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EXHIBIT 99.1
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OFFICE OF THRIFT SUPERVISION
WASHINGTON, D.C. 20552
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FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 [No Fee Required]
FOR THE TRANSITION PERIOD FROM TO
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MUTUAL SAVINGS BANK, F.S.B., A STOCK COMPANY
(Exact name of registrant as specified in its charter)
UNITED STATES OF AMERICA 38-0861665
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
623 WASHINGTON AVENUE 48708
BAY CITY, MICHIGAN (Zip Code)
(Address of principal executive offices)
Registrant's telephone number: (517) 892-3511
Securities registered pursuant to section 12 (b) of the Act:
Title of each class to be so registered Name of each exchange on which registered
NONE NOT APPLICABLE
Securities registered pursuant to section 12 (g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or 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. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 5, 1999, computed by reference to the closing price
for such stock on the composite reporting system on such date, was $42,674,510
(assuming, but not admitting for any purpose, that all directors and executive
officers of the registrant may be deemed affiliates).
The number of shares of the registrant's common stock outstanding as of
March 5, 1999 was 4,290,414.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's annual report to stockholders for the year
ended December 31, 1998 is incorporated by reference to Part II of this Form
10-K.
Portions of the registrant's proxy statement for its 1999 annual meeting of
the stockholders expected to be held on April 27, 1999 is incorporated by
reference to Part III of this Form 10-K.
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TABLE OF CONTENTS
PAGE NUMBER
PART I
Item 1. Business..........................................................................................3
Item 2. Properties.......................................................................................38
Item 3. Legal Proceedings................................................................................40
Item 4. Submission of Matters to a Vote of Security Holders..............................................41
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................41
Item 6. Selected Financial Data..........................................................................41
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation.........................................................................41
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.......................................41
Item 8. Financial Statements and Supplementary Data......................................................41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................................................41
PART III
Item 10. Directors and Executive Officers of the Registrant...............................................42
Item 11. Executive Compensation...........................................................................42
Item 12. Security Ownership of Certain Beneficial Owners and Management...................................42
Item 13. Certain Relationships and Related Transactions...................................................42
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................43
SIGNATURES.......................................................................................................44
When used in this Form 10-K or future filings by Mutual Savings Bank,
f.s.b. ("MSB") with the Office of Thrift Supervision, in MSB's press releases or
other public or stockholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be,"
"will allow," "intends to," "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.
MSB wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect MSB's financial performance and could cause MSB's actual
results for future periods to differ materially from those anticipated or
projected.
MSB does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
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PART I
ITEM 1. BUSINESS
GENERAL
Mutual Savings Bank, f.s.b., A Stock Company ("MSB" or the "Bank") was
originally organized in 1890 as a Michigan-chartered building and loan
association. In 1928, MSB merged with another Michigan-chartered building and
loan association, which had been organized in 1887. MSB converted to a federally
chartered mutual savings and loan association in 1985, under the name Mutual
Savings and Loan Association, F.A. In 1990, MSB converted to a federal savings
bank.
On July 16, 1992, MSB completed its conversion from a federally chartered mutual
savings bank to a federally chartered stock savings bank, by issuing 2,875,000
shares of $0.01 par value common stock at a price of $4.375 per share, as
adjusted for a 100% common stock split in the form of a dividend, paid on
September 8, 1993. In November 1993, MSB issued an additional 1,347,138 shares
as part of a rights offering to existing stockholders at $17.25 a share.
MSB's principal business is attracting retail deposits and investing those
deposits, together with other borrowings and funds generated from operations, in
one- to four-family residential mortgage loans, consumer loans, commercial real
estate and business loans, mortgage-backed securities, U.S. Government and
Federal agency securities and other marketable securities. MSB's revenues are
derived principally from interest earned on its loans, mortgage-backed
securities and investment portfolios, as well as gains and fees on loans sold,
loan servicing fee income, service charges on deposit accounts and commission
income from the sale of investment and insurance products. MSB's expenses
primarily consist of interest paid on its deposits and borrowings, employee
compensation, occupancy expenses, federal deposit insurance premiums and general
and administrative expenses. MSB's primary sources of funds are deposits,
borrowings, principal and interest payments on loans and mortgage-backed
securities and proceeds from sales of mortgage loans.
MSB also operates two wholly owned subsidiaries, MSB Service Corporation
("MSBc"), formerly known as Finance Service Corporation of Bay City, and MSB
Investment and Insurance Services, Inc., ("MSBi"), formerly known as Financial
Service Insurance Agency, Inc. MSB's two subsidiaries have contracted with
unaffiliated third parties to provide various investment services including the
sale of mutual fund and annuity products. MSBi also sells life insurance,
long-term care insurance and group health and disability insurance.
MARKET AREA AND COMPETITION
MSB is currently operating as a financial institution offering a variety of
deposit, loan and investment and insurance products to its customers. MSB
operates through a main office and 21 branch offices located in 12 counties in
central and southern Michigan. The main office is located in the central
business district of Bay City, Michigan. MSB is the only major thrift with its
headquarters in the area and has been servicing the retail needs of the area for
over 100 years. Seventeen of the branch offices are located in small and
mid-sized communities located around
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Saginaw Bay and across central Michigan. The remaining four branch offices are
located in the southern portion of the state in Battle Creek (see Item No. 2,
Properties). Most of MSB's facilities are located on corner lots as
free-standing buildings. These locations provide convenient access for customers
as well as competitive hours. MSB's retail offices provide the core deposits
needed by the Bank to operate.
MSB considers its market area to be the towns and areas where its offices are
located. In terms of deposit products, MSB's market share in these areas ranged
from 1% or less in the city of Saginaw to over 31% in the town of Sebewaing. In
the other communities it serves, MSB had between 2% and 29% of the market for
deposits.
Although the economic environment of Michigan is heavily linked to the
automotive industry, a large segment is agricultural, which helps to reduce the
effects of changes in automobile production. Central Michigan, where most of
MSB's offices are located, has a strong blend of these two important economic
bases. In addition, the headquarters of Dow Chemical and Dow Corning are located
in Midland, where MSB has an office, and the headquarters of Kellogg is located
in Battle Creek, where MSB has four offices.
MSB competes with commercial banks, credit unions and other financial
institutions for loan originations and deposits. MSB also faces competition from
mortgage bankers and brokers for loan originations. MSB faces additional
competition for deposits from short-term money market funds and other corporate
and government securities funds. MSB competes for loans principally through the
interest rates and loan fees it charges, the level of closing costs it imposes,
and the efficiency and quality of the services and products it provides to
borrowers. It competes for deposits primarily through pricing, by offering a
variety of deposit accounts and the quality of customer service.
MSB's loan products are designed to provide a variety of lending services to its
customers and local communities, and also to compete in its market area. MSB
intends to retain in its portfolio certain originated residential mortgage loans
(primarily adjustable rate, balloon and fifteen year fixed rate mortgage loans)
while the remainder are generally sold in the secondary market. MSB also
originates and retains various types of consumer loans and commercial loans.
The level of loan originations is affected by competition and the general level
of interest rates; therefore, it is difficult to predict the future level of
loan originations. Also, competition may increase as a result of the lifting of
restrictions on the interstate operations of financial institutions.
LENDING ACTIVITIES
Loan Portfolio Composition.
MSB's loan portfolio (excluding mortgage-backed securities) consists primarily
of first mortgage loans and construction loans, secured by owner-occupied one-
to four-family, primary residences. At December 31, 1998, 72.66% of net loans
receivable consisted of one- to four-family residential and construction loans.
Of these, 5.50% were loans originated under MSB's two-step mortgage program,
with rates that are fixed for either five or seven years, and then are adjusted
for the remainder of the loan term. An additional 48.02% were adjustable rate
mortgage ("ARM") loans
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that include mortgages that have a first interest rate adjustment date from one
to ten years after the date of origination. At December 31, 1998, purchased
residential mortgage loans, which consist primarily of one- to four-family
residential mortgage loans, totaled $11.068 million, or 4.65%, of MSB's one- to
four-family residential loans and construction loans receivable.
The remaining loans in MSB's portfolio, which totaled 32.80% of net loans
receivable at December 31, 1998, consist of commercial loans, various types of
consumer loans (e.g., home equity and home improvement loans, indirect vehicle
loans, installment loans, insured student loans and loans secured by deposits),
multi-family residential loans and land loans (e.g., loans on vacant property on
which the borrower intends to build a residence). Commercial loans include
$2,962,000 secured by leases.
The table on page 6 sets forth the composition of MSB's loan portfolio by type
as of the dates indicated.
The following table sets forth MSB's loan originations, purchases, sales and
principal repayments for the periods indicated:
For the Years Ended December 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands)
Total gross loans receivable at beginning of period $ 321,393 $ 260,953 $ 199,106
--------- --------- ---------
Loans originated:
Mortgage 297,536 129,099 150,219
Commercial 33,337 19,604 12,249
Consumer 32,299 53,141 27,922
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Total loans originated 363,172 201,844 190,390
Commercial loans purchased 1,952 76 2,189
Loans sold (200,863) (65,867) (66,653)
Loan principal repayments (140,080) (75,613) (64,079)
--------- --------- ---------
Total gross loans receivable at end of period 345,574 321,393 260,953
Less:
Loans in process (16,907) (5,356) (8,852)
Deferred loan costs, net of fees and unearned loan discounts 868 1,037 402
Allowance for loan losses (1,843) (1,969) (1,855)
--------- --------- ---------
Total loans receivable, net at end of period $ 327,692 $ 315,105 $ 250,648
========= ========= =========
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At December 31,
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1998 1997 1996
---------------------- ----------------------- -----------------------
Amount Percent Amount Percent Amount Percent
---------- --------- ---------- --------- ---------- ---------
(Dollars in thousands)
Type of loan:
Mortgage loans:
One- to four-family residential (1) $ 226,083 68.99% $ 215,745 68.47% $ 189,018 75.41%
Multi-family residential -- -- -- -- 32 0.01
Construction loans 12,021 3.67 12,515 3.97 17,034 6.80
Land loans 1,376 0.42 1,004 0.32 647 0.26
---------- --------- ---------- --------- ---------- ---------
Total mortgage loans 239,480 73.08 229,264 72.76 206,731 82.48
---------- --------- ---------- --------- ---------- ---------
Other loans:
Commercial loans and mortgages 48,487 14.80 23,628 7.50 14,044 5.60
Consumer loans (2) 57,607 17.58 68,501 21.74 40,178 16.03
---------- --------- ---------- --------- ---------- ---------
Total other loans 106,094 32.38 92,129 29.24 54,222 21.63
---------- --------- ---------- --------- ---------- ---------
Total loans receivable 345,574 105.46 321,393 102.00 260,953 104.11
---------- --------- ---------- --------- ---------- ---------
Less:
Loans in process (16,907) -5.16 (5,356) -1.70 (8,852) -3.53
Deferred loan costs, net of fees
and unearned loan discounts 868 0.26 1,037 0.33 402 0.16
Allowance for loan losses (1,843) -0.56 (1,969) -0.63 (1,855) -0.74
---------- --------- ---------- --------- ---------- ---------
Total loans receivable, net $ 327,692 100.00% $ 315,105 100.00% $ 250,648 100.00%
========== ========= ========== ========= ========== =========
(1) Federal Housing Administration
("FHA") insured and Veterans
Administration ("VA") partially
guaranteed mortgage loans included
in one-to four-family residential. $ 371 0.11% $ 570 0.18% $ 746 0.30%
(2) Second mortgages and home equity
loans included in consumer loans. $ 36,486 11.13% $ 42,584 13.51% $ 31,037 12.38%
At December 31,
------------------------------------------------
1995 1994
---------------------- ----------------------
Amount Percent Amount Percent
-------- --------- -------- ---------
Type of loan:
Mortgage loans:
One- to four-family residential (1) $150,873 77.87% $126,895 80.00%
Multi-family residential 34 0.02 34 0.02
Construction loans 8,035 4.15 3,801 2.40
Land loans 300 0.15 197 0.12
-------- --------- -------- ---------
Total mortgage loans 159,242 82.19 130,927 82.54
-------- --------- -------- ---------
Other loans:
Commercial loans and mortgages 10,238 5.28 15,958 10.07
Consumer loans (2) 29,626 15.29 15,076 9.50
-------- --------- -------- ---------
Total other loans 39,864 20.57 31,034 19.57
-------- --------- -------- ---------
Total loans receivable 199,106 102.76 161,961 102.11
-------- --------- -------- ---------
Less:
Loans in process (3,954) -2.04 (1,598) -1.01
Deferred loan costs, net of fees
and unearned loan discounts 331 0.17 (176) -0.11
Allowance for loan losses (1,723) -0.89 (1,572) -0.99
-------- --------- -------- ---------
Total loans receivable, net $193,760 100.00% $158,615 100.00%
======== ========= ======== =========
(1) Federal Housing Administration
("FHA") insured and Veterans
Administration ("VA") partially
guaranteed mortgage loans included
in one-to four-family residential. $ 993 0.51% $ 1,324 0.83%
(2) Second mortgages and home equity
loans included in consumer loans. $ 22,400 11.56% $ 7,609 4.80%
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Loan Maturity and Repricing.
