1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the period ended September 30, 1998
-------------------
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
------------------------ ------------------------
Commission file Number 0-10535
CITIZENS BANKING CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2378932
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
328 S. Saginaw St., Flint, Michigan 48502
- ---------------------------------------- -------------------
(Address of principal executive offices) (Zip Code)
(810) 766-7500
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(Registrant's telephone number, including area code)
None
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days
X Yes No
---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 6, 1998
--------------------------- --------------------------------
Common Stock, No Par Value 28,094,536 Shares
(This report contains 24 pages)
2
Citizens Banking Corporation
Index to Form 10-Q
Page
----
Part I - FINANCIAL INFORMATION
Item 1 - Consolidated Financial Statements............................... 3
Item 2 - Management's Discussion and Analysis of Financial Condition
And Results of Operations....................................... 8
Part II - OTHER INFORMATION
Item 1 - Legal Proceedings.............................................. 23
Item 2 - Changes in Securities.......................................... 23
Item 3 - Defaults Upon Senior Securities................................ 23
Item 4 - Submission of Matters to a Vote of Security Holders............ 23
Item 5 - Other Information.............................................. 23
Item 6 - Exhibits and Reports on Form 8-K............................... 23
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PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, December 31,
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 166,854 $ 168,351
Money market investments:
Interest-bearing deposits with banks 64 246
Term federal funds and other 2,358 11,976
----------- -----------
Total money market investments 2,422 12,222
Securities available-for-sale:
U.S. Treasury and federal agency securities 428,555 390,046
State and municipal securities 161,395 166,877
Other securities 26,202 18,459
----------- -----------
Total investment securities 616,152 575,382
Loans:
Commercial 1,484,301 1,317,213
Real estate construction 86,493 71,035
Real estate mortgage 762,583 779,567
Consumer 1,182,747 1,336,120
Lease financing 23,163 37,684
----------- -----------
Total loans 3,539,287 3,541,619
Less: Allowance for loan losses (47,136) (45,911)
----------- -----------
Net loans 3,492,151 3,495,708
Premises and equipment 74,440 69,415
Intangible assets 55,857 60,016
Other assets 54,667 58,177
----------- -----------
TOTAL ASSETS $ 4,462,543 $ 4,439,271
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 604,189 $ 600,498
Interest-bearing 3,043,567 3,093,848
----------- -----------
Total deposits 3,647,756 3,694,346
Federal funds purchased and securities sold
under agreements to repurchase 159,940 141,713
Other short-term borrowings 27,561 33,153
Other liabilities 51,320 52,052
Long-term debt 141,168 108,165
----------- -----------
Total liabilities 4,027,745 4,029,429
SHAREHOLDERS' EQUITY
Preferred stock - No par value -- --
Common stock - No par value 118,488 120,274
Retained earnings 310,353 285,706
Accumulated other comprehensive income 5,957 3,862
----------- -----------
Total shareholders' equity 434,798 409,842
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,462,543 $ 4,439,271
=========== ===========
===================================================================================================================================
See notes to consolidated financial statements.
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==========================================================================================================
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands, except per share amounts) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans $75,848 $ 75,292 $226,988 $ 217,646
Interest and dividends on investment securities:
Taxable 7,179 8,035 21,481 25,033
Nontaxable 1,877 2,140 5,721 6,710
Money market investments 551 181 1,942 482
------- -------- -------- ---------
Total interest income 85,455 85,648 256,132 249,871
------- -------- -------- ---------
INTEREST EXPENSE
Deposits 31,951 33,133 97,151 95,733
Short-term borrowings 1,512 2,297 4,569 7,025
Long-term debt 1,956 1,473 6,138 4,349
------- -------- -------- ---------
Total interest expense 35,419 36,903 107,858 107,107
------- -------- -------- ---------
NET INTEREST INCOME 50,036 48,745 148,274 142,764
Provision for loan losses 3,510 5,245 10,530 12,197
------- -------- -------- ---------
Net interest income after provision for loan losses 46,526 43,500 137,744 130,567
------- -------- -------- ---------
NONINTEREST INCOME
Trust fees 4,633 3,858 13,881 11,672
Service charges on deposit accounts 3,258 3,129 9,513 9,163
Bankcard fees 2,083 1,917 5,653 5,271
Mortgage and other loan income 1,534 521 2,869 1,152
Brokerage and investment fees 663 422 1,860 1,261
Cash management services 583 440 1,685 1,349
Investment securities gains (losses) 49 (755) 103 (812)
Other 1,935 2,135 6,132 5,498
------- -------- -------- ---------
Total noninterest income 14,738 11,667 41,696 34,554
------- -------- -------- ---------
NONINTEREST EXPENSE
Salaries and employee benefits 20,145 19,986 61,344 60,778
Equipment 2,921 3,069 9,079 9,428
Occupancy 2,845 2,820 8,516 8,700
Intangible asset amortization 1,386 1,386 4,159 4,712
Bankcard fees 1,680 1,579 4,373 3,757
Stationery and supplies 875 968 2,795 3,076
Postage and delivery 953 1,116 3,165 3,305
Advertising and public relations 1,072 911 3,477 3,351
Special charge --- 23,734 --- 23,734
Other 8,392 5,771 22,252 18,845
------- -------- -------- ---------
Total noninterest expense 40,269 61,340 119,160 139,686
------- -------- -------- ---------
INCOME BEFORE INCOME TAXES 20,995 (6,173) 60,280 25,435
Income taxes 6,406 (1,222) 18,486 8,182
------- -------- -------- ---------
NET INCOME (LOSS) $14,589 $ (4,951) $ 41,794 $ 17,253
======= ======== ======== =========
NET INCOME (LOSS) PER SHARE:
Basic $ 0.52 $ (0.18) $ 1.49 $ 0.62
Diluted 0.50 (0.18) 1.45 0.61
AVERAGE SHARES OUTSTANDING:
Basic 28,164 27,896 28,138 27,834
Diluted 28,754 27,896 28,767 28,339
==========================================================================================================
See notes to consolidated financial statements
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- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Accumulated
Other
Common Retained Comprehensive
(in thousands except per share amounts) Stock Earnings Income Total
- -------------------------------------------------------------------------------------------------------------------------------
BALANCE - SEPTEMBER 30, 1997 $ 119,031 $ 276,778 $ 3,296 $ 399,105
Net income 14,255 14,255
Net unrealized gain on securities available-for-sale,
net of tax effect 566 566
---------
Total comprehensive income 14,821
Exercise of stock options, net of
shares purchased 1,243 1,243
Cash dividends - $0.19 per share (5,327) (5,327)
--------- -------- --------- ---------
BALANCE - DECEMBER 31, 1997 120,274 285,706 3,862 409,842
Net income 13,522 13,522
Net unrealized gain on securities available-for-sale,
net of tax effect (352) (352)
---------
Total comprehensive income 13,170
Exercise of stock options, net of
shares purchased 1,139 1,139
Cash dividends - $0.19 per share (5,324) (5,324)
--------- -------- --------- ---------
BALANCE - MARCH 31, 1998 121,413 293,904 3,510 418,827
Net income 13,683 13,683
Net unrealized loss on securities available-for-sale,
net of tax effect 135 135
---------
Total comprehensive income 13,818
Exercise of stock options, net of
shares purchased 2,142 2,142
Shares acquired for exercise of stock options (2,095) (2,095)
Cash dividends - $0.21 per share (5,909) (5,909)
--------- -------- --------- ---------
BALANCE - JUNE 30, 1998 121,460 301,678 3,645 426,783
Net income 14,589 14,589
Net unrealized gain on securities available-for-sale,
net of tax effect 2,312 2,312
---------
Total comprehensive income 16,901
Exercise of stock options, net of
shares purchased 182 182
Shares acquired for exercise of stock options (3,154) (3,154)
Cash dividends - $0.21 per share (5,914) (5,914)
--------- --------- --------- ---------
BALANCE - SEPTEMBER 30, 1998 $ 118,488 $ 310,353 $ 5,957 $ 434,798
========= ========= ========= =========
===============================================================================================================================
See notes to consolidated financial statements.
