about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
Capital to Risk-
Weighted Assets
------------------ Tier 1 Capital
Total Tier 1 to Average Assets
-------- -------- -----------------
Well capitalized 10% 6% 5%
Adequately capitalized 8 4 4
Undercapitalized 6 3 3
(Continued)
II-25
40
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - RESTRICTIONS ON RETAINED EARNINGS AND CAPITAL
REQUIREMENTS (Continued)
As a result of the Bank's charter change, the 1997 and 1996 regulatory capital
levels are based upon the Federal Deposit Insurance Corporation and Office of
Thrift Supervision guidelines, respectively. At year end, the Bank's actual
capital levels (in millions) and minimum required levels were:
Minimum Required
To Be Well
Minimum Required Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- --------- --------- --------- ---------
1997
- ----
Total capital (to risk weighted assets) $62.2 11.3% $43.9 8.0% $54.8 10.0%
Tier 1 capital (to risk weighted assets) 58.9 10.7 21.9 4.0 32.9 6.0
Tier 1 capital (to average total assets) 58.9 6.8 34.5 4.0 43.4 5.0
1996
- ----
Total capital (to risk weighted assets) $54.3 10.4% $41.8 8.0% $52.3 10.0%
Tier 1 capital (to risk weighted assets) 51.2 9.8 20.9 4.0 31.4 6.0
Tier 1 capital (to adjusted total assets) 51.2 6.2 33.2 4.0 41.5 5.0
Tangible capital (to adjusted
total assets) 51.2 6.2 12.5 1.5 N/A
The Bank at year-end 1997 and 1996 was categorized as well capitalized.
During 1995, the Bank made a capital distribution to the Company in the amount
of $15,000,000. This distribution was made primarily to allow the Company to
fund the acquisition discussed in Note 2 and stock repurchase transactions
discussed in Note 14. During 1996 and 1997, the Bank made capital
distributions to the Company in the amount of $2,449,000 and $4,000,000,
respectively. These distributions were made primarily to allow the Company to
pay dividends and fund the stock repurchase transactions discussed in Note 13.
The distributions were within the guidelines described above.
At the time of conversion to a stock association, a liquidation account of
$26,527,000 was established which is equal to the Bank's total net worth as of
the date of the latest audited balance sheet appearing in the final conversion
prospectus. The liquidation account will be maintained for the benefit of
eligible depositors who continue to maintain their accounts at the Bank after
the conversion. The liquidation account is to be reduced annually to the
extent that eligible depositors have reduced their qualifying deposits.
Subsequent increases do not restore an eligible account holder's interest in
the liquidation account. In the event of a complete liquidation, each eligible
depositor will be entitled to receive a distribution from the liquidation
account in an amount proportionate to the current adjusted qualifying balances
for accounts then held. The Bank may not pay dividends that would reduce
shareholders' equity below the required liquidation account balance.
(Continued)
II-26
41
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - STOCK REPURCHASE PROGRAMS
During 1995, the Company received regulatory approval to repurchase up to
861,153 shares of its common stock. During 1996 and 1995, 524,553 and 336,600
shares were repurchased at an average price of $14.85 and $12.52, respectively.
In 1996 and 1997, the Company received regulatory approval to repurchase up to
284,860 and 270,570 shares, respectively, of its common stock. Through
December 31, 1996, no shares were repurchased under these approvals. During
1997, 436,975 shares were repurchased at an average price of $20.21. The
repurchase approval expires on June 12, 1998. Subsequent to December 31, 1997,
and through February 20, 1998, the Company repurchased 64,000 shares at an
average price of $30.24.
Repurchased shares are treated as treasury shares and are available for general
corporate purposes, including issuance in connection with stock based
compensation and warrant plans.
All share and per share information has been retroactively adjusted to reflect
the 10% stock dividend paid on September 30, 1997.