The following table summarizes the scheduled maturity or period to repricing of
MSB's real estate construction and commercial loans excluding lease financing
loans at December 31, 1998. Demand loans and loans having no stated schedule of
repayments and no stated maturity are reported as due in one year or less. Real
estate construction loans all have adjustable rates and are generally indexed to
the one year Treasury rate. Loan balances are reported gross, before undisbursed
loan proceeds, unearned discounts, deferred loan fees or allowances for loan
losses. The following table includes scheduled principal amortization in the
period when due.
One Two Three Five
Within Year Years Years Years
One Through Through Through Through
Year Two Years Three Years Five Years Ten Years Total
--------- --------- ----------- ---------- --------- ---------
(In thousands)
Real estate construction loans $ 12,021 $ -- $ -- $ -- $ -- $ 12,021
--------- --------- ----------- ---------- --------- ---------
Other loans:
Commercial mortgage -- construction 13,518 43 47 106 39 13,753
Commercial loans -- other (1) 2,344 228 186 184 6 2,948
--------- --------- ----------- ---------- --------- ---------
Total other loans 15,862 271 233 290 45 16,701
--------- --------- ----------- ---------- --------- ---------
Total loans $ 27,883 $ 271 $ 233 $ 290 $ 45 $ 28,722
========= ========= =========== ========== ========= =========
(1) Excludes lease financing loans.
The following table sets forth the dollar amount of commercial loans excluding
lease financing loans at December 31, 1998 that have fixed interest rates and
those that have floating or adjustable interest rates that have a scheduled
maturity or period to repricing after December 31, 1999:
Floating or
Fixed Rate Adjustable Rate Totals
---------- --------------- ------
(In thousands)
Commercial mortgage -- construction $ 235 $ -- $ 235
Commercial loans -- other (1) 604 -- 604
---------- --------------- ------
Total loans $ 839 $ -- $ 839
========== =============== ======
(1) Excludes lease financing loans.
RESIDENTIAL REAL ESTATE LENDING
Originated One- to four-family Mortgage Loans.
MSB offers first mortgage loans secured by one- to four-family residences
(including townhouse and condominium units) in the Bank's lending areas. Most
loans are qualified for sale in the secondary market. Generally, fixed rate
mortgage loans with maturities of 20 through 30 years are sold through a conduit
sales program or directly to the Federal Home Loan Mortgage Corporation
("FHLMC") or the Federal National Mortgage Association ("FNMA"). All other
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loans are generally retained in MSB's own portfolio to generate interest income.
Currently, loans are sold with the servicing being retained by MSB, with the
exception of FHA loans originated by the Bank. These loans are sold with the
servicing released to the purchaser or a third party. Generally, all one- to
four-family residential mortgage loans are underwritten according to FHLMC, FNMA
or other conduit guidelines, with the exception of certain loans designed for
the Bank's own portfolio.
Upon receipt of a completed loan application from a prospective borrower for a
loan secured by one- to four-family residential real estate, a credit report is
ordered, income and certain other information is verified and, if necessary,
additional financial information is requested. An appraisal of the real estate
intended to secure the proposed loan is generally required. All appraisers are
selected from a list of appraisers that has been approved by MSB's Board of
Directors. MSB's Appraisal Review Committee reviews a random sample of
appraisals.
It is MSB's policy to obtain title insurance on all real estate mortgage loans.
Borrowers must also obtain hazard insurance prior to closing. Borrowers
generally are required (when the loan-to-value exceeds 80%) to advance funds on
a monthly basis together with each payment of principal and interest to a
mortgage escrow account from which MSB makes disbursements for items such as
real estate taxes and hazard and private mortgage insurance premiums.
MSB is exposed to interest rate risk on all loans that it retains. ARM loans
generally entail different credit risks than fixed rate loans, primarily
because, as interest rates rise, the payment by the borrower rises, increasing
the potential for default. In order to reduce this risk, MSB's policy is to
qualify borrowers at the maximum rate that could be in effect after the first
year for ARM loans. The rate used to qualify the borrower may be higher or lower
than the fully indexed rate. This is in accordance with FNMA and FHLMC
guidelines.
Borrowers may obtain loans at a lower interest rate by paying discount points
based on the loan amount. To the extent that borrowers do not pay discount
points to reduce the interest rate, MSB will generally obtain a premium when it
sells the loan in the secondary market.
Originated mortgage loans in MSB's portfolio generally include due-on-sale
clauses, which provide the Bank with the contractual right to deem the loan
immediately due and payable in the event that the borrower transfers ownership
of the property without MSB's consent. Generally, it is MSB's policy to enforce
due-on-sale provisions.
Loan originations are generally obtained from existing or past customers and
members of the local communities where MSB's retail offices are located. Loan
originations primarily depend on the level of interest rates, economic
conditions and competition. Loans are originated by personnel located in the
Bank's offices, who are paid a commission for each loan originated. All
applications are reviewed and approved by personnel located in MSB's main
office. The Officers Loan Committee, consisting of the First Vice President -
Director of Loan Operations and representatives from each lending area, meets
weekly to review loans recently applied for from the prior week. The Committee
can approve loans for borrowers with an aggregate exposure of up to $500,000.
Loans for borrowers with an aggregate exposure from $500,000 to $1,000,000 are
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approved by the Board Loan Committee that currently consists of the Chief
Executive Officer, the President and Chief Operating Officer and four other
officers of the Bank. Loans for borrowers with an aggregate exposure over
$1,000,000 require the approval of the Board of Directors.
Purchased Residential Mortgage Loans.
Prior to 1989, MSB purchased participation interests (with the Bank's
participation generally ranging from approximately 50% to 100%) in loans from
selected financial institutions. The purchased loans are first mortgage loans or
contracts for deeds with original loan-to-value ratios of 95% or less and are
secured by one- to four-family residential properties, virtually all of which
are single-family primary residences. At December 31, 1998, purchased
residential mortgage loans totaled $11.068 million, or 3.38% of MSB's net total
loans.
At December 31, 1998, 90.97% of the purchased residential mortgage loans were
secured by properties located in Florida. The following table sets forth the
estimated amount of MSB's purchased and originated residential mortgage loans,
including loans held-for-sale and participations, secured by properties located
in Michigan, New York, Florida, Texas and other states, and information with
respect to purchased and originated commercial loans and participations:
At December 31, 1998
------------------------------------------------------------------------------------------------------
Residential Commercial
------------------------------------------------ -------------------------------------------------
Loans Loans Loans Loans
Originated Purchased Total Percent Originated Purchased Total Percent
---------- --------- ---------- --------- ---------- --------- --------- ---------
(Dollars in thousands)
Michigan $ 225,064 $ 578 $ 225,642 91.93% $ 46,398 $ 1,827 $ 48,225 99.46%
New York -- -- -- -- 262 -- 262 0.54
Florida 1,069 10,069 11,138 4.54 -- -- -- --
Texas 7,815 160 7,975 3.25 -- -- -- --
Other 422 261 683 0.28 -- -- -- --
---------- --------- ---------- --------- ---------- --------- --------- ---------
Total $ 234,370 $ 11,068 $ 245,438 100.00% $ 46,660 $ 1,827 $ 48,487 100.00%
========== ========= ========== ========= ========== ========= ========= =========
COMMERCIAL LENDING
MSB currently originates commercial real estate loans, residential subdivision
development loans, business loans, lines of credit and letters of credit loans.
At December 31, 1998, commercial loans totaled $48.487 million, or 14.80%, of
net loans receivable. MSB had ten commercial loans in excess of $1,000,000
outstanding at December 31, 1998. At December 31, 1998, $26.001 million in
commercial loans were at fixed rates and $22.486 million were at adjustable
rates.
Commercial Real Estate Loans.
Of the $48.487 million in commercial loans, approximately $42.577 million, or
87.81%, was comprised of commercial real estate loans. Approximately $1,827,000
of these commercial real estate loans were purchased, rather than originated, by
MSB. MSB has entered into a 15% loan participation agreement with another
financial institution totaling $1,890,000 relating to the development of a
subdivision located in southeastern Michigan. This loan totaled $1,764,000 at
December 31, 1998.
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Commercial real estate loans are generally originated in amounts up to 80% of
the appraised value of the property. The appraised value is generally determined
by an independent appraiser previously approved by the Bank. MSB's commercial
real estate loans are for construction and/or permanent loans secured by
improved property such as speculative home construction and land development,
office buildings, retail stores and strip shopping centers, light industrial
buildings, apartment buildings and motels. Borrowers generally are required to
personally guarantee loans secured by commercial real estate, and obtain hazard
and title insurance. Commercial real estate loans are originated with varying
maturities and with fixed or adjustable interest rates generally based upon
market rates for the type of property.
MSB participates in the Community Investment Program administered by the Federal
Home Loan Bank ("FHLB") System. At December 31, 1998, MSB had six loans totaling
$13.267 million for low- and moderate-income housing units using this program.
Loans secured by commercial real estate properties are generally larger and
involve greater risk than residential mortgage loans. The increased credit risk
is a result of several factors, including the concentration of principal in a
smaller number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty in
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by commercial real estate properties is often dependent on
successful operation or management of the properties. If the cash flow from the
property is reduced, the borrower's ability to repay the loan may be impaired.
Loans secured by commercial real estate also may involve a greater degree of
environment risk.
Commercial Business Loans.
At December 31, 1998, approximately $5,909,000, or 12.19%, of MSB's commercial
loan portfolio consisted of commercial business loans. MSB from time to time
will originate commercial business loans and lines of credit, which are secured
by leases, equipment and inventory and other assets to businesses in its lending
area.