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- ---------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS Of CASH FLOWS (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Nine Months Ended
September 30,
(in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 41,794 $ 17,253
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 10,530 12,197
Depreciation 6,108 6,829
Amortization of intangibles 4,159 4,712
Write down of intangibles -- 7,570
Net amortization on investment securities 1,250 794
Investment securities (gains) losses (103) 812
Other 1,650 (1,854)
--------- ---------
Net cash provided by operating activities 65,388 48,313
INVESTING ACTIVITIES:
Net decrease in money market investments 9,800 (18,218)
Securities available-for-sale:
Proceeds from sales 9,625 170,600
Proceeds from maturities 199,562 90,978
Purchases (247,881) (129,523)
Net increase in loans (6,973) (275,041)
Purchases of premises and equipment (11,133) (3,598)
--------- ---------
Net cash used by investing activities (47,000) (164,802)
FINANCING ACTIVITIES:
Net increase (decrease) in demand and savings deposits 2,427 (33,456)
Net increase (decrease) in time deposits (49,017) 130,005
Net increase (decrease) in short-term borrowings 12,635 (6,736)
Proceeds from issuance of long-term debt 77,550 55,000
Principal reductions in long-term debt (44,547) (46,960)
Cash dividends paid (17,147) (13,959)
Proceeds from stock options exercised 3,463 769
Shares acquired for exercise of stock options (5,249) --
Cash in lieu of fractional shares -- (50)
--------- ---------
Net cash provided by financing activities (19,885) 84,613
--------- ---------
Net decrease in cash and due from banks (1,497) (31,876)
Cash and due from banks at beginning of period 168,351 182,039
--------- ---------
Cash and due from banks at end of period $ 166,854 $ 150,163
========= =========
===============================================================================================================
See notes to consolidated financial statements.
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CITIZENS BANKING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions for Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three and nine
month periods ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998.
NOTE 2. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year financial statement presentation. All financial information presented
reflects the consolidated results of Citizens Banking Corporation and CB
Financial Corporation.
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following is a review of the Corporation's performance for the three and
nine-month periods ended September 30, 1998. This discussion should be read in
conjunction with the accompanying unaudited financial statements and notes
thereto appearing on pages 3 through 7 of this report and the Corporation's 1997
Annual Report on Form 10-K.
- -------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL DATA
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands, except per share data) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 85,455 $ 85,648 $ 256,132 $ 249,871
Net interest income 50,036 48,745 148,274 142,764
Provision for loan losses 3,510 5,245 10,530 12,197
Investment securities gains (losses) 49 (755) 103 (812)
Other noninterest income 14,689 12,422 41,593 35,366
Noninterest expense before special charge 40,269 37,606 119,160 115,952
Special charge, net of tax -- 17,263 -- 17,263
Income taxes 6,406 5,249 18,486 14,653
Net income (loss) 14,589 (4,951) 41,794 17,253
Net income before special charge(1) 14,589 12,312 41,794 34,516
Cash dividends 5,914 5,298 17,147 13,959
PER SHARE DATA
Basic net income (loss) $ 0.52 $ (0.18) $ 1.49 $ 0.62
Diluted net income (loss) 0.50 (0.18) 1.45 0.61
Diluted net income before special charge(1) 0.50 0.43 1.45 1.22
Cash dividends 0.21 0.19 0.61 0.55
Book value (end of period) -- -- 15.46 14.30
Market value (end of period close) -- -- 32.88 29.33
FINANCIAL RATIOS (ANNUALIZED)
Return on average shareholders' equity(1) 13.46 11.99 13.26 11.53
Return on average assets(1) 1.30 1.10 1.26 1.06
Net interest margin (taxable equivalent) 4.98 4.86 4.92 4.84
Net loan charge-offs to average loans 0.38 0.51 0.35 0.33
Average equity to average total assets 9.67 9.21 9.48 9.17
Nonperforming assets to loans plus other repossessed
assets acquired (end of period) -- -- 0.78 0.72
Nonperforming assets to total assets (end of period) -- -- 0.62 0.57
BALANCE SHEET TOTALS Percent
At Period End (September 30) Change
------
Assets 1.1 $ 4,462,543 $ 4,413,434
Loans 1.2 3,539,287 3,496,528
Deposits (1.3) 3,647,756 3,695,300
Shareholders' equity 8.9 434,798 399,105
Average balances
Assets 1.9 4,444,185 4,361,659
Loans 4.9 3,505,735 3,341,447
Deposits 1.8 3,694,325 3,630,251
Shareholders' equity 5.3 421,353 400,141
=========================================================================================================================
(1) 1997 operating income before special charge with CB Financial Corporation
merger and information technology operations reorganization.
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PERFORMANCE SUMMARY
Selected financial data as of September 30, 1998 and 1997 and for the three and
nine month periods then ended are presented in the table on page 8. The results
of operations for the three and nine month periods ended September 30, 1997,
reflect a special charge of $17.3 million, after tax, related to the July 1,
1997 merger with CB Financial Corporation and the reorganization of Citizens'
information technology operations. Earnings, before the special charge, in both
the three and nine-month periods ended September 30, 1998 increased over the
same periods of 1997, due to higher net interest income and noninterest income,
and a reduction in the provision for loan losses. This improvement was partially
offset by higher operating expenses (before the special charge) and income
taxes. Net interest income increased due to loan growth and higher earning asset
levels in both the three and nine-month periods. Noninterest income increased
primarily due to growth in trust fees, brokerage and investment fees, and
mortgage and other loan income, as well as new title insurance services. New
data processing services and higher bankcard fees offset, in part, by savings
derived from the 1997 merger with CB Financial Corporation resulted in an
increase in noninterest expense (before the special charge). The merger with CB
Financial Corporation was accounted for as a pooling-of-interests and,
accordingly, all amounts presented give effect to this acquisition.
NET INTEREST INCOME
Net interest income and average balances and yields on major categories of
interest-earning assets and interest-bearing liabilities for the three and nine
months ended September 30, 1998 and 1997 are summarized on page 11. The effects
of changes in average market rates of interest ("rate") and average balances
("volume") are quantified in the table below.
- ----------------------------------------------------------------------------------------------------------------------
ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
1998 Compared with 1997
-----------------------
Three Months Ended September 30 Nine Months Ended September 30
----------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
Net ------------------- Net -------------------
(in thousands) Change (1) Rate Volume (2) Change (1) Rate Volume (2)
- ----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Money market investments:
Time Deposits with banks $ -- $ -- $ -- $ (3) $ 2 $ (5)
Federal funds sold 397 1 396 1,564 -- 1,564
Term federal funds sold and other (27) (3) (24) (101) (5) (96)
Investment securities:
Taxable (856) 114 (970) (3,552) 660 (4,212)
Tax-exempt (263) (69) (194) (989) (142) (847)
Loans 556 (1,475) 2,031 9,342 (645) 9,987
------- ------ ------- -------- -------- --------
Total (193) (1,432) 1,239 6,261 (130) 6,391
------- ------- ------- -------- -------- --------
INTEREST EXPENSE
Deposits:
Demand (33) (77) 44 (161) (83) (78)
Savings (308) (485) 177 (749) (1,245) 496
Time (841) (411) (430) 2,328 140 2,188
Short-term borrowings (785) (51) (734) (2,456) (209) (2,247)
Long-term debt 483 (123) 606 1,789 (286) 2,075
------ ------ ------- -------- -------- --------
Total (1,484) (1,147) (337) 751 (1,683) 2,434
------ ------ ------- -------- -------- --------
NET INTEREST INCOME $ 1,291 $ (285) $ 1,576 $ 5,510 $ 1,553 $ 3,957
======= ======= ======= ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------
(1) Changes are based on actual interest income and do not reflect taxable
equivalent adjustments.
(2) Rate/Volume variances are allocated to changes due to volume.