NOTE 14 - STOCK WARRANT PLAN
In connection with the acquisition of AFSB on February 13, 1996, the Company
issued 566,546 warrants to the former AFSB shareholders. Prior to the 10%
stock dividend paid on September 30, 1997, each warrant entitled the holder to
purchase one share of the Company's common stock at an exercise price of
$17.50. Effective September 30, 1997, each warrant allows the holder to
purchase 1.1 shares of common stock at a price of $15.91 per share reflecting a
proportionate adjustment as a result of the 10% stock dividend. All warrants
were exercisable immediately upon issue and expire on February 13, 1999.
No warrants were exercised during 1996. During 1997, 31,555 shares of the
Company's common stock were issued upon the exercise of 28,687 warrants. At
December 31, 1997, 537,859 warrants were exercisable.
NOTE 15 - STOCK-BASED COMPENSATION PLANS
As part of the conversion from a federally chartered mutual savings bank to a
federally chartered stock savings bank, an employee stock ownership plan
("ESOP") was established for the benefit of substantially all employees. The
ESOP borrowed $4,222,050 from the Company and used those funds to acquire
464,426 shares of the Company's stock at $9.09 per share. Participants become
fully vested in allocated shares after five years of credited service and may
receive their distribution in the form of cash or stock.
Shares issued to the ESOP are allocated to ESOP participants based on principal
and interest payments made by the ESOP on the loan. The loan is secured by
shares purchased with the loan proceeds and will be repaid by the ESOP with
funds from the Company's discretionary contributions to the ESOP and earnings
on ESOP assets. Principal payments are scheduled to occur in even quarterly
amounts over a ten-year period. However, in the event contributions exceed the
minimum debt service requirements, additional principal payments will be made.
For purposes of the following disclosure, all share and per share information
has been retroactively adjusted to reflect the 10% stock dividend paid on
September 30, 1997. During 1997, 1996 and 1995, 51,907, 54,568 and 54,724
shares of stock with a fair value of $21.90, $15.17 and $12.63 per share were
committed to be released, resulting in ESOP compensation expense of $1,137,000,
$828,000 and $691,000, respectively. Shares held by the ESOP at December 31
are as follows:
(Continued)
II-27
42
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1997 1996 1995
------- ----------- -----------
(Dollars in thousands)
Allocated shares 207,641 155,734 101,166
Unallocated shares 256,785 308,692 363,260
------- ----------- -----------
Total ESOP shares 464,426 464,426 464,426
======= =========== ===========
Fair value of unallocated shares $8,731 $4,717 $5,160
======= =========== ===========
(Continued)
II-28
43
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - STOCK-BASED COMPENSATION PLANS (Continued)
A stock option and incentive plan ("SOP") and management recognition plan
("MRP") were authorized by the shareholders at the April 25, 1995, annual
meeting. The MRP is a restricted stock award plan. The SOP and MRP are
administered by a Committee of Directors of the Company. This Committee
selects recipients and terms of awards pursuant to the Plan. Total shares made
available under the SOP and MRP are 922,405 and 247,308, respectively, as
adjusted for the 10% stock dividend.
MRP awards vest in five equal annual installments, subject to the continuous
employment of the recipients as defined under such plans. SOP options vest in
five equal annual installments and expire ten years from the date of grant. No
compensation expense is being recognized in connection with the grant of the
options for which the exercise prices equal the Company's stock price at the
dates of grant. Compensation expense for the MRP is based upon market price at
the date of grant and is recognized on a prorata basis over the vesting period
of the awards. Compensation cost charged against income for the MRP was
$572,000, $576,000 and $355,000 for 1997, 1996 and 1995, respectively. The
unamortized unearned compensation value of the MRP is shown as a reduction to
shareholders' equity in the accompanying consolidated balance sheets.