Unlike residential mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment and other income
and which are secured by real property, the value of which tends to be more
ascertainable, commercial business loans typically are made on the basis of the
borrower's ability to make repayment from the cash flow of the borrower's
business. As a result, the availability of funds for the repayment of commercial
business loans may be substantially dependent on the success of the business
itself (which, in turn, is likely to be dependent, in part, upon the general
economic environment). MSB's commercial business loans are usually secured by
business assets. However, the collateral securing the loans may depreciate over
time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
CONSUMER LENDING
MSB originates a variety of secured consumer loans, including closed-end, fixed
rate and variable rate home equity loans, home improvement loans, automobile
loans, boat and other recreational vehicle loans, insured student loans, and
loans secured by deposits held by the Bank. MSB also offers unsecured loans at
competitive rates. MSB began to actively market consumer loans
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during 1994 in order to meet customer needs and because of the shorter term of,
and normally higher yields on, such loans.
Consumer loans totaled $57.607 million (consisting of $36.486 million in home
equity loans, $796,000 in insured student loans, $416,000 in originated mobile
home loans, $17.899 million in automobile, recreational vehicle and boat loans,
$368,000 in loans secured by deposits, $4,000 in Michigan Education Trust loans,
and $1,638,000 in unsecured loans), or 17.58%, of net loans receivable at
December 31, 1998.
MSB's indirect consumer lending program that was initiated in the fourth quarter
of 1996 resulted in indirect loan originations of $20.085 million in 1997 and
$3.690 million in 1998. MSB phased out its indirect automobile lending
operations beginning on October 1, 1998. Indirect consumer loans were originated
through automobile, boat and recreational vehicle dealers. These loans generally
have a higher credit risk than direct loans because the loans are originated
through dealers to borrowers who may not have other banking relationships with
MSB. MSB generally applied the same underwriting criteria to indirect loans as
are applied to other consumer loans. However, MSB permitted the borrower to
finance items such as service contracts, extended warranties and credit life
insurance on indirect loans which resulted in many higher loan-to-collateral
value ratios than direct loans. At December 31, 1998, MSB's consumer loan
portfolio included $14.285 million of indirect loans.
While MSB attempted to employ prudent credit standards in originating indirect
loans, there is an inherent risk that a portion of these loans will default. In
such instances, the repossessed collateral securing the loan may not be
sufficient for repayment of the loan and the remaining deficiency may not be
collectible. MSB does not have recourse to the dealer in the event of a default
of an indirect loan. Loans secured by assets that depreciate rapidly, such as
automobiles, boats and recreational vehicles, are generally considered to entail
greater risks than residential mortgage loans.
LOAN ORIGINATION AND OTHER FEES
MSB records income, including capitalized originated mortgage servicing rights,
in connection with loan originations, loan sales, loan servicing, loan
modifications, late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period with the volume
and type of loans originated and serviced.
In its lending, MSB obtains loan fees that are calculated as a percentage of the
amount borrowed. The fees received in connection with the origination of
residential real estate loans include points paid by the borrower, origination
fees and premiums received for the sale of loans in the secondary market.
During the year ended December 31, 1998, MSB recorded gains and fees on loans
sold of $2,237,000 in connection with the origination and sale of residential
mortgage loans. Other fees totaling $306,000 were recorded in connection with
mortgage, consumer and commercial loans. MSB capitalized approximately
$1,651,000 of originated mortgage servicing rights ("OMSR") and recorded
$679,000 of OMSR amortization (that is netted against loan servicing fee income)
12
during the year ended December 31, 1998. Direct costs incurred on originated
loans held in the Bank's portfolio, net of origination fees, are deferred. MSB
had $903,000 in net deferred loan costs (net of origination fees) at December
31, 1998.
In addition, MSB receives fees for servicing the loans it originates. MSB earned
$639,000 in loan servicing fee income for the year ended December 31, 1998. Loan
servicing income as a percentage of net interest income was 5.32%, 9.91% and
12.93% for the years ended December 31, 1998, 1997 and 1996, respectively.
SECONDARY MARKET ACTIVITIES
As described above, MSB generally sells the 20 through 30 year fixed rate loans
that it originates to FHLMC, FNMA or a conduit sales program. Generally, such
fixed rate loans are "pre-sold," in that the loans are originated against and in
conformity with existing commitments the Bank has made with FHLMC, FNMA or
another approved investor. By selling these fixed rate loans in the secondary
market, MSB reduces its interest rate risk exposure. This activity also allows
MSB to continue to make loans when deposit flows decline or funds are not
otherwise available for lending, as the proceeds from sales in the secondary
market can be redeployed into new loans. During the year ended December 31,
1998, MSB sold $200.863 million in loans to FHLMC and FNMA.
MSB may also package fixed rate loans in its portfolio into FHLMC or FNMA pools,
which it would exchange for agency-guaranteed securities backed by mortgages.
The mortgage-backed securities could then be used to collateralize borrowings or
be sold in the secondary market to raise additional funds. During the year ended
December 31, 1998, MSB did not securitize any originated loans from its
portfolio.
In the past, MSB has pooled some of the loans it had originated and exchanged
them for FNMA and FHLMC mortgage-backed securities backed by pools of loans sold
with recourse; some of these securities were sold in the open market. In
addition, certain loans were sold, with recourse, directly to another financial
institution. Approximately $4,753,000 in loans sold with recourse were
outstanding as of December 31, 1998. At December 31, 1998, there were $80,000 of
delinquent loans sold with recourse (calculated based on loans 60 or more days
past due).
Upon the sale of loans, MSB generally retains the responsibility for collecting
and remitting loan payments, ensuring that real estate tax payments are made on
behalf of the borrowers, and otherwise servicing the loans. Typically, MSB
receives servicing fees for performing the services, which results in fee
income. The majority of loan sales are made with servicing retained by the Bank.
During the third quarter of 1996, MSB sold $53.798 million of bulk mortgage loan
servicing rights. The sold mortgage loan servicing related to loans primarily
originated in Texas and Florida. MSB closed its loan production offices located
in Texas and Florida in May 1994.
DELINQUENCIES AND CLASSIFIED ASSETS
MSB is, in general, a secured lender. The lending policy of the Bank includes
general guidelines for a loan's loan-to-value ratio (at origination, the ratio
of the principal amount of the loan to the lower of the loan's collateral
appraised value or, if applicable, its sales price). MSB's general loan-to-value
guidelines include a maximum loan-to-value ratio of 90% for residential real
estate loans.
13
MSB will originate loans with a loan-to-value ratio greater than 90% if private
mortgage insurance or the equivalent is obtained to reduce the effective
loan-to-value ratio to below 80%. Other general guidelines include a maximum
loan-to-value ratio of 90% for home equity loans. MSB may lend in excess of 100%
of the collateral value on certain consumer loans, including indirect loans. MSB
generally requires insurance for collateral securing a loan.
Delinquent Loans.
Delinquencies on all loans are reviewed monthly by MSB's Board of Directors.
Procedures taken with respect to delinquent loans differ depending on whether
the loan was originated or purchased by the Bank and the type of loan.
MSB's collection procedures with respect to loans originated by the Bank include
written notice of delinquency and contact by letter or by telephone by the
Bank's collection staff on a weekly basis. Most loan delinquencies are cured
within 90 days without legal action. Based on the type of loan, if the
delinquency exceeds 45 to 90 days, MSB institutes measures to enforce its
remedies resulting from the default, including commencing foreclosure action or
repossession. A decision as to whether and when to initiate foreclosure
proceedings or repossession procedures is based on such factors as the amount of
the outstanding loan in relation to the original indebtedness, the extent of
delinquency, the borrower's ability and willingness to cooperate in curing
delinquencies and any environmental issues that may need to be addressed. With
respect to delinquent FHA and VA mortgage loans, MSB follows notification and
foreclosure procedures prescribed by FHA and VA.
With respect to purchased mortgage loans and loan participations, MSB receives
monthly reports from the loan servicers with which MSB monitors its purchased
mortgage loan and loan participation portfolio. Pursuant to the servicing
agreements, MSB relies on the loan servicers to contact delinquent borrowers,
collect delinquent amounts and initiate foreclosure proceedings, when necessary,
in accordance with applicable laws and regulations.
Property acquired by MSB as a result of a foreclosure is classified as real
estate owned ("REO") and other repossessed assets. MSB, for financial accounting
purposes, discontinues accruing interest on delinquent loans that are more than
90 days past due, at which time all accrued but uncollected interest is reversed
or reserved against.
14
The following table shows loans, delinquent as to principal or interest, in
MSB's portfolio at December 31, 1998, 1997 and 1996:
Delinquent Loans - 90 Days or More Past Due
-----------------------------------------------------------------------------
At December 31,
-----------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ---------------------
Number Principal Number Principal Number Principal
of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans
-------- --------- ------- --------- ------- ---------
(Dollars in thousands)
Mortgage loans:
One- to four-family residential -
non-guaranteed 5 $ 110 7 $ 166 9 $ 375
-------- --------- ------- --------- ------- ---------
Other loans:
Commercial -- -- 1 31 -- --
Consumer 10 86 6 64 4 38
-------- --------- ------- --------- ------- ---------
Total other loans 10 86 7 95 4 38
-------- --------- ------- --------- ------- ---------
Total loans 15 $ 196 14 $ 261 13 $ 413
======== ========= ======= ========= ======= =========
The following table sets forth information regarding non-accrual loans, REO and
other repossessed assets and total non-performing assets at the dates indicated:
At December 31,
----------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- --------- --------- ---------
(In thousands)
Loans 90 days or more past due:
One- to four-family residential $ 110 $ 166 $ 375 $ 411 $ 438
Commercial -- 31 -- 16 222
Consumer loans 86 64 38 14 --
---------- ---------- --------- --------- ---------
Total loans 90 days or more past due
and non-accrual 196 261 413 441 660
Total REO and other repossessed assets 329 192 488 541 971
---------- ---------- --------- --------- ---------
Total non-performing assets $ 525 $ 453 $ 901 $ 982 $ 1,631
========== ========== ========= ========= =========
Total loans delinquent 90 days or more
to net loans receivable 0.06% 0.08% 0.16% 0.23% 0.42%
Total loans delinquent 90 days or more
to total assets 0.03 0.04 0.06 0.06 0.08
Non-performing assets to total assets 0.09 0.07 0.14 0.14 0.19
During the year ended December 31, 1998, the amount of additional interest
income that would have been recorded on non-accrual loans amounted to $73,000.
This amount was not included in the Bank's interest income for the period.
During this same period, interest income recognized (on a cash basis) on
non-accrual loans totaled $13,000.
Classified Assets.
The office of Thrift Supervision ("OTS") has adopted, by regulation, a
classification system for problem assets of insured institutions. Under this
system, problem assets of insured institutions
15
are classified as "special mention," "substandard," "doubtful" or "loss." An
asset that currently does not warrant classification as "substandard" but that
possesses weaknesses or deficiencies deserving close attention is required to be
designated "special mention." An asset is considered "substandard" if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified as
"doubtful" have all of the weaknesses inherent in those classified
"substandard," with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets classified
as "loss" are those considered "uncollectible" and of such little value that
their continuance as assets without the establishment of a specific loss reserve
is not warranted.
When an insured institution classifies problem assets as either substandard or
doubtful, it is required to establish general valuation allowances in accordance
with generally accepted accounting principles ("GAAP") in an amount deemed
prudent by Management. General valuation allowances represent loss allowances
that have been established to recognize the inherent risk associated with
lending activities, but that, unlike specific valuation allowances, have not
been allocated to particular problem assets. When an insured institution
classifies problem assets as "loss," it is required either to establish a
specific valuation allowance equal to the amount so classified or to charge off
such amount. An institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS, which can, among other things, modify any asset classification or order the
establishment of additional general or specific valuation allowances.