For the third quarter of 1998, net favorable volume related variances in net
interest income offset, in part, by net unfavorable rate related variances
resulted in an increase of $1,291,000 in net interest income, as compared to the
same period in 1997. For the nine-month period ended September 30, 1998,
favorable volume and rate related variances resulted in an increase in net
interest income of $5,510,000, as compared to the same period in 1997. For the
third quarter of 1998, higher loan and
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10
federal funds sold balances, and lower time deposit balances, offset, in part,
by reduced levels of investment securities, accounted for the majority of the
volume increases. For the nine-month period ended September 30, 1998, higher
loan and federal funds sold balances offset, in part, by time deposit growth and
lower levels of investment securities accounted for most of the volume
increases. In both the three and nine month periods, higher levels of long-term
debt were offset by lower short term borrowings as the corporation extended
certain debt maturities in the current interest rate environment.
Yields on earning assets decreased to 8.38% from 8.42% for the three months
ended September 30, 1998 as compared with the same period in 1997 due to lower
yields in the commercial loan portfolio. Yields on earning assets increased to
8.40% from 8.37% for the nine months ended September 30, 1998 as compared to the
same period in 1997. The increase resulted from higher yields on taxable
investment securities and a higher concentration of loans to earning assets.
This improved composition of assets and the overall higher level of earning
assets resulted in net volume related increases in interest income of $1,239,000
and $6,391,000 for the three and nine month periods ended September 30, 1998,
respectively, as compared to the same periods in 1997.
The cost of interest-bearing liabilities decreased to 4.22% from 4.34% for the
three month period ended September 30, 1998, as compared with the same period in
1997, and remained unchanged at 4.28% for the nine month period ended September
30, 1998, as compared to the prior year. The decrease in the third quarter
reflected the overall lower interest rate environment as the cost of all
categories of interest-bearing liabilities declined compared with the same
period of 1997. For the nine month period ended September 30, 1998 the lower
cost of most interest bearing liabilities was offset by a slight increase in
time deposit rates and a continued shift in deposits from regular savings and
demand accounts to higher cost investment savings and time accounts.
Management continually monitors the Corporation's balance sheet to insulate net
interest income from significant swings caused by interest rate volatility. If
market rates change in 1998, corresponding changes in funding costs would be
considered to avoid any potential negative impact on net interest income. The
Corporation's policies in this regard are further discussed in the section
titled "Interest Rate Risk".
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11
AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
1998 1997
------------------------------------- ---------------------------------------
Three Months Ended September 30 AVERAGE AVERAGE Average Average
(in thousands) BALANCE INTEREST(1) RATE(2) Balance Interest(1) Rate(2)
- -----------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS
Money market investments:
Interest earning deposits with banks $ 54 $ 1 4.44% $ 49 $ 1 6.08%
Federal funds sold 36,685 516 5.59 8,548 119 5.53
Term federal funds sold and other 3,195 34 4.24 5,137 61 4.72
Investment securities(3):
Taxable 444,145 7,179 6.45 514,708 8,035 6.23
Tax-exempt 143,185 1,877 8.11 160,279 2,140 8.24
Loans:
Commercial 1,468,212 31,121 8.60 1,273,404 28,192 8.90
Real estate 798,059 16,245 8.14 782,523 15,905 8.13
Consumer 1,213,299 28,051 9.18 1,334,473 30,554 9.09
Lease financing 24,756 431 6.97 40,901 641 6.27
---------- ---------- ---------- ----------
Total earning assets(3) 4,131,590 85,455 8.38 4,120,022 85,648 8.42
NONEARNING ASSETS
Cash and due from banks 176,799 149,302
Bank premises and equipment 73,924 72,208
Other nonearning assets 112,744 126,477
Allowance for loan losses (46,935) (45,539)
---------- ----------
Total assets $ 4,448,122 $4,422,470
=========== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Demand deposits 393,436 1,500 1.51 375,544 1,533 1.62
Savings deposits 1,031,503 7,188 2.76 1,046,604 7,496 2.84
Time deposits 1,642,983 23,263 5.62 1,683,525 24,104 5.68
Short-term borrowings 127,738 1,512 4.70 183,505 2,297 4.97
Long-term debt 135,808 1,956 5.72 88,457 1,473 6.64
---------- ---------- ---------- ----------
Total interest-bearing liabilities 3,331,468 35,419 4.22 3,377,635 36,903 4.34
NONINTEREST-BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand deposits 614,466 581,554
Other liabilities 72,241 55,844
Shareholders' equity 429,947 407,437
---------- ----------
Total liabilities and shareholders'
equity $ 4,448,122 $4,422,470
=========== ==========
NET INTEREST INCOME $ 50,036 $ 48,745
========= ==========
NET INTEREST INCOME AS A PERCENT OF EARNING ASSETS 4.98% 4.86%
=============================================================================================================================
(1) Interest income shown on actual basis and does not include taxable
equivalent adjustments.
(2) Average rates are presented on an annual basis and include taxable
equivalent adjustments to interest income of $1,497 and $1,439 for the three
months ended September 30, 1998 and 1997, respectively, based on a tax
rate of 35%.
(3) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost,
adjusted for amortization of premiums and accretion of discounts.
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12
AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
1998 1997
------------------------------------- ---------------------------------------
Nine Months Ended September 30 AVERAGE AVERAGE Average Average
(in thousands) BALANCE INTEREST(1) RATE(2) Balance Interest(1) Rate(2)
- ------------------------------------------------------------------------------------------------------------------------------------
EARNING ASSETS
Money market investments:
Interest earning deposits with banks $ 40 $ 2 6.26% $ 145 $ 5 4.88%
Federal funds sold 44,337 1,841 5.55 6,687 277 5.55
Term federal funds sold and other 3,047 99 4.32 5,491 200 4.86
Investment securities(3):
Taxable 444,850 21,481 6.44 541,132 25,033 6.17
Tax-exempt 144,573 5,721 8.16 167,611 6,710 8.24
Loans:
Commercial 1,416,629 90,579 8.67 1,253,106 82,286 8.88
Real estate 797,524 48,796 8.16 774,244 46,797 8.06
Consumer 1,262,017 86,008 9.11 1,271,369 86,414 9.09
Lease financing 29,565 1,605 7.24 42,729 2,149 6.71
----------- ----------- ----------- ----------
Total earning assets(3) 4,142,582 256,132 8.40 4,062,514 249,871 8.37
NONEARNING ASSETS
Cash and due from banks 159,596 146,163
Bank premises and equipment 71,785 73,310
Other nonearning assets 116,963 123,702
Allowance for loan losses (46,741) (44,030)
----------- -----------
Total assets $ 4,444,185 $ 4,361,659
=========== ===========
INTEREST-BEARING LIABILITIES
Deposits:
Demand deposits 384,725 4,468 1.55 383,827 4,629 1.61
Savings deposits 1,029,727 21,424 2.78 1,053,848 22,173 2.81
Time deposits 1,687,453 71,259 5.65 1,634,278 68,931 5.64
Short-term borrowings 128,461 4,569 4.76 191,952 7,025 4.89
Long-term debt 139,781 6,138 5.87 85,703 4,349 6.78
----------- ----------- ----------- ----------
Total interest-bearing liabilities 3,370,147 107,858 4.28 3,349,608 107,107 4.28
NONINTEREST-BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand deposits 592,420 558,298
Other liabilities 60,265 53,612
Shareholders' equity 421,353 400,141
----------- -----------
Total liabilities and shareholders' equity $ 4,444,185 $ 4,361,659
=========== ===========
NET INTEREST INCOME $ 148,274 $ 142,764
=========== ===========
NET INTEREST INCOME AS A PERCENT OF EARNING ASSETS 4.92% 4.84%
====================================================================================================================================
(1) Interest income shown on actual basis and does not include taxable
equivalent adjustments.
(2) Average rates are presented on an annual basis and include taxable
equivalent adjustments to interest income of $4,406 and $4,662 for the nine
months ended September 30, 1998 and 1997, respectively, based on a tax
rate of 35%.