Statement of Financial Accounting Standards No. 123, which became effective for
1996, requires pro forma disclosures for companies that do not adopt its fair
value accounting method for stock-based employee compensation. Accordingly,
the following pro forma information presents net income, earnings per common
share and earnings per common share assuming dilution had the fair value method
been used to measure compensation cost for the SOP. In future years, the pro
forma effect of not applying this standard is expected to increase as
additional options are granted. The compensation cost charged against income
for the MRP is the same as if the provisions of FAS No. 123 had been applied.
1997 1996 1995
---- ---- ----
(Dollars in thousands except share data)
Net income as reported $7,527 $3,094 $3,629
Pro forma net income 7,150 2,783 3,441
Earnings per common share as reported 1.46 .56 .63
Pro forma earnings per common share 1.39 .50 .59
Earning per common share assuming dilution as reported 1.34 .54 .63
Pro forma earnings per common share assuming dilution 1.29 .50 .59
The fair values of SOP options granted during 1997, 1996, and 1995 were
estimated using the following weighted-average assumptions.
1997 1996 1995
---- ---- ----
Risk-free interest rate 6.27% 5.78% 7.01%
Expected life 10 Years 10 Years 10 Years
Expected volatility of stock price 6.00% 4.00% 4.00%
Expected dividends 1.97% 2.23% 2.43%
(Continued)
II-29
44
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - STOCK-BASED COMPENSATION PLANS (Continued)
Information pursuant to the SOP at December 31 is as follows:
Weighted-
Weighted- Range of Average
Number Average Exercise Fair Value
of Options Exercise Price Price of Grants
---------- -------------- ------------- ----------
Outstanding, beginning of 1995
Granted 502,158 $ 11.99 $3.45
-------
Outstanding, end of 1995 502,158 11.99
Granted 113,835 $ 14.74 $3.50
Conversion of AFSB options 163,403 3.93
Exercised (138,266) 3.71
Forfeited (3,751) 11.99
---------
Outstanding, end of 1996 637,379 $ 12.27 $4.37- $14.89
Granted 82,585 20.54 $6.01
Exercised (24,032) 10.74
Forfeited (25,152) 12.37
--------
Outstanding, end of 1997 670,780 $ 13.28 $4.37-$29.13
SOP options exercisable at year-end are as follows:
Weighted-
Average
Number Exercise
of Options Price
------------- ----------
1996 122,164 $10.89
1997 221,289 11.51
No options were vested at December 31, 1995.
At year-end 1997, the weighted average remaining life of options outstanding
was 7.91 years.
All share and per share information has been retroactively adjusted to reflect
the 10% stock dividend paid on September 30, 1997.
(Continued)
II-30
45
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - PENSION PLANS
The Company sponsors two noncontributory defined benefit pension plans, one for
the Bank and one for AFSB, covering substantially all employees.
The following sets forth the funded status and amounts recognized in the
consolidated financial statements at December 31, 1995 for the Bank plan and
December 31, 1996 and 1997 for the Bank plan and the AFSB plan combined
(subsequent to the acquisition discussed in Note 2). The information reflects
the curtailment of the Bank plan on January 1, 1994 and the AFSB plan on
December 31, 1995, which had no material effect on the Company's results of
operations.
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Actuarial present value of benefit obligations
Accumulated benefit obligation $(3,947) $(4,077) $(1,318)
======== ======= =======
Projected benefit obligation for service
rendered to date $(3,947) $(4,077) $(1,318)
Plan assets at fair value 5,923 5,467 1,355
-------- ------- -------
Excess of plan assets over projected
benefit obligation 1,976 1,390 37
Unrecognized net (gain) loss (405) 48 119
-------- ------- -------
Prepaid pension asset $ 1,571 $1,438 $ 156
======== ======= =======
Net pension cost included in operations, including
the effects of curtailment, consisted of the
following components
Interest cost on projected benefit obligation $ 280 $ 274 $ 89
Actual return on plan assets (878) (663) (93)
Net amortization and deferral 466 270 (12)
-------- ------- -------
Net pension income $ (132) $ (119) $ (16)
======== ======= =======
(Continued)
II-31
46
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - PENSION PLANS (Continued)
The weighted average discount rate used in determining the actuarial present
value of the projected benefit obligation was 7.00% for all years presented.