In connection with the filing of its periodic reports with the OTS, MSB
regularly reviews its loans to determine whether any loans require
classification in accordance with applicable regulations. As of December 31,
1998, MSB had total classified assets of $1,449,000. Of these classified assets,
$329,000 were REO, real estate in judgment or other repossessed assets,
$1,066,000 were "substandard" loans, $54,000 is a "doubtful" loan and $84,000
were "loss" loans. All of the "loss" loans were fully reserved against and are
shown net of reserves in the classified assets. The loans classified as "loss"
consist of various consumer loans.
MSB's $1,449,000 of classified assets, representing 0.26% of MSB's total assets
at December 31, 1998, are summarized in the following table:
Substandard Doubtful Total
---------------------- ------------------------ ----------------------
Type of Loan or Asset Number Amount Number Amount Number Amount
- --------------------------------------- --------- --------- ---------- ---------- ---------- ---------
(Dollars in thousands)
One- to four-family 16 $ 639 1 $ 54 17 $ 693
Commercial 5 257 -- -- 5 257
Consumer 13 170 -- -- 13 170
REO (residential) 4 118 -- -- 4 118
REO (commercial or other assets) 2 173 -- -- 2 173
Other repossessed assets (consumer) 9 38 -- -- 9 38
--------- --------- ---------- ---------- ---------- ---------
49 $ 1,395 1 $ 54 50 $ 1,449
========= ========= ========== ========== ========== =========
16
Allowance for Loan Losses.
Losses on loans are charged to the allowance for loan losses. Additions to this
allowance are made by recoveries of loans previously charged off and by a
provision charged to expense. The allowance is maintained at an amount that
Management believes will be adequate to absorb loan losses on existing loans
that may become uncollectible. Although MSB phased out its indirect automobile
lending operations beginning on October 1, 1998, MSB currently intends to
continue to originate other consumer loans that are considered to involve a
higher degree of credit risk than one-to-four-family residential mortgage loans.
MSB's provision for loan losses in future periods may be substantially greater
than the prior periods as a result of an increase in lending and the type of
lending. Furthermore, because future events affecting borrowers and collateral
cannot be predicted with certainty, there can be no assurance that existing
reserves will be adequate or that substantial increases will not be required
should the quality of the loans deteriorate. A significant increase in the
provision for loan losses or significant loan losses for which adequate reserves
have not been established may materially affect results of operations.
The allowance for loan losses is established through a provision for loan losses
based on Management's evaluation of the risk inherent in its loan portfolio. On
a monthly basis, Management reviews all loans that are reported delinquent, and
the existing loan loss reserves for each category of loan. For each category of
loan, a minimum reserve level, expressed as a percentage of that loan type held
in the Bank's portfolio, has been established. This target level takes into
consideration, among other matters, the nature of the underlying collateral,
economic conditions, historical loan loss experience, historical delinquencies
and other factors that warrant recognition in providing for an adequate loan
loss allowance. This evaluation requires material estimates that may be
susceptible to significant change. If the delinquency report indicates that the
amount of classified loans in a given category has increased, Management
increases the general loan loss reserve for that category so that the minimum
reserve level is maintained.
17
The following table sets forth an analysis of the allowance for loan losses:
For the Years Ended December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- --------- --------- ------- -------
(Dollars in thousands)
Allowance at beginning of period $ 1,969 $ 1,855 $ 1,723 $ 1,572 $ 2,504
-------- --------- --------- ------- -------
Provisions for loan losses 585 225 180 169 50
-------- --------- --------- ------- -------
Charge-offs:
Residential real estate (15) (18) (20) -- (200)
Commercial loans (297) -- (13) (83) (813)
Consumer loans (413) (98) (20) -- (3)
-------- --------- --------- ------- -------
Total charge-offs (725) (116) (53) (83) (1,016)
-------- --------- --------- ------- -------
Recoveries:
Residential real estate -- -- -- 36 19
Commercial loans 1 2 4 27 9
Consumer loans 13 3 1 2 6
-------- --------- --------- ------- -------
Total recoveries 14 5 5 65 34
-------- --------- --------- ------- -------
Net charge-offs (711) (111) (48) (18) (982)
-------- --------- --------- ------- -------
Allowance at end of period $ 1,843 $ 1,969 $ 1,855 $ 1,723 $ 1,572
======== ========= ========= ======= =======
Ratio of allowance for loan losses to
total loans at the end of the period 0.56% 0.62% 0.73% 0.88% 0.98%
Ratio of net charge-offs to average
loans outstanding during the period 0.23 0.04 0.02 0.01 0.61
Ratio of allowance to non-accrual loans
at the end of the period 940.31 754.41 449.15 390.70 238.18
The table on page 18 sets forth the allowance for loan losses by loan category
at December 31, for the years indicated.
18
1998 1997 1996
----------------------------- ------------------------------ --------------------------------
% of % of % of
Loans in Loans in Loans in
As a % of Category As a % of Category As a % of Category
Out- to Total Out- to Total Out- to Total
standing Net Out- standing Net Out- standing Net Out-
Loans in standing Loans in standing Loans in standing
Amount Category Loans Amount Category Loans Amount Category Loans
-------- --------- -------- -------- --------- -------- -------- --------- --------
(Dollars in thousands)
Specific allowances:
Mortgage loans:
Residential $ -- --% 68.99% $ -- --% 68.47% $ 3 --% 75.42%
Construction -- -- 3.67 -- -- 3.97 -- -- 6.80
Land -- -- 0.42 -- -- 0.32 -- -- 0.26
Other loans:
Commercial -- -- 14.80 298 1.26 7.50 298 2.12 5.60
Consumer 84 0.15 17.58 -- -- 21.74 -- -- 16.03
-------- -------- -------- --------- -------- -------- --------- --------
84 105.46% 298 102.00% 301 104.11%
======== ======== ========
General allowances:
Mortgage loans:
Residential 626 0.28 68.99% 758 0.35 68.47% 608 0.32 75.42%
Construction 24 0.20 3.67 -- -- 3.97 -- -- 6.80
Land 3 0.22 0.42 -- -- 0.32 -- -- 0.26
Other loans:
Commercial 628 1.30 14.80 422 1.79 7.50 655 4.66 5.60
Consumer 478 0.83 17.58 491 0.72 21.74 291 0.72 16.03
------- -------- -------- -------- ------- --------
Total allowances
for loan losses $ 1,843 105.46% $ 1,969 102.00% $ 1,855 104.11%
======= ======== ======== ======== ======= ========
1995 1994
--------------------------------- -------------------------------
% of % of
Loans in Loans in
As a % of Category As a % of Category
Out- to Total Out- to Total
standing Net Out- standing Net Out-
Loans in standing Loans in standing
Amount Category Loans Amount Category Loans
-------- --------- -------- -------- --------- --------
Specific allowances:
Mortgage loans:
Residential $ 12 0.01% 77.89% $ 10 0.01% 80.02%
Construction -- -- 4.15 -- -- 2.40
Land -- -- 0.15 -- -- 0.12
Other loans:
Commercial 297 2.90 5.28 284 1.78 10.07
Consumer 14 0.05 15.29 -- -- 9.50
-------- --------- --------- -------- --------- ---------
323 102.76% 294 102.11%
General allowances:
Mortgage loans:
Residential 572 0.38 77.89% 451 0.34 80.02%
Construction -- -- 4.15 -- -- 2.40
Land -- -- 0.15 -- -- 0.12
Other loans:
Commercial 665 6.50 5.28 734 4.60 10.07
Consumer 163 0.55 15.29 93 0.62 9.50
-------- --------- -------- ---------
Total allowances
for loan losses $ 1,723 102.76% $ 1,572 102.11%
======== ========= ======== =========
19
INVESTMENT ACTIVITIES
The Board of Directors establishes the investment policy of the Bank. This
policy dictates that MSB hold its investments to maturity unless classified
otherwise at the time of purchase. Purchases of investments and mortgage-backed
securities are based upon consideration of the safety of principal, liquidity
requirements of the Bank and the yield to the Bank. MSB's policy permits
investment in various types of liquid assets permissible under OTS regulations,
which include U.S. Treasury obligations, securities of various federal agencies,
certain certificates of deposit of insured banks and savings institutions,
certain bankers' acceptances and federal funds. MSB also invests in investment
grade corporate debt securities, ARM-backed securities and fixed rate
mortgage-backed securities with maturities not greater than fifteen years.
The following tables set forth certain information regarding the carrying and
market values of MSB's investment securities and mortgage-backed securities
portfolios at the dates indicated:
Investment Securities
-----------------------------------------------------------------------------------------------------
At December 31,
-----------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- ------------------------------ -------------------------------
Estimated Percent Estimated Percent Estimated Percent
Carrying Fair of Carrying Fair of Carrying Fair of
Value Value Portfolio Value Value Portfolio Value Value Portfolio
--------- --------- --------- -------- --------- --------- -------- --------- ---------
(Dollars in thousands)
Available-for-sale $ 166 $ 166 1.18% $ 199 $ 199 100.00% $ 199 $ 199 100.00%
Held-to-maturity 13,888 13,888 98.82 -- -- -- -- -- --
--------- --------- --------- -------- --------- --------- -------- --------- ---------
Total investment
securities $ 14,054 $ 14,054 100.00% $ 199 $ 199 100.00% $ 199 $ 199 100.00%
========= ========= ========= ======== ========= ========= ======== ========= =========
Mortgage-Backed Securities
--------------------------------------------------------------------------------------------------
At December 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ------------------------------ -------------------------------
Estimated Percent Estimated Percent Estimated Percent
Carrying Fair of Carrying Fair of Carrying Fair of
Value Value Portfolio Value Value Portfolio Value Value Portfolio
--------- --------- --------- -------- --------- --------- -------- --------- ---------
(Dollars in thousands)
Available-for-sale $ 52,275 $ 52,275 28.83% $ 71,955 $ 71,955 24.53% $ 84,381 $ 84,381 22.05%
Held-to-maturity 129,064 129,027 71.17 221,391 218,359 75.47 298,275 292,135 77.95
--------- -------- --------- --------- --------- --------- --------- --------- ---------
Total mortgage-
backed securities $ 181,339 $181,302 100.00% $ 293,346 $ 290,314 100.00% $ 382,656 $ 376,516 100.00%
========= ======== ========= ========= ========= ========= ========= ========= =========
20
The following table sets forth certain information regarding weighted-average
yields and contractual maturities of MSB's mortgage-backed securities at
December 31, 1998:
Mortgage-Backed Securities
-----------------------------------------------------------------------------------------------
Less Than One to Five to
One Year Five Years Ten Years Over Ten Years Total
----------------- ----------------- ----------------- ------------------ -----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ------- -------- ------- ------- ------- -------- -------- -------- -------
(Dollars in thousands)
Available-for-
sale (1) (2) $ 11,043 6.08% $ 11,551 5.38% $11,655 5.69% $ 17,926 6.02% $ 52,175 5.82%
Held- to-maturity 9,767 5.94 115,270 5.40 4,027 5.99 -- -- 129,064 5.46
--------- -------- ------- -------- ---------
Total mortgage-
backed securities $ 20,810 6.01% $126,821 5.40% $15,682 5.77% $ 17,926 6.02% $ 181,239 5.56%
========= ======== ======= ======== =========
(1) Balances and yield calculations are exclusive of net unrealized gain (loss)
on available-for-sale securities.
(2) Includes $10.035 million of adjustable rate mortgage-backed securities in
the "over ten years" maturity category.
Investment Securities.