(3) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost,
adjusted for amortization of premiums and accretion of discounts.
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13
PROVISION AND ALLOWANCE FOR LOAN LOSSES
Management provides for possible loan losses at a rate considered appropriate
based on judgments regarding economic conditions, historical loss experience,
the size and composition of the loan portfolio, the amount and character of
nonperforming assets, estimated future net charge-offs and other factors. A
summary of loan loss experience during the three and nine months periods ended
September 30, 1998 and 1997 is provided below. The provision for loan losses
decreased $1,735,000 during the three months ended September 30, 1998, as
compared with the same period in 1997, and decreased $1,667,000 in the first
nine months of 1998 versus the same period of 1997.
The ratio of net loans charged off to average loans outstanding was down
thirteen basis points in the third quarter of 1998 but up two basis points for
the nine-month period ended September 30, 1998, as compared to the same periods
in 1997. The changes reflect a large lease charge-off in the third quarter of
1997 and increased levels of charge-offs in the Corporation's indirect consumer
loan portfolio during 1998.
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ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses - beginning of period $ 46,956 $ 45,198 $ 45,911 $ 42,166
Charge-offs 4,127 5,085 11,940 10,862
Recoveries 797 683 2,635 2,540
---------- ---------- ---------- ----------
Net charge-offs 3,330 4,402 9,305 8,322
Provision for loan losses 3,510 5,245 10,530 12,197
---------- ---------- ---------- ----------
Allowance for loan losses - end of period $ 47,136 $ 46,041 $ 47,136 $ 46,041
========== ========== ========== ==========
Loans outstanding at period end $3,539,287 $3,496,528 $3,539,287 $3,496,528
Average loans outstanding during period 3,504,326 3,431,301 3,505,734 3,341,447
Allowance for loan losses as a percentage of loans
outstanding at period end 1.33% 1.32% 1.33% 1.32%
Ratio of net charge-offs during period to average
loans outstanding (annualized) 0.38 0.51 0.35 0.33
Loan loss coverage (allowance as a multiple of net
charge-offs, annualized) 3.5x 2.6x 3.8x 4.1x
- -----------------------------------------------------------------------------------------------------------------------------
The Corporation maintains formal policies and procedures to monitor and control
credit risk. The Corporation's loan portfolio has no significant concentrations
in any one industry or any exposure to foreign loans. The Corporation has
generally not extended credit to finance highly leveraged transactions nor does
it intend to do so in the future. Based on present information, management
believes the allowance for loan losses is adequate to meet known risks in the
loan portfolio.
Employment levels and other economic conditions in the Corporation's local
markets may have a significant impact on the level of credit losses. Management
has identified and devotes appropriate attention to credits that may not be
performing as well as expected. Nonperforming loans are further discussed in the
section entitled "Nonperforming Assets."
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NONINTEREST INCOME
A summary of significant sources of noninterest income during the three and nine
months ended September 30, 1998 and 1997 follows:
- -------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Three Months Ended Nine Months Ended Percent
September 30, September 30, Change in 1998
--------------------- -------------------- -----------------------
Three Nine
(in thousands) 1998 1997 1998 1997 Months Months
- -------------------------------------------------------------------------------------------------------------------------
Trust fees $ 4,633 $ 3,858 $ 13,881 $ 11,672 20.1 % 18.9 %
Service charges on deposit accts 3,258 3,129 9,513 9,163 4.1 3.8
Bankcard fees 2,083 1,917 5,653 5,271 8.7 7.2
Brokerage and investment fees 663 422 1,860 1,261 57.1 47.5
Mortgage and other loan income 1,534 521 2,869 1,152 194.4 149.0
ATM network user fees 763 910 2,206 2,150 (16.2) 2.6
Cash management services 583 440 1,685 1,349 32.5 24.9
Title insurance fees 258 --- 746 --- (1) (1)
Investment securities gains (losses) 49 (755) 103 (812) (1) (1)
Other, net 914 1,225 3,180 3,348 (25.4) (5.0)
--------- ---------- --------- ---------
Total noninterest income $ 14,738 $ 11,667 $ 41,696 $ 34,554 26.3% 20.7%
========= ========== ========= =========
- -------------------------------------------------------------------------------------------------------------------------
(1) Not meaningful
Noninterest income increased 26.3% and 20.7% in the three and nine-month periods
ended September 30, 1998, respectively, as compared to the same periods in 1997.
Nearly every category of noninterest income was higher in 1998 than in 1997, for
both the three and nine-month periods ended September 30. The corporation
experienced significant increases in trust fees, brokerage and investment fees,
mortgage and other loan income, cash management fees and title insurance fees.
ATM network user fees decreased 16.2% in the third quarter, primarily due to a
volume decrease in customer surcharge fees and foreign ATM network fees.
Increased trust fee income for personal and employee benefit trust services
attributed to a 20.1% and 18.9% increase for the three and nine months ended
September 30, 1998, respectively, as compared to the same periods in the prior
year. The increases were the result of improved pricing strategies and higher
volumes of managed assets. Brokerage and investment fees increased 57.1% and
47.5% for the three and nine months ended September 30, 1998, respectively, as
compared to the same periods in 1997. This increase was the result of increased
sales efforts and better penetration of the corporation's client base.
Mortgage and other loan income increased 194.4% and 149.0% for the three and
nine months ended September 30, 1998, respectively, over the same periods in
1997. The increase reflects a gain of $630,000 from sale of a portfolio of
student loans in the third quarter of 1998 and an increase in servicing release
premiums from sale of residential mortgage loans into the secondary market.
Mortgage volumes have increased steadily due to focused sales efforts and a
favorable interest rate environment for most of 1997 and the first nine months
of 1998. Cash management services fees increased 32.5% and 24.9% for the three
and nine months ended September 30, 1998, respectively, as compared to the same
periods in the prior year. Generally, clients have responded to enhanced
investment options, which include various money market and treasury obligation
mutual funds from which the Corporation receives a management fee.
During the fourth quarter of 1997, the Corporation established Citizens Title
Services, Inc. a subsidiary of Citizens Bank. This new subsidiary provides title
insurance to buyers and sellers of residential and commercial mortgage
properties including those occurring due to loan refinancing. Title insurance
fees were $258,000 and $746,000 in the three and nine-month periods ended
September 30, 1998, respectively.
Other miscellaneous income decreased 25.4% in the third quarter of 1998, as
compared to the same period in 1997, due to a gain of $291,000 on the sale, in
July 1997, of a bank branch office and the corresponding deposits. The 1998 and
1997 third quarter and year-to-date gains and losses on the sale of investment
securities resulted from the sale of certain securities to reposition the
investment portfolio based on the current rate environment and, in part, to fund
loan growth and meet liquidity needs.
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NONINTEREST EXPENSE
Significant changes in noninterest expense during the three and nine months
ended September 30, 1998 and 1997 is summarized in the table below.