The expected long-term rate of return on assets was 8.25% for 1997 and 1996 and
8.00% for 1995. As a result of the plan curtailments, all accumulated benefits
under the plans are vested and no further benefits arising from service to the
Bank will accrue.
The plan assets of the Bank's plan are invested in a group annuity fund at a
major life insurance company. The plan assets of AFSB's plan are invested in
U.S. Government and corporate bonds and listed stocks.
The Company maintains a 401(k) plan covering substantially all employees.
Employees who are 21 years and older and who have completed one year of service
are eligible. Employees may elect to contribute to the plan from 1% to 15% of
their salary subject to a statutory maximum amount. Prior to establishing the
ESOP, the Company paid a 25% matching contribution on employee contributions
that did not exceed 4% of their compensation. Employees become 100% vested in
the Company's matching contribution after five years of service.
(Continued)
II-32
47
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - SAIF ASSESSMENT
Legislation was signed into law on September 30, 1996, to recapitalize the
Savings Association Insurance Fund (SAIF), requiring the Bank to pay a one-time
special assessment of $3,510,000. This amount is reflected in noninterest
expense in the 1996 consolidated statement of income.
NOTE 18 - FEDERAL INCOME TAXES
The provision for federal income taxes consists of the following:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Current tax expense $ 3,961 $ 1,674 $ 1,837
Deferred tax expense (benefit) 312 290 74
------------ ------------- ---------
$ 4,273 $ 1,964 $ 1,911
============ ============= =========
The provision for federal income taxes differs from that computed at the
statutory corporate tax rate as follows:
1997 1996 1995
---- ---- ----
Statutory rate 34% 34% 34%
==== ==== ====
Tax expense at statutory rate $ 4,012 $ 1,720 $ 1,884
Low-income housing credit (239) (150) (150)
ESOP 227 113 66
Tax-exempt interest (84) (63)
Goodwill amortization 319 279
Change in deferred tax asset
valuation allowance (60) 186
Other 98 65 (75)
---------- ---------- -----------
$4,273 $1,964 $1,911
========== ========== ===========
(Continued)
II-33
48
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - FEDERAL INCOME TAXES (Continued)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 1997 and
1996 are as follows:
>
1997 1996
----------- -----------
(Dollars in thousands)
Deferred tax assets
Deferred loan fees $ 163 $ 160
Management recognition plan restricted stock 89 91
ESOP 42 25
Capital loss carryforward 126 186
Unrealized loss on available for sale securities 41
Accrued expenses 22 59
Allowance for loan losses 59 8
Nonaccrual loan interest 66 20
Other 64 43
----------- -----------
631 633
Deferred tax liabilities
Depreciation (578) (552)
Pension (394) (427)
Purchase accounting adjustment (692) (380)
FHLB stock dividends (68) (68)
Mortgage servicing rights (86) (8)
Unrealized gain on available for sale securities (32)
Other (76) (48)
----------- -----------
(1,926) (1,483)
Valuation allowance for deferred tax assets (126) (186)
----------- -----------
Net deferred tax liability $ (1,421) $ (1,036)
=========== ===========
A valuation allowance related to deferred tax assets is required when it is
considered more likely than not that all or part of the benefits relating to
such assets will not be realized. Management established a valuation allowance
for the benefits associated with the losses on mutual fund securities at
December 31, 1996, since such losses were capital in nature and could only be
realized through offsetting capital gains. Sources of capital gains were not
available at either December 31, 1997 or 1996.
During 1997, new tax law was established regarding thrift bad debt reserves.