At December 31, 1998, investment securities (exclusive of FHLMC and FNMA
mortgage-backed securities) consist of one collateralized mortgage obligation
("CMO") residual classified as available-for-sale with a carrying value and an
estimated fair value of $166,000 and four commercial paper securities (all of
which matured by February 1999) which were classified as held-to-maturity with a
carrying value and an estimated fair value of $13.888 million.
CMO residuals are claims on any excess cash flows from a CMO issue, after the
payments due to the holders of the other classes have been made and trust
administrative expenses have been met. The economic value of a residual is a
function of the present value of the anticipated excess cash flows. These cash
flows are highly sensitive to prepayments, indenture call provisions and
existing levels of market interest rates.
During 1997 MSB began to enter into purchases of securities under agreements to
resell substantially identical securities. During 1998 the maximum amount
outstanding at any month end was $8,502,000. During 1997 there were no
securities purchased under agreements to resell outstanding at any month end.
The amounts advanced under these agreements represent short-term loans.
Mortgage-Backed Securities.
MSB's mortgage-backed securities are insured or guaranteed by FHLMC or FNMA.
Mortgage-backed securities generally increase the quality of MSB's assets by
virtue of the guarantees that back them, are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations
of the Bank. As a result of the repayments of the underlying loans, the actual
maturities of mortgage-backed securities are often substantially less than the
scheduled maturities.
21
SOURCES OF FUNDS
General.
Deposits are the primary source of MSB's funds for use in lending and for other
general business purposes. Other funding sources include borrowings from
securities sold under agreements to repurchase ("Repurchase Agreements") and
advances from the FHLB of Indianapolis.
MSB also obtains funds from normal loan and mortgage-backed securities
amortization and prepayments and from operations. Contractual loan payments are
a relatively stable source of funds, while deposit inflows and outflows and loan
and mortgage-backed securities prepayments are significantly influenced by
general market interest rates, competition and economic conditions. Borrowings
may be used on a short-term basis to compensate for seasonal or other reductions
in normal sources of funds or for deposit inflows at less than projected levels.
Borrowings may also be used on a longer-term basis to support expanded lending
or investment activities.
Deposits.
MSB offers a variety of deposit accounts having a range of interest rates and
terms. MSB's deposits consist of savings, checking, money market and certificate
accounts. The flow of deposits is influenced significantly by general economic
conditions, changes in money market and prevailing interest rates and
competition. MSB's deposits are obtained primarily from the areas in which its
retail offices are located. Currently, MSB does not use brokers to obtain
deposits, relying primarily on marketing, customer service and long-standing
customer relationships to attract and retain deposits. The following tables
contain information relating to deposits at December 31, 1998:
22
Weighted Percentage
Average Minimum of Total
Rate Term Checking and Savings Amount Balance Deposits
- ------------- --------------- ------------------------------------ ----------- ------------ ----------
(In thousands)
N/A% N/A Non-interest checking $ -- $ 10,527 2.50%
1.74 N/A NOW accounts -- 36,493 8.67
2.25 N/A Passbook and statement savings 100 39,787 9.45
3.85 N/A Money market accounts 1,000 69,708 16.56
Certificates of Deposit
4.47 91 days Fixed term, fixed rate 500 1,568 0.37
4.94 4-6 months Fixed term, fixed rate 500 16,743 3.98
5.15 7-12 months Fixed term, fixed rate 500 43,344 10.30
5.43 13-24 months Fixed term, fixed rate 500 53,858 12.80
5.68 25-36 months Fixed term, fixed rate 500 46,831 11.13
5.83 37-60 months Fixed term, fixed rate 500 14,974 3.56
7.37 61-120 months Fixed term, fixed rate 500 195 0.05
4.45 91 days IRA accounts fixed rate 500 244 0.06
4.87 4-6 months IRA accounts fixed rate 500 547 0.13
5.20 7-12 months IRA accounts fixed rate 500 1,024 0.24
5.43 13-24 months IRA accounts fixed rate 500 8,286 1.97
5.65 25-36 months IRA accounts fixed rate 500 3,597 0.85
6.01 37-60 months IRA accounts fixed rate 500 17,534 4.17
4.47 13-18 months IRA accounts variable rate 50 3,313 0.79
2.91 7-12 months Fixed term, variable rate, Pen. free 500 31,933 7.59
2.87 7-12 months Fixed term, variable rate, IRA Pen. free 500 536 0.13
5.11 1-12 months Jumbo certificates 100,000 10,327 2.45
5.13 1-12 months Mini-jumbo 50,000 9,449 2.25
---------- ------
Total deposits $ 420,818 100.00%
========== ======
The following table sets forth the composition of MSB's deposits by type as of
the dates indicated:
At December 31,
-------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- --------------------------------- ----------------------
Percent Increase Percent Increase Percent
Amount of Total (Decrease) Amount of Total (Decrease) Amount of Total
-------- -------- ---------- -------- --------- ---------- ---------- ---------
(Dollars in thousands)
Non-interest-bearing $ 10,527 2.50% $ 717 $ 9,810 2.41% $ 888 $ 8,922 2.17%
NOW accounts 36,493 8.67 6,523 29,970 7.36 4,006 25,964 6.33
Passbook and statement
savings 39,787 9.45 2,425 37,362 9.17 (2,896) 40,258 9.81
Money market accounts 69,708 16.56 5,979 63,729 15.64 6,053 57,676 14.06
Certificates which mature
in the years ending:
December 31, 1997 -- -- -- -- -- (192,680) 192,680 46.96
December 31, 1998 -- -- (183,051) 183,051 44.93 133,145 49,906 12.16
December 31, 1999 194,383 46.21 141,060 53,323 13.09 35,324 17,999 4.39
December 31, 2000 45,866 10.90 27,303 18,563 4.56 9,098 9,465 2.31
December 31, 2001 13,891 3.30 6,715 7,176 1.76 (261) 7,437 1.81
December 31, 2002 9,233 2.19 4,829 4,404 1.08 4,404 -- --
December 31, 2003 930 0.22 930 -- -- -- -- --
-------- ------ -------- -------- ------ -------- --------- ------
Total deposits $420,818 100.00% $ 13,430 $407,388 100.00% $(2,919) $ 410,307 100.00%
======== ====== ======== ======== ====== ======== ========= ======
23
The following table indicates the amounts of MSB's jumbo certificates of deposit
by time remaining until maturity, as of December 31, 1998:
Jumbo Certificates
Maturity Period of Deposit
------------------------- ------------------
(In thousands)
Three months or less $ 4,213
Three through six months 3,280
Six through twelve months 2,834
------------------
Total $ 10,327
==================
During 1999, $194.383 million of deposits at an average rate of 4.93% are
expected to mature as follows:
Period Amount Coupon
------------------------------------- -------------- ---------
(In thousands)
Quarter ending March 31, 1999 $ 57,717 4.97%
Quarter ending June 30, 1999 62,291 4.93
Quarter ending September 30, 1999 42,662 4.97
Quarter ending December 31, 1999 31,713 4.79
--------------
$ 194,383 4.93%
==============
Borrowings.
MSB enters into Repurchase Agreements with approved securities dealers. In a
typical transaction, MSB sells a specific issue of mortgage-backed securities
owned by the Bank to a securities dealer as agent for the Bank. The securities
dealer holds these securities in a fiduciary capacity for the account of the
Bank. At the time the sale is made, MSB enters into a contract with the
securities dealer to repurchase the same securities at the same price for
redelivery at a later date. Irrespective of the coupon interest rate of the
securities, MSB pays interest at a negotiated rate related to market conditions
during the time it has "sold" the securities. At the repurchase date, the
securities dealer redelivers the identical mortgage-backed securities to MSB and
MSB repays the securities dealer the amount of the repurchase price plus the
interest. During the period of the Repurchase Agreement, MSB continues to earn
the coupon rate on the securities securing the borrowing. A Repurchase Agreement
is typically short-term in nature and is in essence a borrowing transaction.
GAAP treats these Repurchase Agreements as borrowings. Such agreements provide a
source of funds for MSB's lending and investment activities. MSB attempts to
minimize any risk associated with the use of Repurchase Agreements by using only
reputable, well-capitalized securities dealers approved by MSB's Board of
Directors and by minimizing any over-collateralization of the transaction.
Management reviews the financial condition of counterparties to such
transactions quarterly. Management expects to use Repurchase Agreements as a
source of funds when it is necessary to supplement the resources provided by
deposits and principal and interest payments on loans, its primary sources of
funds.
24
The following table presents maturity information regarding Repurchase
Agreements of MSB at December 31, 1998:
At December 31, 1998
------------------------------------------------------------------------------------
30 Greater
Days or 31 to 90 91 to Than One
Overnight Less Days (1) 365 Days Year Total
------------ --------- ------------ ----------- ------------ -----------
(In thousands)
Repurchase Agreements $ -- $ -- $ 20,000 $ -- $ 25,000 $ 45,000
Weighted-average interest rate --% --% 5.69% --% 5.87% 5.79%
(1) The 31 to 90 Days amount includes a $20.000 million Repurchase Agreement
with a stated maturity of June 12, 2002. This Repurchase Agreement has a
fixed interest rate of 5.685% and included an initial call option for the
other party on June 12, 1998 followed by quarterly call options thereafter.
The following table presents information regarding amounts at risk (excess of
the market value of the collateral over the face value of the borrowing,
inclusive of interest) by counterparty, and the weighted-average maturity of
each counterparty position. A counterparty is the securities dealer involved in
the transaction.
At December 31, 1998
-------------------------------------------------------------------------------------------
Market
Borrowing Value of Weighted
Amount Collateral Amount % of Average
(Inc. Interest) (Inc. Interest) At Risk Capital Maturity
---------------- -------------- ----------- --------- ------------
(In thousands)
Lehman Brothers $ 15,077 $ 15,901 $ 824 2.28%743 Days
Merrill Lynch 30,093 31,541 1,448 4.01 225 Days
---------------- -------------- ----------- --------
Total $ 45,170 $ 47,442 $ 2,272 6.29%397 Days
================ ============== =========== ========
One of the functions of the FHLB system is to serve as a reserve source of
credit for its member savings institutions. As a member of the FHLB system, MSB
is required to own capital stock in the FHLB of Indianapolis. MSB is permitted
to apply for FHLB advances using its stock, mortgage-backed securities and
certain of its home mortgages as collateral, provided it meets certain
creditworthiness standards set by the FHLB. The FHLB has a variety of different
advance programs, each with different interest rates, provisions, maximum
amounts and maturities. At December 31, 1998, MSB had outstanding advances from
the FHLB totaling $53.292 million and unamortized advance commitment fees of
$6,000.
25
The following table presents certain information regarding borrowings of MSB at
the end of and during the periods indicated:
At December 31,
----------------------------------------------
1998 1997 1996
------------ ------------ -----------
(In thousands)
Balance outstanding of:
Repurchase Agreements $ 45,000 $ 85,000 $ 127,000
FHLB advances 53,286 100,561 74,923
Other borrowings -- -- 1,351
Approximate weighted-average rate paid on:
Repurchase Agreements 5.79% 6.17% 5.93%
FHLB advances 6.32 7.06 7.41
Other borrowings -- -- 9.98
During the Years Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------- ------------
(In thousands)
Maximum amount of borrowings outstanding at any month end:
Repurchase Agreements $ 85,000 $ 140,000 $ 169,965
FHLB advances 100,567 109,178 74,923
Other borrowings -- 1,351 1,699
Approximate average month-end borrowings with respect to:
Repurchase Agreements 62,917 117,800 152,002
FHLB advances 80,055 84,020 70,321
Other borrowings -- 225 1,670
Approximate weighted-average rate paid on:
Repurchase Agreements 6.09% 6.07% 5.71%
FHLB advances 6.99 7.36 7.53
Other borrowings -- 9.97 10.01
SUBSIDIARIES
MSB has two wholly owned subsidiaries, MSBc and MSBi. MSB's two subsidiaries
have contracted with unaffiliated third parties to provide various investment
services including the sale of mutual fund and annuity products. MSBi also sells
life insurance, long-term care insurance and group health and disability
insurance. MSBc also owns stock in MIMLIC Life Insurance Company (a mortgage
life reinsurance company).