- -------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
Three Months Ended Nine Months Ended Percent
September 30, September 30, Change in 1998
------------------ ------------------ -------------------
Three Nine
(in thousands) 1998 1997 1998 1997 Months Months
- -------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $20,145 $19,986 $ 61,344 $ 60,778 0.8 % 0.9 %
Equipment 2,921 3,069 9,079 9,428 (4.8) (3.7)
Occupancy 2,845 2,820 8,516 8,700 0.9 (2.1)
Intangible asset amortization 1,386 1,386 4,159 4,712 --- (11.7)
Bankcard fees 1,680 1,579 4,373 3,757 6.4 16.4
Stationery and supplies 875 968 2,795 3,076 (9.6) (9.1)
Postage and delivery 953 1,116 3,165 3,305 (14.6) (4.2)
Advertising and public relations 1,072 911 3,477 3,351 17.7 3.8
Data processing services 1,873 92 4,174 310 (2) (2)
Professional services 1,094 1,342 3,376 4,256 (18.5) (20.7)
Other loan fees 1,023 796 2,609 2,406 28.5 8.4
Telephone 1,128 811 2,977 2,461 39.1 21.0
Special Charge (1) --- 23,734 --- 23,734 (2) (2)
Other, net 3,274 2,730 9,116 9,412 19.9 (3.1)
------- ------- -------- --------
Total noninterest expense $40,269 $61,340 $119,160 $139,686 (34.4)% (14.7)%
======= ======= ======== ========
- -------------------------------------------------------------------------------------------------------------------------
(1) Special charge associated with CB Financial Corporation merger and
information technology operations reorganization
(2) Not meaningful
The three and nine month periods ended September 30, 1997, reflect a special
charge of $23.7 million ($17.3 million, after tax) related to the July 1, 1997
merger with CB Financial Corporation and the reorganization of Citizens'
information technology operations. Operating expenses, excluding the special
charge, increased 7.1% and 2.8% for the three and nine months ended September
30, 1998, respectively, as compared to the same periods in 1997. The increase in
operating expenses is primarily attributable to data processing services
associated with the Corporation's new information technology partnership with
M&I Data Services, entered into in the third quarter of 1997. This increase was
partially offset by operating efficiencies achieved from the July 1, 1997 merger
with CB Financial Corporation and a reduction in personnel and other expenses
related to the Corporation's information technology operations. The conversions
to M&I's core application systems were completed by June 1998. Further
performance improvement is anticipated with the conversion in November 1998 of
the Corporation's remaining mainframe applications to a client server based
platform. In addition, the Corporation believes that system upgrades and
standardization provided by its partnership with M&I Data Services will enhance
product development, support future strategic initiatives and facilitate
long-term expense control. This strategic arrangement will also address many
Year 2000 information systems-related issues.
This disclosure contains forward-looking statements about expected savings and
effects of the Corporation's information technology arrangement which are
subject to risks and uncertainties that could cause actual results to differ.
These risks and uncertainties include unanticipated changes in the competitive
environment.
SALARIES AND EMPLOYEE BENEFITS
Salaries and employee benefits expense increased only 0.8% and 0.9% for the
three and nine months ended September 30, 1998, respectively, as compared to the
same periods in the prior year. The increases for the three and nine month
periods were due to higher incentive based compensation and normal merit
increases predominantly offset by lower staffing levels due to efficiencies
resulting from the CB Financial Corporation merger and the information
technology arrangement with M&I Data Services.
OTHER NONINTEREST EXPENSES
Before the special charge, other noninterest expenses, increased 14.2% and 4.8%
for the three and nine months ended September 30, 1998, respectively, as
compared to the same periods in 1997. The increases were primarily due to new
data processing charges and related increases in telephone costs (voice and data
communication), training and travel costs, and
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higher bankcard fees, other loan fees and advertising and public relations
costs. These increases in both the three and nine month periods were partially
offset by lower costs for equipment, stationery and supplies, postage and
delivery, and professional services (i.e., auditing, consulting, etc.).
Due to the information technology partnership with M&I Data Services, the
Corporation incurred new data processing charges and higher training and travel,
and voice and data communication costs. These increases were offset, in part, by
related reductions in compensation, equipment costs and consulting and other
professional services. Economies of scale and savings from consolidation of data
processing, proof and other functions related to the July 1, 1997 merger with CB
Financial Corporation, are reflected in reduced stationery and supplies; postage
and delivery; regulatory examination and professional fees for legal and
auditing services.
Bankcard fees increased due to higher transaction volume, increased costs for
processing services and enhanced loss prevention efforts. Intangible asset
amortization expense declined due to the third quarter 1997 write-down of
goodwill and core deposit intangibles related to previous acquisitions of CB
Financial Corporation. Advertising and public relations costs were up to promote
awareness of the Corporation's full complement of financial planning services
and Clients First! image, as well as the related introduction of new loan,
deposit and financial products and services. Other loan fees increased as higher
commercial and mortgage loan volumes resulted in recognition of additional
appraisal and processing fees.
INCOME TAXES
Higher pre-tax earnings and a slightly lower level of tax-exempt interest income
resulted in increased federal income tax expense for the three and nine months
ended September 30, 1998, as compared to the same periods in the prior year.
BALANCE SHEET
The Corporation had total assets of $4.463 billion as of September 30, 1998, an
increase of $23.3 million or 0.5% from $4.439 billion as of December 31, 1997.
Average earning assets comprised 93.2% of average total assets during the first
nine months of 1998 compared with 93.1% in the first nine months of 1997.
INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS
Total average investments, including money market investments, comprised 15.4%
of average earning assets during the first nine months of 1998, compared with
17.7% for the same period of 1997. Liquidity provided from the sale and maturity
of investment securities (primarily U.S. Treasury securities) was reinvested in
higher yielding federal agency mortgage-backed securities and was used to fund
loan growth resulting in a higher composition of loans to earning assets and
improved yield on earning assets.
LOANS
The Corporation extends credit primarily within the market areas of its two
banking subsidiaries located in Michigan and Illinois. The loan portfolio is
widely diversified by borrower and industry groups with no significant
concentrations in any industry. Due to selective promotions and a relatively low
interest rate environment, the Corporation experienced greater loan demand with
total average loans increasing 4.9% in the first nine months of 1998 as compared
to the same period in 1997. This growth occurred primarily within the commercial
and real estate mortgage categories.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccrual loans, restructured loans, loans 90
days past due and still accruing interest, and other real estate owned. Certain
of these loans, as defined below, are considered to be impaired. The Corporation
maintains policies and procedures to identify and monitor nonaccrual loans. A
loan is placed on nonaccrual status when there is doubt regarding collection of
principal or interest, or when principal or interest is past due 90 days or more
and the loan is not well secured and in the process of collection. Interest
accrued but not collected is reversed and charged against income when the loan
is placed on nonaccrual status.
The following describes the Corporation's policy and related disclosures for
impaired loans. The Corporation establishes a valuation allowance for impaired
loans. A loan is considered impaired when management determines it is probable
that all the principal and interest due under the contractual terms of the loan
will not be collected. In most instances, the impairment is measured based on
the fair value of the underlying collateral. Impairment may also be measured
based on the present value of expected future cash flows discounted at the
loan's effective interest rate. Cash collected on impaired nonaccrual loans is
applied to principle until collection of principle is no longer in doubt and
then to interest income. Interest income on all other impaired loans is
recognized on an accrual basis.
Certain of the Corporation's nonperforming loans included in the following table
are considered to be impaired. The Corporation measures impairment on all large
balance nonaccrual commercial and commercial real estate loans. Certain
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large balance accruing loans rated substandard or worse are also measured for
impairment. In most instances, impairment is measured based on the fair value of
the underlying collateral. Impairment losses are included in the provision for
loan losses. The policy does not apply to large groups of smaller balance
homogeneous loans that are collectively evaluated for impairment, except for
those loans restructured under a troubled debt restructuring. Loans collectively
evaluated for impairment include certain smaller balance commercial loans,
consumer loans, residential real estate loans, and credit card loans, and are
not included in the impaired loan data in the following paragraphs.
At September 30, 1998, loans considered to be impaired under the Statements
totaled $17.8 million (of which $13.1 million were on a nonaccrual basis).
Included within this amount was $8.2 million of impaired loans for which the
related allowance for loan losses was $1.6 million and $9.6 million of impaired
loans for which the fair value exceeded the recorded investment in the loan. The
average recorded investment in impaired loans during the quarter ended September
30, 1998 was approximately $18.5 million. For the quarter ended September 30,
1998, the Corporation recognized interest income of approximately $0.1 million.
No interest was recognized on a cash basis as all cash collected on nonaccrual
impaired loans was applied to loan principal.
At September 30, 1997, loans considered to be impaired under the Statements
totaled $18.7 million (of which $11.4 million were on a nonaccrual basis).