Under the new rules, recapture of a portion of the tax bad debt reserve is
required. Beginning with the 1998 tax year, the Company will include an
additional $520,000 per year for six years in its taxable income. These new
rules had no impact on the consolidated financial statements as accounting
provisions have required recording deferred taxes for the amounts to be
recaptured.
Retained earnings at December 31, 1997 and 1996 includes approximately $8.8
million for which no federal income tax liability has been recorded. This
amount represents an allocation of income to bad debt deductions for tax
purposes alone. Reduction of amounts so allocated for purposes other than tax
bad debt losses or adjustments from carryback of net operating losses would
create income for tax purposes only, which would be subject to current tax.
The unrecorded deferred tax liability on the above amount at December 31, 1997
and 1996 was approximately $3.0 million.
(Continued)
II-34
49
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the Earnings per common
share and Earnings per common share assuming dilution is as follows for the
years ended December 31:
1997 1996 1995
--- ----- ----
(Dollars in thousands except share data)
EARNINGS PER COMMON SHARE
Net Income available to
common shareholders $7,527 $3,094 $3,629
====== ====== ======
Weighted average common
shares outstanding 5,150,401 5,552,911 5,746,453
========= ========= =========
EARNINGS PER COMMON SHARE $1.46 $.56 $.63
===== ===== ====
EARNINGS PER COMMON SHARE
ASSUMING DILUTION
Net Income available to
common shareholders $7,527 $3,094 $3,629
====== ====== ======
Weighted average common
shares outstanding 5,150,401 5,552,911 5,746,453
Add: Dilutive effects of assumed
exercises of stock options and
warrants 458,659 132,656 34,803
------- ------- ------
Weighted average common and
dilutive potential common shares
outstanding 5,609,060 5,685,567 5,781,256
========= ========= =========
EARNINGS PER COMMON SHARE
ASSUMING DILUTION $ 1.34 $ .54 $ .63
========= ====== =======
All share and per share information has been retroactively adjusted to reflect
the 10% stock dividend paid on September 30, 1997.
(Continued)
II-35
50
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practicable to estimate that
value:
Cash and cash equivalents
For these short-term instruments, the carrying amount is a reasonable estimate
of fair value.
Securities
Fair values for securities are based on quoted market prices or dealer quotes.
If a quoted market price is not available, fair value is estimated using quoted
market prices for similar instruments.
Federal Home Loan Bank stock
The carrying amount of this stock is a reasonable estimate of fair value.
Loans
The fair value of fixed and variable rate loans is principally estimated by
discounting future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. Prepayment speeds are assumed in projecting future cash
flows based upon the current interest rate environment and recent actual
prepayment history. The carrying value of the allowance for loan losses is a
reasonable estimate of fair value.
Deposit liabilities
The fair value of demand deposits, savings accounts and money market deposits
is the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated by discounting future cash
flows using the rates currently offered for deposits of similar remaining
maturities.
Accrued interest receivable and payable
For these items, the carrying amount is a reasonable estimate of fair value.
Federal Home Loan Bank advances
The fair values for these advances are determined by discounting cash flows
using rates currently offered for advances of similar remaining maturities.
(Continued)
II-36
51
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Federal Funds purchased
For these short term instruments, the carrying amount is a reasonable estimate
of fair value.
Commitments to extend credit
The fair value of commitments is estimated using the fees currently charged to
enter similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair value of
commitments was immaterial at the reporting dates presented.