PERSONNEL
As of December 31, 1998, MSB had approximately 207 full-time and 53 part-time
employees. The employees are not represented by a collective bargaining agent,
and MSB considers its relationship with its employees to be excellent.
26
REGULATION AND SUPERVISION
GENERAL
MSB is chartered under federal law by the OTS. It is a member of the FHLB
System, and its deposit accounts are insured up to legal limits by the Federal
Deposit Insurance Corporation ("FDIC") under the Savings Association Insurance
Fund ("SAIF"). The OTS is charged with overseeing and regulating MSB's
activities and monitoring its financial condition. This regulatory framework
sets parameters for MSB's activities and operations and grants the OTS extensive
discretion with regard to its supervisory and enforcement powers and examination
policies. MSB files periodic reports with the OTS concerning its activities and
financial condition, must obtain OTS approval prior to entering into certain
transactions or initiating new activities, and is subject to periodic
examination by the OTS to evaluate MSB's compliance with various regulatory
requirements.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities.
The activities of savings institutions are governed by the Home Owners' Loan
Act, as amended (the "HOLA"), and, in certain respects, the Federal Deposit
Insurance Act (the "FDI Act"). The HOLA and the FDI Act were amended by the
Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA")
and the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"). FIRREA was enacted for the purpose of resolving problem savings
institutions, establishing a new thrift insurance fund, reorganizing the
regulatory structure applicable to savings institutions, and imposing bank-like
standards on savings institutions. FDICIA, among other things, requires that
federal banking regulators intervene promptly when a depository institution
experiences financial difficulties, mandates the establishment of a risk-based
deposit insurance assessment system and requires imposition of numerous
additional safety and soundness operational standards and restrictions. FIRREA
and FDICIA both contain provisions affecting numerous aspects of the operations
and regulations of federally-insured savings institutions and empowers the OTS
and the FDIC, among other agencies, to promulgate regulations implementing their
provisions.
Branching.
A federally-chartered savings institution can establish branches in any state or
states in the United States and its territories, subject to a few exceptions.
The exercise by the OTS of its authority to permit interstate branching by
federal savings institutions is preemptive of any state law purporting to
address the subject of branching by a federal savings institution.
Loans to One Borrower.
Under HOLA, savings institutions are generally subject to the national bank
limits regarding loans to one borrower. Generally, savings institutions may not
make a loan or extend credit to a single or related group of borrowers in excess
of 15% of the institution's unimpaired capital and surplus, where the borrowing
is not fully secured by readily-marketable collateral. An additional amount may
be loaned, equal to 10% of the institution's unimpaired capital and surplus, if
such additional borrowing is secured by readily-marketable collateral at least
equal to the amount of such
27
additional funds. At December 31, 1998, MSB had no outstanding loans or
commitments that exceeded the loans to one borrower limit at the time made or
committed.
Brokered Deposits.
Well-capitalized savings institutions that are not troubled are not subject to
brokered deposit limitations. Adequately-capitalized institutions are able to
accept, renew or roll over brokered deposits but only (i) with a waiver from the
FDIC and (ii) subject to the limitation that they do not pay an effective yield
on any such deposit that exceeds by more than (a) 75 basis points the effective
yield paid on deposits of comparable size and maturity in such institution's
normal market area for deposits accepted in its normal market area or (b) 120
basis points of the current yield on similar maturity U.S. Treasury obligations
or, in the case of any deposit at least half of which is uninsured, 130% of such
Treasury yield. Undercapitalized institutions are not permitted to accept
brokered deposits and may not solicit deposits by offering an effective yield
that exceeds by more than 75 basis points the prevailing effective yields on
insured deposits of comparable maturity in the institution's normal market area
or in the market area in which such deposits are being solicited. MSB is not
presently soliciting brokered deposits.
Enforcement.
Under the FDI Act, the OTS has primary enforcement responsibility over savings
institutions and has the authority to bring enforcement action against all
"institution-related parties," including stockholders, and any attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Civil
penalties cover a wide range of violations and actions. Criminal penalties for
most financial institution crimes include fines and imprisonment. In addition,
regulators have substantial discretion to impose enforcement action on an
institution that fails to comply with its regulatory requirements, particularly
with respect to amounts of capital. Possible enforcement action ranges from
requiring the preparation of a capital plan or imposition of a capital directive
to receivership, conservatorship or the termination of deposit insurance. Under
the FDI Act, the FDIC has the authority to recommend to the Director of the OTS
enforcement action be taken with respect to a particular savings institution. If
action is not taken by the Director, the FDIC has authority to take enforcement
action under certain circumstances.
Assessments.
Savings institutions are required by OTS regulation to pay assessments to the
OTS to fund the operations of the OTS. The general assessment paid on a
semi-annual basis is computed based upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the institution's latest
quarterly thrift financial report.
Federal Home Loan Bank System.
MSB is a member of the FHLB System, which consists of 12 regional FHLB's. The
FHLB provides a central credit facility primarily for member institutions. MSB,
as a member of the FHLB-Indianapolis, is required to acquire and hold shares of
capital stock in that FHLB in an amount at least equal to 1% of the aggregate
principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its advances (borrowings)
from the FHLB-Indianapolis, whichever is greater. MSB is in compliance with this
requirement, with an investment in FHLB-Indianapolis stock at December 31, 1998,
of $7,023,000. FHLB
28
advances must be secured by specified types of collateral and may be obtained
only for the purpose of purchasing or funding new residential housing finance
assets.
Qualified Thrift Lender Test.
In September 1996, the Economic Growth and Regulatory Paperwork Reduction Act of
1996 became law (the "Economic Growth Act of 1996"). In the past, savings
institutions were required to satisfy a qualified thrift lender test ("QTL"
test) by maintaining 65% of their portfolio assets (defined as all assets minus
intangible assets, property used by the institution in conducting its business
and liquid assets equal to 20% of total assets) in certain "qualified thrift
investments" (primarily residential mortgages and related investments, including
certain mortgage-backed securities) on a monthly basis in nine out of every
twelve months.
The Economic Growth Act of 1996 liberalized the QTL test for savings
institutions by permitting them to satisfy a similar-but-different 60% asset
test under the Internal Revenue Code. Alternatively, savings institutions may
meet the QTL test by satisfying a more liberal 65% asset test that allows an
institution to include small business, credit card and education loans as
qualified investments for purposes of the test. Furthermore, consumer loans now
count as qualified thrift investments up to 20% of portfolio assets. On November
27, 1996, OTS issued an interim final rule that implements provisions of the
Economic Growth Act of 1996, including the amended QTL test.
Before the Economic Growth Act of 1996, federal savings institutions were able
to lend up to 10% of their assets in commercial business loans (i.e., secured or
unsecured loans for commercial, corporate, business, or agricultural purposes)
and, subject to OTS approval for a higher amount, up to 400% of their capital in
commercial real estate loans. In addition, federal savings institutions were
permitted to originate consumer loans (i.e., loans for personal, family or
household purposes) in an amount not to exceed 35% of their assets.
The Economic Growth Act of 1996 amended the commercial-lending-asset limit by
increasing the ceiling from 10% to 20%, but provides that amounts in excess of
10% may be used only for small business loans. Moreover, the new law exempts
credit card and educational loans from any percentage of asset limitations
applicable to consumer loans. The interim final rule issued by the OTS on
November 27, 1996, defines a "small business loan" as one which meets the Small
Business Administration size eligibility standards. This definition also applies
for purposes of the new QTL test.
OTS Capital Requirements.
The OTS capital regulations require savings institutions to meet three capital
standards: a 1.5% tangible capital standard, a 4% leverage ratio (or core
capital ratio) and an 8% risk-based capital standard.
Tangible capital is defined as common stockholders' equity (including retained
earnings), non-cumulative perpetual preferred stock and related earnings and
minority interests in equity accounts of fully consolidated subsidiaries, less
intangible assets (other than mortgage servicing rights) and certain equity and
debt investments in non-qualifying subsidiaries (as hereinafter defined).
29
Core capital is defined as common stockholders' equity (including retained
earnings), certain non-cumulative perpetual preferred stock and related surplus,
minority interests in equity accounts of consolidated subsidiaries, certain
amounts of goodwill resulting from prior regulatory accounting practices, less
intangible assets (other than mortgage servicing rights) and certain equity and
debt investments in non-qualifying subsidiaries.
The OTS capital regulation requires that in meeting the leverage ratio, tangible
and risk-based capital standards, savings institutions must deduct investments
in and loans to subsidiaries engaged in activities not permissible for a
national bank (a "non-qualifying subsidiary"). At December 31, 1998, MSB did not
own a non-qualifying subsidiary.
In April 1991, the OTS issued a proposal to amend its regulatory capital
regulation to establish a 3% leverage ratio (defined as the ratio of core
capital to adjusted total assets) for institutions with the strongest regulatory
rating for its financial and managerial condition. For all other institutions,
the minimum core capital leverage ratio would be 3% plus at least an additional
100 to 200 basis points. In determining the amount of additional capital under
the proposal, the OTS would assess both the quality of risk management systems
and the level of overall risk in each individual institution through the
supervisory process on a case-by-case basis. Institutions that failed the new
leverage ratio would be required to file with the OTS a capital plan that
details the steps they would take to reach compliance. If enacted in final form
as proposed, Management does not believe that the proposed regulation would have
a material effect on MSB.
Although the OTS has not adopted this regulation in final form, generally a
savings institution that has a leverage capital ratio of less than 4% will be
deemed to be "undercapitalized" under the OTS prompt corrective action
regulations and consequently can be subject to various limitations on
activities.
The OTS' risk-based capital standard requires that savings institutions maintain
a ratio of total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of 8%. In calculating total capital, a savings
institution must deduct reciprocal holdings of depository institution capital
instruments, all equity investments and that portion of land loans and
non-residential construction loans in excess of an 80% loan-to-value ratio and
its interest rate risk component (as discussed below), in addition to the assets
that must be deducted in calculating core capital. In determining the amount of
risk-weighted assets, all assets, including certain off-balance sheet assets,
are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital
regulation based on the risks the OTS believes are inherent in the type of
asset.
The components of core capital are equivalent to those discussed above under the
3% leverage standard. The components of supplementary capital include cumulative
preferred stock, long-term perpetual preferred stock, certain perpetual
subordinated debt, mandatory convertible subordinated debt, certain
intermediate-term preferred stock, certain mandatorily redeemable preferred
stock allowance for loan and lease losses (up to 1.25% of risk-weighted assets)
and certain unrealized gains on equity securities. Allowance for loan and lease
losses includable in supplementary capital is limited to a maximum of 1.25%.
Overall, the amount of capital counted
30
toward supplementary capital cannot exceed 100% of core capital. At December 31,
1998, MSB met each of its capital requirements.
FDICIA required that the OTS (and other federal banking agencies) revise
risk-based capital standards, with appropriate transition rules, to ensure that
they take account of interest rate risk, concentration of risk and the risks of
non-traditional activities.
Interest Rate Risk Regulations.