Included within this amount was $7.0 million of impaired loans for which the
related allowance for loan losses was $0.6 million and $11.7 million of impaired
loans for which the fair value exceeded the recorded investment in the loan. The
average recorded investment in impaired loans during the quarter ended September
30, 1997 was approximately $17.8 million. For the quarter ended September 30,
1997, the Corporation recognized interest income of $0.3 million, which included
$0.2 million of interest income, recognized using the cash basis method of
income recognition.
The table below provides a summary of nonperforming assets as of September 30,
1998, December 31, 1997 and September 30, 1997. Total nonperforming assets
amounted to $27.5 million as of September 30, 1998, compared with $25.0 million
as of December 31, 1997 and $25.2 million as of September 30, 1997.
Nonperforming assets at September 30, 1998 were up $2,537,000 or 10.2% over
year-end 1997 as an increase in nonaccrual loans 90 or more days past due was
offset, in part, by a reduction in nonaccrual loans less than 30 days past due
and in other repossessed assets acquired. The increase in nonaccrual loans 90 or
more days past due occurred primarily within the commercial and commercial
mortgage portfolios. These credits are generally well secured and are not
expected to represent a significant risk to the Corporation.
- ------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
SEPTEMBER 30, December 31, September 30,
(IN THOUSANDS) 1998 1997 1997
- ------------------------------------------------------------------------------------------------------------------
NONPERFORMING LOANS
Nonaccrual
Less than 30 days past due $ 2,853 $ 5,128 $ 5,171
From 30 to 89 days past due 2,117 2,021 1,463
90 or more days past due 19,370 12,840 13,617
------- ------- -------
Total 24,340 19,989 20,251
90 days past due and still accruing 908 1,185 662
Restructured 134 446 487
------- -------- -------
Total nonperforming loans 25,382 21,620 21,400
OTHER REPOSSESSED ASSETS ACQUIRED (ORAA) 2,123 3,348 3,766
-------- -------- -------
Total nonperforming assets $ 27,505 $ 24,968 $25,166
======== ======== =======
Nonperforming assets as a percent of total loans plus ORAA 0.78% 0.70% 0.72%
Nonperforming assets as a percent of total assets 0.62 0.56 0.57
- ------------------------------------------------------------------------------------------------------------------
Employment levels and other economic conditions in the Corporation's local
markets can impact the level and composition of nonperforming assets. In a
deteriorating or weak economy, higher levels of nonperforming assets,
charge-offs and provisions for loan losses could result which may adversely
impact the Corporation's results.
In addition to nonperforming loans, management identifies and closely monitors
other credits that are current in terms of principal and interest payments but,
in management's opinion, may deteriorate in quality if economic conditions
change. As of September 30, 1998, such credits amounted to $22.3 million or 0.6%
of total loans, compared with $25.0 million or 0.7%
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18
at December 31, 1997 and $23.9 million or 0.6% as of September 30, 1997. These
loans are primarily commercial and commercial real estate loans made in the
normal course of business and do not represent a concentration in any one
industry.
DEPOSITS
Average deposits increased 1.8% in the first nine months of 1998 as compared to
the same period in 1997. The shift in deposits from passbook and statement
savings accounts to higher yielding investment rate savings and time accounts
reflects changing customer liquidity preferences and the desire for higher
yields. The Corporation gathers deposits primarily in its local markets and
historically has not relied on brokered funds to sustain liquidity. In the third
quarter of 1997, the Corporation obtained approximately $20.0 million in
brokered deposits as an alternative source of funding. The deposits mature in
intervals over the next three years. The Corporation will continue to evaluate
the use of alternative funding sources such as brokered deposits as funding
needs change. Management continues to promote relationship driven core deposit
growth and stability through focused marketing efforts and competitive pricing
strategies.
SHORT-TERM BORROWINGS AND LONG-TERM DEBT
On average, total short-term borrowings decreased to $128.5 million during the
first nine months of 1998 compared with $192.0 million during the same period of
1997. Long-term debt accounted for $139.8 million or 4.1% of average
interest-bearing funds for the first nine months of 1998, increasing from $85.7
million or 2.6% of average interest-bearing funds for the same period in 1997.
The shift in funding from short-term borrowings to long-term debt reflects the
relative attractiveness of long-term financing versus short-term borrowing in
the current interest rate environment. At September 30, 1998, $117.5 million of
the long-term debt consists of borrowings from the Federal Home Loan Bank by the
Corporation's lead subsidiary bank. The borrowings mature at different intervals
over the next five years except for $60 million, which matures in 10 years.
These borrowings are utilized to fund the Corporation's loan growth.
NEW ACCOUNTING PRONOUNCEMENTS
In September 1996, the Financial Accounting Standards Board (FASB) issued
Statement No. 125 "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities". In December 1996, the Financial Accounting
Standards Board issued Statement No. 127, which delayed the effective dates of
certain provisions of the original Statement. The Statements establish
accounting and reporting standards to assist in determining when to recognize or
derecognize financial assets and liabilities in the financial statements after a
transfer of financial assets has occurred. The Corporation has adopted the
Statements to the extent permitted in 1997 and has adopted the remaining
provisions effective January 1, 1998. The adoption did not have a material
effect on the Corporation.
In September 1997, the FASB issued Statement No. 131 "Disclosure about Segments
of an Enterprise and Related Information". The Statement changes the manner in
which public companies report segment information in annual reports and requires
companies to report selected segment information in interim financial reports.
Public companies will be required to report financial and descriptive
information about the company's operating segments. The Statement is effective
for fiscal years beginning after December 15, 1997 with reclassification of the
financial statements for earlier periods required for comparative purposes. In
the year of adoption, companies will not be required to disclose interim period
information. The Corporation plans to adopt the Statement for year-end 1998
reporting.
In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." The Statement will
standardize pension and other post employee benefit disclosures making them
easier and less costly to prepare and more understandable. The Statement will
eliminate certain existing disclosures, but ads new disclosures regarding the
benefit obligation and changes in the fair value of plan assets. The Statement
is effective for fiscal years beginning after December 31, 1997. The Statement
will be adopted for year-end 1998 reporting and is not expected to materially
change the Corporation's annual employee benefit disclosures.
In September 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for hedging activities and for derivative instruments,
including certain derivative instruments embedded in other contracts. This
statement requires a company to recognize all derivatives as either assets or
liabilities in its balance sheet and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as a
fair value, cash flow, or foreign currency hedge. The accounting for changes in
the fair value of a derivative (i.e., gains and losses) depends on the intended
use of the derivative and the resulting designation. If the Corporation elects
to apply hedge accounting, it is required to establish at the inception of the
hedge the method it will use for assessing the effectiveness of the hedging
derivative and the measurement approach for determining the ineffective aspect
of the hedge. This statement is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Corporation plans to adopt this
Statement effective January 1, 2000. Presently the Corporation does not utilize
derivative or related types of financial instruments except for Federal agency
collateralized mortgage obligations. Therefore, this Statement is not
anticipated to have a material impact on the Corporation.
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IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs that utilize two digits
rather than four digits to define years for computer calculations. Any computer
or electronic calculation recognizing a two digit date rather than a four digit
date may incur system failure or miscalculate information when using a date
after December 31, 1999, resulting in potentially serious impairment to business
operations.
In September 1996, the Corporation formed a task force to identify Year 2000
related issues and develop an enterprise-wide strategy to prepare for the Year
2000, which would encompass in-house systems, service bureaus for outsourced
systems, vendors, customers, and suppliers. The project began with an assessment
of the information technology and non-information technology systems that
required modification for the Year 2000. The Corporation inventoried hardware
and software systems, surveyed all vendors for their Year 2000 status,
identified resources required to resolve the problems, and developed a Year 2000
implementation plan with specific goals and target dates. Further, in the fall
of 1997, formal discussions were initiated with the Corporation's significant
commercial business clients to determine the extent to which the client's
computer systems are vulnerable to Year 2000 failure.
Concurrently, another task force was formed to provide a solution for the
previously planned replacement of the Corporation's core application systems.