The estimated fair values of the Company's financial instruments are as follows
at December 31:
1 9 9 7 1 9 9 6
------- -------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ----------- ----------- -------
(Dollars in thousands)
Financial assets
Cash and cash
equivalents $32,524 $32,524 $22,801 $22,801
Securities available
for sale 57,308 57,308 62,906 62,906
Federal Home Loan
Bank stock 7,308 7,308 6,958 6,958
Loans held for sale 1,955 1,955 -- --
Loans, net 747,423 754,092 715,551 718,363
Accrued interest
receivable 4,528 4,528 4,691 4,691
Financial liabilities
Deposits 654,560 655,796 622,492 625,170
Federal funds purchased -- -- 2,000 2,000
Federal Home Loan
Bank advances 145,458 145,494 139,170 138,824
Accrued interest payable 2,442 2,442 2,027 2,027
(Continued)
II-37
52
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Ottawa Financial Corporation at December 31:
CONDENSED BALANCE SHEETS
1997 1996
---- ----
(Dollars in thousands)
ASSETS
Cash and due from financial institutions $ 1,406 $ 1,087
Securities available for sale 6,218
Accrued interest receivable 75
Loans receivable from Employee Stock Ownership Plan 2,533 2,955
Investment in subsidiary bank 72,634 66,873
Other assets 176 90
----------- -----------
Total assets $ 76,749 $ 77,298
=========== ===========
LIABILITIES
Other liabilities $ 386 $ 381
SHAREHOLDERS' EQUITY 76,363 76,917
----------- -----------
Total liabilities and shareholders' equity $ 76,749 $ 77,298
=========== ===========
(Continued)
II-38
53
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
(Continued)
CONDENSED STATEMENTS OF INCOME, FOR THE YEARS:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
Interest and dividend income
Securities $ 175 $ 807 $ 2,064
Loan to Employee Stock Ownership Plan 210 243 274
Dividends from subsidiary bank 4,000 2,449 15,000
------------ --------- --------
4,385 3,499 17,338
Net gain on sale of securities 151 270
Operating expenses 769 737 673
------------ --------- --------
INCOME BEFORE FEDERAL INCOME TAXES AND
EQUITY IN UNDISTRIBUTED EARNINGS OF
SUBSIDIARY BANK 3,767 3,032 16,665
Federal income tax expense (benefit) (88) 198 562
------------ --------- --------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARY BANK 3,855 2,834 16,103
Equity in undistributed (excess distributed)
earnings of subsidiary bank 3,672 260 (12,474)
------------ --------- --------
NET INCOME $ 7,527 $ 3,094 $ 3,629
============ ========= ========
(Continued)
II-39
54
OTTAWA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
(Continued)
CONDENSED STATEMENTS OF CASH FLOWS, FOR THE YEARS:
1997 1996 1995
---- ---- ----
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,527 $ 3,094 $ 3,629
Adjustments to reconcile net income to
cash provided by operations
Equity in income of subsidiary bank (7,672) (2,709) (2,526)
Net accretion of securities discounts (12) (17) (146)
Net gain on sale of securities (151) (270)
Change in
Interest receivable 75 305 110
Other assets (86) 322 (417)
Other liabilities 68 270 40
-------- -------- --------
Net cash provided by operating activities (251) 995 690
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (18,413)
Proceeds from sales of securities available
for sale 5,884 36,118
Proceeds from calls and maturities of
securities available for sale 307 1,064 8,174
Principal reduction of ESOP note receivable 422 422 422
Contribution to subsidiary bank (112) (108) (123)
Cash paid in the acquisition of AFSB (30,943)
Cash dividends received from subsidiary bank 4,000 2,449 15,000
-------- -------- -------
Net cash used in investing activities 10,501 9,002 5,060
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury shares (8,833) (7,787) (4,215)
Proceeds from exercise of stock options 258 508
Proceeds from exercise of stock warrants 502
Cash dividends paid (1,858) (1,699) (1,600)
-------- -------- --------
Net cash from financing activities (9,931) (8,978) (5,815)
-------- -------- --------
Net change in cash 319 1,019 (65)
Cash at beginning of period 1,087 68 133
-------- -------- --------
CASH AT END OF PERIOD $ 1,406 $1,087 $ 68
======== ======== ========
II-40
55
OTTAWA FINANCIAL CORPORATION
QUARTERLY FINANCIAL DATA
Unaudited
The following is a summary of selected unaudited quarterly results of operations
for the years ended December 31, 1997, and 1996. In the opinion of management,
all adjustments necessary for a fair presentation of such financial data have
been included. All such adjustments are of a normal recurring nature.