On December 1, 1998, the OTS adopted comprehensive guidance, in the form of
Thrift Bulletin 13a ("TB 13a"), covering interest rate risk, investment
securities and use of financial derivatives. TB 13a replaces seven prior OTS
thrift bulletins covering these and related topics. The OTS also updated its
regulations with a new rule (effective January 1, 1999) on forward commitments,
futures transactions and financial options transactions. The new rule, which is
designed to work with TB 13a, establishes general requirements applicable to all
derivative instruments, sets forth responsibilities of the board of directors
and management with respect to financial derivatives and makes clear that
reducing risk exposure should be the primary reason for entering into a
derivatives transaction. TB 13a provides guidelines for evaluating an
institution's risk management, identifies a set of "sound practices" for
consideration of management and describes the qualitative and quantitative
guidelines the OTS will use in assessing an institution's current exposure to
interest rate changes and its ability to manage that exposure effectively. The
OTS will use the results of its net portfolio value ("NPV") model to measure an
institution's current exposure. Under TB 13a, an institution's board of
directors should establish interest rate risk limits in terms of its capital
position (its economic capital-to-assets ratio). Investment securities and
derivatives, especially those with the potential to alter significantly an
institution's risk profile, should be evaluated on the basis of their impact on
the institution's economic capital. Institutions with greater capacity to absorb
potential losses will have greater latitude in using derivatives and other
complex financial instruments. MSB's Board of Directors has established interest
rate risk limits under TB 13a. As of December 31, 1998 MSB is in compliance with
these Board established limits.
Liquidity.
MSB is required to maintain an average daily balance of liquid assets (e.g.,
cash, accrued interest on liquid assets, certain time deposits, savings
accounts, bankers' acceptances, specified United States Government, state or
federal agency obligations, shares of certain mutual funds and certain corporate
debt securities and commercial paper) equal to not less than a specified
percentage of the average daily balance of its net withdrawable deposit accounts
plus short-term borrowings. This liquidity requirement may be changed from time
to time by the OTS. The OTS may initiate enforcement actions for failure to meet
these liquidity requirements. At December 31, 1998, MSB complied with the
regulatory liquidity requirements.
Insurance of Deposit Accounts.
The Deposit Insurance Funds Act of 1996 ("DIFA") mandated that the FDIC impose a
special assessment on the SAIF-assessable deposits of each insured depository
institution at a rate applicable to all such institutions that the FDIC
determined would cause the SAIF to achieve its designated reserve ratio of 1.25%
as of October 1, 1996. In response to the recapitalization of the SAIF, the FDIC
announced on December 11, 1996 that deposit insurance rates for most
31
savings institutions insured under the SAIF would be lowered to zero effective
January 1, 1997, thereby equalizing deposit premiums for savings institutions
and banks. DIFA allowed the FDIC to exempt any insured institution that it
determined to be weak from paying the special assessment if the FDIC determined
that the exemption would reduce the risk to the SAIF. On October 21, 1996, MSB
applied to the FDIC for an exemption from the special assessment mandated by the
DIFA. The FDIC granted the exemption. Therefore, MSB did not pay the special
assessment, but instead pays semiannual assessments to the SAIF initially
according to the rate schedule that was in effect for SAIF assessments on June
30, 1995 for a period through the end of 1999. MSB's deposit insurance rate was
31.82 basis points for the three months ended December 31, 1998. MSB anticipates
a deposit insurance rate of 32.10 basis points for the first quarter of 1999.
FDICIA required the FDIC to establish a risk-based assessment system for insured
depository institutions that takes into account the risks attributable to
different categories and concentrations of assets and liabilities. Under the
rule, the FDIC assigns an institution to one of three capital categories
consisting of (i) well-capitalized, (ii) adequately-capitalized or (iii)
undercapitalized, and one of three supervisory subcategories. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by the institution's primary federal regulator
and information which the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
category to which it is assigned.
Limitation on Capital Distributions.
The OTS regulations impose limitations upon all capital distributions by savings
institutions, such as cash dividends, payments to repurchase or otherwise
acquire its shares, payments to shareholders of another institution in a
cash-out merger and other distributions charged against capital. The regulations
establish three tiers of institutions. An institution that exceeds all fully
phased-in capital requirements before and after the proposed capital
distribution ("Tier 1 Institution") and has not been advised by the OTS that it
is in need of more than normal supervision, could, after prior notice but
without the approval of the OTS, make capital distributions during a calendar
year up to the higher of (a) 100% of its net income to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (b) 75% of its net reserve over the most
recent four-quarter period. Any additional capital distributions would require
prior regulatory approval. In computing the institution's permissible percentage
of capital distributions, previous distributions made during the prior four
quarter period must be included. In the event the institution's capital fell
below its fully phased-in requirement or the OTS notified it that it was in need
of more than normal supervision, the ability to make capital distributions could
be restricted. In addition, the OTS could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice. Moreover, under the OTS prompt corrective action
regulations, the institution would be prohibited from making any capital
distribution if, after the distribution, the institution would have, (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio
of less than 4%, or (iii) a leverage ratio of less than 4% or has a leverage
ratio that is less than 3% if the
32
institution is rated composite 1 under the CAMELS rating system in the most
recent examination of the institution and is not experiencing or anticipating
significant growth.
Effective April 1, 1999, the OTS revised its capital distribution regulation.
Under the revised regulation, institutions that are not subsidiaries of a
savings and loan holding company can qualify for a capital distribution without
a notice or application to OTS, if they meet certain conditions, including
retaining a well-capitalized designation following the distribution and having
CAMELS and compliance ratings of 1 or 2. Other institutions either have to
notify OTS or obtain the OTS's approval, depending on the condition of the
institution and the amount and nature of the capital distribution, but such
institutions may now file a schedule of proposed capital distributions for a
year at a time, rather than filing separate notices.
Community Reinvestment.
Pursuant to OTS regulations, an institution's performance in meeting the credit
needs of its entire community, including low- and moderate-income areas, as
required by the Community Reinvestment Act (the "CRA"), will generally be
evaluated under three tests: the "lending test," the "investment test," and the
"service test." The lending test analyzes lending performance using five
criteria: (i) the number and amount of loans in the institution's assessment
area, (ii) the geographic distribution of lending, including the proportion of
lending in the assessment area, the dispersion of lending in the assessment
area, and the number and amount of loans in low-, moderate-, middle-, and
upper-income areas in the assessment area, (iii) borrower characteristics, such
as the income level of individual borrowers and the size of businesses or farms,
(iv) the number and amount, as well as the complexity and innovativeness of an
institution's community development lending and (v) the use of innovative or
flexible lending practices in a safe and sound manner to address the credit
needs of low- or moderate-income individuals or areas. The investment test
analyzes investment performance using four criteria: (i) the dollar amount of
qualified investments, (ii) the innovativeness or complexity of qualified
investments, (iii) the responsiveness of qualified investments to credit and
community development needs, and (iv) the degree to which the qualified
investments made by the institution are not routinely provided by private
investors. The service test analyzes service performance using six criteria: (i)
the institution's branch distribution among low-, moderate-, middle-, and
upper-income areas, (ii) its record of opening and closing branches,
particularly in low- and moderate-income areas, (iii) the availability and
effectiveness of alternative systems for delivering retail banking services,
(iv) the range of services provided in low-, moderate-, middle- and upper-income
areas and extent to which those services are tailored to meet the needs of those
areas, (v) the extent to which the institution provides community development
services, and (vi) the innovativeness and responsiveness of community
development services provided.
Transactions with Related Parties.
MSB's authority to engage in transactions with related parties or "affiliates,"
(i.e., any company that controls or is under common control with an institution)
including its non-savings institution subsidiaries or to make loans to certain
insiders, is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA").
Subsidiaries of a savings institution are generally exempted from the definition
of "affiliate." Section 23A limits the aggregate amount of transactions with any
individual affiliate to 10% of the capital and surplus of the savings
institution and also limits the aggregate amount of transactions with all
affiliates to 20% of the savings institution's capital and
33
surplus. Certain transactions with affiliates are required to be secured by
collateral in an amount and of a type described in the FRA and the purchase of
low-quality assets from affiliates is generally prohibited. Section 23B provides
that certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In the absence of comparable transactions, such transactions may only
occur under terms and circumstances, including credit standards, that in good
faith would be offered to or would apply to non-affiliated companies.
Notwithstanding Sections 23A and 23B, FIRREA prohibits any savings institution
from lending to any affiliate that is engaged in activities that are not
permissible for bank holding companies under Section 4(c) of The Bank Holding
Company Act. Further, no savings institution may purchase the securities of any
affiliate other than a subsidiary.
MSB's authority to extend credit to executive officers, directors and 10%
shareholders, as well as such entities such persons control are currently
governed by Sections 22(g) and 22(h) of the FRA and Regulation O promulgated by
the Federal Reserve Board. Among other things, these regulations require such
loans to be made on terms substantially similar to those offered to unaffiliated
individuals, place limits on the amount of loans MSB may make to such persons
based, in part, on MSB's capital position, and require certain approval
procedures to be followed. OTS regulations, with the exception of minor
variations, apply Regulation O to savings institutions.
Prompt Corrective Regulatory Action.
FDICIA establishes a system of prompt corrective action to resolve the problems
of undercapitalized institutions. Under this system, the OTS is required to take
certain supervisory actions against undercapitalized institutions, the severity
of which depends upon the institution's degree of undercapitalization.
Generally, subject to a narrow exception, FDICIA requires the OTS to appoint a
receiver or conservator for an institution that is critically undercapitalized.
FDICIA authorizes the OTS to specify the ratio of tangible equity to assets at
which an institution becomes critically undercapitalized and requires that ratio
be no less than 2% of assets.
Under OTS regulations, a savings institution is considered to be
undercapitalized if it has risk-based capital of less than 8% or has a Tier 1
risk-based capital ratio that is less than 4% or has a leverage ratio that is
less than 4% or has a leverage ratio less than 3% if the savings institution is
rated composite 1 under the CAMELS rating system in the most recent examination
of the institution. A savings institution that has risk-based capital less than
6% or a Tier 1 risk-based capital ratio that is less than 3% or a leverage ratio
that is less than 3% would be considered to be "significantly undercapitalized."
A savings institution that has a tangible equity to total assets ratio equal to
or less than 2% would be deemed to be "critically undercapitalized." Generally,
a capital restoration plan must be filed with the OTS within 45 days of the date
an institution receives notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. In addition, numerous mandatory
supervisory actions become immediately applicable to the institution, including,
but not limited to, restrictions on growth, investment activities, capital
distributions, and affiliate transactions. In addition, the OTS could issue a
34
capital directive to the savings institution that includes additional
discretionary restrictions on the savings institution.
Real Estate Lending Standards.
The OTS and the other federal banking agencies have uniform regulations
prescribing real estate lending standards. The OTS regulation requires each
savings institution to establish and maintain written internal real estate
lending standards consistent with safe and sound banking practices and
appropriate to the size of the institution and the nature and scope of its real
estate lending activities. The policy must also be consistent with applicable
OTS guidelines, which include maximum loan-to-value ratios for certain types of
real estate loans. Owner-occupied one-to four-family mortgage loans and home
equity loans do not have maximum loan-to-value ratio limits, but those with a
loan-to-value ratio at origination of 90% or greater are to be secured by
private mortgage insurance or readily marketable collateral. Institutions are
also permitted to make a limited amount of loans that do not conform to the
proposed loan-to-value limitations so long as such exceptions are appropriately
reviewed and justified. The guidelines also list a number of lending situations
in which exceptions to the loan-to-value standard are justified.
Standards for Safety and Soundness.