The primary objectives of this second task force were (a) to select an
integrated suite of applications that the Corporation could use to leverage its
ability to quickly respond to the demands of its market place and provide fast
track support of the Corporation's strategic initiatives, and (b) to position
the Corporation with the professional expertise and technological resources to
take advantage of new developments in technology and put information to work for
clients and staff members alike. As a result, the Corporation formed an
information technology partnership with M&I Data Services in the third quarter
of 1997. The Corporation completed integrating its primary data processing
systems with those of M&I Data Services in the second quarter of 1998. In the
third quarter of 1998, M&I Data Services upgraded its systems to be Year 2000
compliant and is currently processing the Corporation's core applications on
these compliant systems. The Corporation expects testing of these systems to be
completed in the first quarter of 1999. The application systems run by M&I Data
Services represent approximately 70% of the Corporation's mission critical
systems.
The Corporation believes that it has completed its assessment of the remaining
computer-based systems and applications and non-information technology systems.
The majority of those applications that are not Year 2000 compliant have been,
or will be, upgraded or replaced by new systems. The costs of new systems have
been, or will be, recorded as an asset and amortized. System assessment and
conversion costs to upgrade the remaining noncompliant systems are expensed as
incurred. A significant portion of the costs associated with making the
remaining applications not covered by new systems Year 2000 compliant do not
represent incremental costs to the Corporation, as they are covered under
current maintenance agreements or involve the redeployment of existing
information technology resources. Costs related to the year 2000 issue are
funded through operating cash flows. The Corporation estimates that it will
spend less than $3.0 million for its Year 2000 compliance efforts. Approximately
$2.0 million to $2.5 million of these expenditures is for new hardware and
software and has or will be capitalized. Year 2000 compliance costs expended
through September 30, 1998 were approximately $250,000. These estimates do not
include the cost of the Corporation's previously planned mission critical
application systems, which have not been accelerated due to the Year 2000
problem.
Currently, the Corporation's remediation efforts are at different phases of
completion. Remediation and testing activities are underway on all of the
Corporation's mission critical information technology and non-information
technology systems and applications. For the Corporation's information
technology exposures, to date the remediation phase is 73% complete (86% of
mission critical applications and 68% of non-mission critical applications).
The Corporation expects to complete software replacement or upgrades in the
first quarter of 1999. Once software is replaced or upgraded for a system, the
Corporation begins implementation and testing. The phases run concurrently for
different systems. To date, the Corporation has implemented 81% and 67% of its
mission critical and non-mission critical remediated systems, respectively, and
completed 40% of its testing. Completion of the implementation and testing
phases for all significant information technology systems is expected by June
30, 1999. The Corporation's exposure to non-information technology systems (i.e.
systems with date sensitive embedded technology requiring Year 2000 upgrades)
relates primarily to the Corporations operating equipment and facilities (e.g.,
security access and alarm systems, elevators, heating and air conditioning
units, etc.). Completion of the implementation and testing of non-information
technology systems is expected by June 30, 1999.
The Corporation is also addressing the readiness of critical suppliers,
customers, governmental agencies and other third parties that provide services
to or receive services from the Corporation. Primarily, the Corporation is
surveying its suppliers and large customers to assess the extent to which the
Corporation is vulnerable to those third parties' failures to resolve their own
Year 2000 issues. The Corporation has received responses from the majority of
its third party vendors and suppliers, confirming that the third parties'
software systems are Year 2000 compliant or, if not compliant, that these third
parties have
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an action plan in place to have them compliant by mid 1999. The testing of
mission critical third party software systems is also in progress. The
Corporation is on schedule to have all testing of third party software systems
completed by June 30, 1999. The Corporation is continuing to seek assurances
that the systems of other companies on which the Corporation's systems rely will
be timely converted or modified. Failure of such entities, or one of their
suppliers or customers, to become compliant in a timely manner could have an
adverse effect on the Corporation's results of operations or financial
condition.
As a bank holding company, the Corporation is also exposed to the credit risk of
its loan customers ("borrowers"). To the extent that major borrowers fail to
adequately address Year 2000 issues, the credit worthiness of these borrowers
may deteriorate and adversely impact the Corporation's subsidiary banks. As a
result, the Corporation has identified material borrowers and has assessed these
borrowers' Year 2000 preparedness. The Year 2000 readiness of material borrowers
will be monitored periodically to access their year 2000 compliance and evaluate
any further risk to the corporation.
The Corporation is enhancing its existing business resumption plans to reflect
known Year 2000 issues and is preparing general contingency plans to address
unforeseen Year 2000 issues. These contingency plans involve, among other
actions, manual workarounds and coordination of personnel and resources. The
Corporation has determined that it must rely primarily on its software vendors
to remedy, in a timely manner, any unforeseen situations of its mission critical
systems. There can be no assurance that any plans will fully mitigate all
difficulties. Furthermore, there may be certain mission critical third parties,
such as utilities or telecommunication companies, where alternative arrangements
or other sources are limited or unavailable.
The failure to identify and correct a material Year 2000 issue could result in
an interruption in, or failure of, certain normal business activities or
operations and could materially and adversely affect the Corporation. The
Corporation, however, has identified and assessed its areas of risk related to
the Year 2000 issue and is not aware of any noncompliant system or application
for which a solution is not available or which would impair the Corporation's
business operations. In addition, the Corporation has not, nor does it intend
to, defer any other projects that could have a material impact on its normal
business activities or operations. The Corporation believes that with upgrades
to existing software, new hardware and software purchases, and the conversion of
the Corporation's core application systems to M&I Data Services Year 2000
compliant systems, the Year 2000 issue will not pose significant operational
disruptions. Further, the additional costs to be incurred are not expected to be
material to the Corporation's results of operations, liquidity, financial
condition or capital resources.
The anticipated costs and projected dates for completion of the Corporation's
Year 2000 projects, were based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the continued
availability of certain resources and other factors. Other unanticipated Year
2000 issues could arise and there can be no assurance that these estimates will
be achieved and actual results could differ from those anticipated. These
unanticipated issues may include, but are not limited to, the ability to
identify and correct all noncompliant systems and applications, the ability of
third parties to become Year 2000 compliant, the availability and cost of
trained personnel, the impact of Year 2000 on our clients and other
uncertainties.
CAPITAL RESOURCES
REGULATORY CAPITAL REQUIREMENTS
Bank holding companies, such as the Corporation, and their bank subsidiaries are
required by banking regulators to meet certain minimum levels of capital
adequacy. These are expressed in the form of certain ratios. Capital is
separated into Tier I capital (essentially common stockholders' equity less
goodwill) and Tier II capital (essentially the allowance for loan losses limited
to 1.25% of risk-weighted assets). The first two ratios, which are based on the
degree of credit risk in the company's assets, provide for weighting assets
based on assigned risk factors and include off-balance sheet items such as loan
commitments and stand-by letters of credit. The ratio of Tier I capital to
risk-weighted assets must be at least 4.0% and the ratio of Total capital (Tier
1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%.
The capital leverage ratio supplements the risk-based capital guidelines. Banks
and bank holding companies are required to maintain a minimum ratio of Tier 1
capital to adjusted quarterly average total assets of 4.0%
The FDIC, the insurer of deposits in financial institutions, has adopted a
risk-based insurance premium system based in part on an institution's capital
adequacy. Under this system, a depository institution is classified into one of
three capital categories (well-capitalized, adequately capitalized or
undercapitalized) according to its risk-based capital and leverage ratios and is
required to pay successively higher premiums depending on its capital levels and
its supervisory rating by its primary regulator. It is the Corporation's
intention to maintain sufficient capital in each of its bank subsidiaries to
permit them to maintain a "well capitalized" designation (the FDIC's highest
rating).
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As summarized below, the Corporation's risk based capital levels were well in
excess of all regulatory standards.