QUARTER ENDED
- ---------------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data (3)) March 31(1) June 30 September 30 December 31
- ---------------------------------------------------------------------------------------------------
1997
Net interest income $ 6,553 $ 6,915 $ 6,784 $ 6,770
Provision for loan losses 150 150 180 180
Non-interest income 721 1,037 942 1,446
Non-interest expense 4,424 4,678 4,727 4,879
Income before income taxes 2,701 3,124 2,819 3,156
Net income 1,716 1,962 1,730 2,119
Earnings per Common Share .32 .38 .34 .42
Earnings per Common Share Assuming Dilution .31 .36 .31 .37
1996
Net interest income $ 4,983 $ 6,158 $ 6,500 $ 6,498
Provision for loan losses 114 150 150 150
Non-interest income 919 902 756 750
Non-interest expense 3,765 4,523 8,650(2) 4,906
Income before income taxes 2,023 2,387 (1,544) 2,192
Net income 1,296 1,456 (1,136) 1,477
Earnings per Common Share .23 .26 (.21) .27
Earnings per Common Share Assuming Dilution .22 .25 (.20) .27
(1) For the quarter ended March 31, 1996, there was significant
variation from prior quarters due to the acquisition of AFSB in
February 1996. This and subsequent quarters reflect results of the
combined organization.
(2) Reflects the one-time SAIF assessment of $3.51 million expensed as
of September 30, 1996 (see Note 17 of the Notes to the Consolidated
Financial Statements).
(3) All per share information has been retroactively adjusted to reflect
the 10% stock dividend paid on September 30, 1997 and the effects of
SFAS No. 128.
56
SHAREHOLDER INFORMATION
CORPORATE HEADQUARTERS
245 Central Avenue
Holland, MI 49423-3298
MARKET
Ottawa Financial Corporation's common stock is traded on the Nasdaq
National Market under the symbol "OFCP." Total shares outstanding as of December
31, 1997, were 5,313,084. The high and low bid quotations for the common stock
as reported on the Nasdaq as well as dividends declared per share, were as
follows.
QUARTER ENDED HIGH LOW DIVIDENDS
March 31, 1996 $15.227 $14.091 $.07
June 30, 1996 $15.000 $14.659 $.07
September 30, 1996 $15.000 $14.545 $.08
December 31, 1996 $15.682 $14.545 $.08
March 31, 1997 $18.977 $15.341 $.08
June 30, 1997 $20.682 $18.636 $.09
September 30, 1997 $27.125 $20.453 $.09
December 31, 1997 $34.000 $26.000 $.10
The information set forth in the table above was provided by The Nasdaq
Stock Market. Such information reflects interdealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
The Board of Directors intends to continue the payment of quarterly
cash dividends, dependent upon the results of operations and financial condition
of the Company and other factors. Restrictions on dividend payments are
described in Note 12 of the Notes to Consolidated Financial Statements.
As of March 12, 1998, the Company had approximately 2,194 shareholders
of record and 5,304,141 shares outstanding of common stock.
ANNUAL REPORT ON FORM 10-K
A copy of Ottawa Financial Corporation's Annual Report on Form 10-K, as
filed with the Securities and Exchange Commission, may be obtained without
charge upon written request to Douglas J. Iverson, Executive Vice President and
Secretary, Ottawa Financial Corporation, 245 Central Avenue, Holland, MI
49423-3298 or by calling (616) 393-7002.
REGISTRAR/TRANSFER AGENT GENERAL COUNSEL
Registrar and Transfer Company Cunningham Dalman, PC
Cranford, NJ Holland, MI
SPECIAL COUNSEL INDEPENDENT AUDITOR
Silver, Freedman & Taff, LLP Crowe, Chizek and Company LLP
Washington, DC Grand Rapids, MI