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS Regulatory
Minimum
For "Well SEPTEMBER 30, December 31, September 30,
Capitalized" 1998 1997 1997
- -----------------------------------------------------------------------------------------------------------------------
Risk based capital:
Tier I 6.0 % 10.4 % 9.8 % 9.6 %
Total capital 10.0 11.6 11.0 10.9
Tier I leverage 5.0 8.5 8.0 7.7
- -----------------------------------------------------------------------------------------------------------------------
COMMON AND PREFERRED STOCK
The Corporation initiated a stock repurchase program in November 1987. Effective
January 27, 1997, the Corporation's stock repurchase program was formally
rescinded by its Board of Directors in conjunction with the agreement to acquire
CB Financial Corporation. Prior to the rescission, a total of 1,891,455 shares
had been purchased under this program at an average price of $10.56 per share.
On May 5, 1998, the Corporation announced the initiation of a new stock
repurchase plan that provides for the repurchase of up to 600,000 shares of its
stock on the open market over the next 24 months. The shares will be utilized to
satisfy the Corporation's obligation to issue shares under its existing employee
and director stock option plans. The Corporation intends to acquire such shares
in a systematic pattern. As of September 30, 1998 a total of 155,500 shares have
been purchased under the plan at a cost of $5,248,581, or an average price of
$33.75 per share. All but 55,006 of these shares have been reissued for the
exercise of stock options. Shares of common stock in treasury are accorded the
treatment as if retired; however, such shares remain available for reissue.
OTHER
Total shareholders' equity was $434.8 million or $15.46 per share as of
September 30, 1998, compared with $409.8 million or $14.61 per share as of
December 31, 1997 and $399.1 million or $14.30 per share as of September 30,
1997. The Corporation declared cash dividends of $0.61 per share during the
first nine months of 1998, an increase of 10.9% over the $0.55 per share
declared during the same period in 1997.
LIQUIDITY AND DEBT CAPACITY
Management closely monitors the level of liquid assets available to meet ongoing
funding needs and to capitalize on opportunities for business expansion. It is
management's intent to maintain adequate liquidity so that sufficient funds are
readily available at a reasonable cost. Various techniques are used by the
Corporation to measure liquidity, including ratio analysis. Some ratios
monitored by the Corporation include: loans to deposits, core funding (deposits
plus a portion of repurchase agreements and long term debt less single maturity
certificates of deposits) to total funding (volatile funding plus core funding)
and liquid assets to volatile funding (interest bearing liabilities plus
noninterest bearing deposits less core funding). During 1997 and 1998, the
Corporation's strategy to operate with a higher loan to deposit ratio improved
the asset mix, resulting in increased net interest income. The Corporation
experienced no liquidity or operational problems as a result of the current
liquidity levels. These ratios are summarized in the following table:
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KEY LIQUIDITY RATIOS
SEPTEMBER 30, December 31, September 30,
1998 1997 1997
- -------------------------------------------------------------------------------------------------------------------------
Quarterly average:
Loans to deposits 95.2 % 94.6 % 93.1 %
Liquid assets to volatile funding 52.7 35.4 31.6
Core funding to total funding 88.7 86.5 87.7
- -------------------------------------------------------------------------------------------------------------------------
The corporation manages liquidity to meet client cash flow needs while
maintaining funds available for loan and investment opportunities. The
corporation's quarterly average loan to deposit ratio increased to 95.2% at
September 30, 1998 from 94.6%
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at December 31, 1997. Management believes that the Corporation has sufficient
liquidity to meet presently known cash flow requirements arising from ongoing
business transactions.
INTEREST RATE RISK
Interest rate risk generally arises when the maturity or repricing structure of
the Corporation's assets and liabilities differs significantly. Asset/liability
management, which among other things addresses such risk, is the process of
developing, testing and implementing strategies that seek to maximize net
interest income, maintain sufficient liquidity and minimize exposure to
significant changes in interest rates. This process includes monitoring
contractual and expected repricing of assets and liabilities as well as
forecasting earnings under different interest rate scenarios and balance sheet
structures. Generally, management seeks a structure that insulates net interest
income from large swings attributable to changes in market interest rates. The
Corporation's static interest rate sensitivity ("GAP") as of September 30, 1998
is illustrated in the table below.
As shown, the Corporation's interest rate risk position is well balanced in the
less than one-year time frame with rate sensitive assets exceeding rate
sensitive liabilities by $12.4 million. This position suggests that the
Corporation's net interest income may not be significantly impacted by changes
in interest rates over the next 12 months. Management is continually reviewing
its interest rate risk position and modifying its strategies based on
projections to minimize the impact of future interest rate changes. While
traditional GAP analysis does not always incorporate adjustments for the
magnitude or timing of noncontractual repricing, this table does incorporate
appropriate adjustments as indicated in footnotes 2 and 3 to the table. Because
of these and other inherent limitations of any GAP analysis, management utilizes
simulation modeling as its primary tool to evaluate the impact of changes in
interest rates and balance sheet strategies. Management uses these simulations
to develop strategies that can limit interest rate risk and provide liquidity to
meet client loan demand and deposit preferences.
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INTEREST RATE SENSITIVITY
TOTAL
September 30, 1998 1-30 31-90 91-180 181-365 WITHIN 1-5 Over
(in millions) Days Days Days Days 1 YEAR Years 5 Years Total
- --------------------------------------------------------------------------------------------------------------------------
RATE SENSITIVE ASSETS (3)
Loans $1,053.1 $ 143.5 $ 203.9 $ 342.2 $1,742.7 $1,364.1 $432.5 $3,539.3
Investment securities 64.1 44.7 59.2 70.7 238.7 231.9 145.5 616.1
Short-term investments 2.4 --- --- --- 2.4 --- --- 2.4
-------- ------- ------- ------- -------- -------- ------ --------
Total $1,119.6 $ 188.2 $ 263.1 $ 412.9 $1,983.8 $1,596.0 $578.0 $4,157.8
======== ======= ======= ======= ======== ======== ====== ========
RATE SENSITIVE LIABILITIES
Deposits (2) $ 216.8 $ 297.1 $ 440.7 $ 702.7 $1,657.3 $1,206.0 $180.3 $3,043.6
Short-term borrowings 187.5 --- --- --- 187.5 --- --- 187.5
Loan-term debt 15.0 6.0 63.0 42.6 126.6 14.4 0.1 141.1
-------- ------- ------- ------- -------- -------- ------ --------
Total $ 419.3 $ 303.1 $ 503.7 $ 745.3 $1,971.4 $1,220.4 $180.4 $3,372.2
======== ======= ======= ======= ======== ======== ====== ========
Period GAP (1) $ 700.3 $(114.9) $(240.6) $(332.4) $ 12.4 $ 375.6 $397.6 $ 785.6
Cumulative GAP 700.3 585.4 344.8 12.4 388.0 785.6
Cumulative GAP to
Total Assets 15.69% 13.12% 7.73% 0.28% 0.28% 8.69% 17.60% 17.60%
Multiple of Rate Sensitive
Assets to Liabilities 2.67 0.62 0.52 0.55 1.01 1.31 3.20 1.23
==========================================================================================================================
(1) GAP is the excess of rate sensitive assets (liabilities).
(2) Includes interest bearing savings and demand deposits of $452 million in
the less than one year category, and $951 million in the over one year
category, based on historical trends for these noncontractual maturity
deposit types, which reflects industry standards.
(3) Incorporates prepayment projections for certain assets which may shorten
the time frame for repricing or maturity compared to contractual runoff.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS--NONE
ITEM 2. CHANGES IN SECURITIES--NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES--NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS--NONE
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(11) Statement re: computation of per share earnings
(27) Financial Data Schedule
(b) Reports on Form 8-K--none
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CITIZENS BANKING CORPORATION
Date November 12, 1998 By /s/ John W. Ennest
--------------------------- -------------------------
John W. Ennest
Vice Chairman of the Board,
Treasurer and Chief Financial
Officer
(Principal Financial Officer)
(Duly Authorized Signatory)
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INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
(11) Statement re: computation of per share earnings
(27) Financial Data Schedule