As required by FDICIA and subsequently amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, the federal banking
regulators adopted interagency guidelines establishing standards for safety and
soundness for depository institutions on matters such as internal controls, loan
documentation, credit underwriting, interest rate risk exposure, asset growth,
compensation and other benefits and asset quality and earnings (the
"Guidelines"). The agencies expect to request a compliance plan from an
institution whose failure to meet one or more of the standards is of such
severity that it could threaten the safe and sound operation of the institution.
FDIC regulations enacted under FDICIA also require all depository institutions
to be examined annually by banking regulators and depository institutions having
$500 million or more in total assets to have an annual independent audit, an
audit committee comprised solely of outside directors, and to appoint outside
auditors to evaluate the institution's internal control structure and
procedures.
Financial Management Requirements.
FDICIA imposes new financial reporting requirements on all depository
institutions with assets of more than $500 million, their management, and their
independent auditors. It also establishes new rules for the composition, duties
and authority of such institutions' audit committees and boards of directors.
Among other things, all such depository institutions will be required to prepare
and make available to the public annual reports on their financial condition and
management (including statements of management's responsibility for the
financial statements, internal controls and compliance with certain federal
banking laws and regulations relating to safety and soundness, and an assessment
by management of the effectiveness of the institution's internal controls and
procedures and the institution's compliance with such laws and regulations). The
institution's independent public accountants are required to attest to the
management assessments regarding the effectiveness of the institution's internal
controls and procedures. Each such institution is also required to have an audit
committee composed of independent directors.
35
FEDERAL RESERVE SYSTEM
The Federal Reserve Bank ("FRB") requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At December 31, 1998, MSB
was in compliance with these reserve requirements. The balances maintained to
meet the reserve requirements imposed by the FRB may be used to satisfy
liquidity requirements that may be imposed by the OTS.
Savings institutions are authorized to borrow from the FRB "discount window,"
but FRB regulations require savings institutions to exhaust other reasonable
alternative sources of funds, including FHLB advances, before borrowing from the
FRB.
RESTRICTION OF ACQUISITION
Federal and state laws and regulations contain a number of provisions that
impose restrictions on changes in control of financial institutions such as MSB,
and that require regulatory approval prior to any such changes in control. With
the passage of FIRREA in 1989, these laws and regulations became less
restrictive, especially with respect to the acquisition of savings institutions
by bank holding companies, which became permissible under FIRREA.
The Change in Bank Control Act and the savings and loan holding company
provisions of HOLA, together with the regulations of the OTS under those Acts,
require that the consent of the OTS be obtained prior to any person or company
acquiring "control" of a savings institution. Under the OTS regulations, control
is conclusively presumed to exist if an individual or company acquires more than
25% of any class of voting stock of a savings institution. Control is rebuttably
presumed to exist if a person acquires more than 10% of any class of voting
stock (or more than 25% of any class of non-voting stock) and is subject to any
of several "control factors." The control factors relate, among other matters,
to the relative ownership position of a person, the percentage of debt and/or
equity of the savings institution controlled by the person, agreements giving
the person influence over a material aspect of the operations of the savings
institution and the number of seats on the Board of Directors of the savings
institution held by the person or his designees. The regulations provide a
procedure for challenge of the rebuttable control presumption. Restrictions
applicable to the operations of savings and loan holding companies and
conditions imposed by the OTS in connection with its approval of companies to
become savings and loan holding companies may deter companies from seeking to
obtain control of MSB.
FDICIA added a new section to HOLA authorizing a federal savings institution to
acquire or be acquired by any insured depository institution. The application
for such acquisition would be required to be acted upon by the OTS within 60
days of filing, unless the OTS extends the period for an additional 30 days for
the submission of additional required information.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
If and to the extent a savings institution's bad debt reserve is used for any
purpose other than to absorb bad debt losses, such as for the payment of
dividends or other distributions with respect to the institution's capital
stock, additional federal income taxes may be imposed on the institution as a
result of recapture of its bad debt reserve into income. Dividends may be paid
out of an
36
institution's unappropriated retained earnings without the imposition of any tax
on the institution, to the extent that the amounts paid do not exceed the
institution's current and post-1951 accumulated earnings and profits as
calculated for federal income tax purposes. Dividends in excess of an
institution's current or post-1951 accumulated earnings and profits,
distributions in redemption of the institution's capital stock, and
distributions in partial or complete liquidation of the institution, are deemed
to be made first from the institution's qualifying bad debt reserve to the
extent that the amount in the reserve exceeds the amount that would have been
computed under the experience method and second from the institution's
supplemental reserve for losses on loans (collectively, the "Excess"). To the
extent that such a dividend or distribution by an institution is deemed paid out
of the Excess, the Excess would be reduced, and the institution's gross income
for tax purposes would be increased, by the amount which, when reduced by the
income tax, if any, attributable to the inclusion of such amount in the
institution's gross income, equals the amount deemed paid out of the Excess.
Corporations, including savings institutions such as MSB, generally are subject
to the alternative minimum tax, to the extent that the amount of such tax
exceeds the amount of the corporations' regular income tax. The Code imposes
this tax at the rate of 20% on a corporation's alternative minimum taxable
income ("AMTI"), that is, regular taxable income with certain adjustments plus
tax preference items, less any available exemption. Tax preference items for
these purposes include, among other items, (i) the excess of a savings
institution's deduction for an addition to its reserve for bad debts over the
amount that would have been allowable if such deduction had been computed under
the experience method, and (ii) interest on certain tax-exempt bonds issued
after August 7, 1986. In addition, a corporation's AMTI is increased by
three-quarters of the amount by which the corporation's adjusted current
earnings ("ACE") exceeds its AMTI (with certain adjustments, including the
disallowance of a net operating loss deduction). If the corporation's AMTI
exceeds its ACE, then, subject to certain limitations, the corporation's AMTI
may be reduced by 75% of the excess of its AMTI (with certain adjustments) over
its ACE. Not more than 90% of the AMTI may be offset by net operating losses (as
modified for AMTI purposes). Payment of alternative minimum tax may be used as
credits against regular tax liabilities in future years. In addition, for
taxable years beginning before 1996, corporations also are subject to an
environmental tax equal to 0.12% of the excess of its AMTI for the taxable year
(determined without regard to net operating losses and the deduction for the
environmental tax) over $2,000,000.
MSB and its consolidated subsidiaries have been audited by the Internal Revenue
Service ("IRS"), or accepted without examination, through the tax year 1990.
With respect to years previously examined by the IRS, all deficiencies have been
satisfied.
MICHIGAN TAXATION
The State of Michigan imposes a "Single Business Tax." The Single Business Tax
is a value-added type of tax and is imposed for the privilege of doing business
in the State of Michigan. The tax rate for the Single Business Tax is 2.3% of
the Michigan adjusted tax base. The Michigan tax base is substantially the same
as federal taxable income increased by compensation, depreciation, and net
operating loss carryovers, if any, utilized in arriving at federal taxable
income and decreased by the cost of acquisition of tangible assets during the
year. The State of Michigan had
37
imposed a tax on intangible personal property in the amount of $0.20 per $1,000
of deposits of a savings institution less the amount of deposits owed to the
federal or Michigan State government, their agencies or certain other financial
institutions. The intangibles tax was repealed effective January 1, 1998 and was
phased out, with reductions of 25% in 1995, 50% in 1996 and 75% in 1997.
EXECUTIVE OFFICERS
Information concerning each executive officer of MSB, who is not also a Director
of MSB, as of March 5, 1999 is set forth below.
Year
Name Age Position Held with MSB Employed
- -------------------------------------------------------------------------------------------------------------------
Bernard D. Williams 39 Senior Vice President, Chief Financial Officer and Treasurer 1990
James P. Gorzinski 29 First Vice President and Director of Loan Operations 1986
Burl C. Howell 59 First Vice President, Director of Human Resources and
Assistant Secretary 1992
Gary W. Wilds 56 First Vice President, General Counsel and Secretary 1995
Thomas A. Rinness 40 First Vice President and Director of Commercial Lending 1998
Bernard D. Williams, C.P.A., joined MSB in September 1990 as Senior Vice
President, Chief Financial Officer, and Treasurer. Mr. Williams holds a B.S. in
Accounting from the University of Missouri at Columbia and an M.B.A. from St.
Louis University.
James P. Gorzinski joined MSB in August 1986. Mr. Gorzinski currently serves as
Director of Loan Operations. Mr. Gorzinski began his career with MSB in the
retail office system, was promoted to the Accounting Department where he
continued to progress in responsibility and position, was promoted to Manager of
Secondary Marketing in January 1994, and most recently was promoted to Director
of Loan Operations in May 1995. Mr. Gorzinski holds a B.B.A. in Accounting from
Saginaw Valley State University.
Burl C. Howell joined MSB in March 1992 as Vice President and Director of Human
Resources. In September 1995 he became First Vice President. Prior to joining
MSB, Mr. Howell was Manager, Compensation and Benefits, of Society Bank, Ann
Arbor, Michigan from January 1990 to February 1992. Mr. Howell holds a B.A. in
Economics from the University of Michigan.
Gary W. Wilds joined MSB in April 1995 as MSB's General Counsel. Most recently
he was employed with the law firm of O'Reilly, Rancillio, Nitz, Turnbull &
Andrews, P.C. in Sterling Heights, Michigan. Mr. Wilds was Senior Vice
President, General Counsel of Colonial Central Savings Bank, f.s.b. from July
1990 through April 1994 when Colonial Central was acquired by Standard Federal
Bank. Mr. Wilds has a B.A. in Political Science from Valparaiso University and a
J.D., cum laude, from Wayne State University Law School.
38
Thomas A. Rinness joined MSB in December 1998. He is First Vice President and
Director of Commercial Lending. Mr. Rinness holds a B.A. in accounting from
Michigan State University and an M.B.A. from Saginaw Valley State University.
Prior to joining MSB, Mr. Rinness was a Vice President of First of America Bank
from May 1982 to May 1998 and a Vice President of NBD Bank from May 1998 until
he joined MSB. The majority of his time was spent in commercial lending,
including five years as a Group Manager.
ITEM 2. PROPERTIES
The total net book value of MSB's premises and equipment at December 31, 1998
was $8,017,000. During 1996 MSB executed a revised contract for electronic data
processing services with Fiserv Solutions, Inc. The current contract was
effective July 1, 1996 and has a December 31, 2001 expiration date. MSB may
terminate the contract upon notice to Fiserv, however, MSB would incur
termination costs if the effective termination date is prior to the contract
expiration date.
MSB conducts its business through a main office and 21 branch offices located in
central and southern Michigan. The following table discloses information
regarding MSB's premises:
39
Net Book Value
(excluding furniture,
fixtures and equipment) Leased
Location at December 31, 1998 or Owned
- ------------------------------------------------------------------------------------------------------------
Executive & Home Office:
623 Washington Avenue Bay City, MI 48708 $ 728,494 (1) Owned
Office Annexes:
600 Saginaw Street Bay City, MI 48708 N/A Owned
615-617 Washington Avenue Bay City, MI 48708 N/A Owned (2)
Branches:
210 South Saginaw Street Midland, MI 48640 217,854 Owned
319 East Broadway Mt. Pleasant, MI 48858 160,077 Owned
3520 Davenport Avenue Saginaw, MI 48602 455,495 Owned
700 West Houghton Avenue West Branch, MI 48661 204,177 Owned
6241 Main Street Cass City, MI 48726 226,242 Owned
427 Mable Street Pinconning, MI 48650 168,129 Owned (3)
228 Newman Street East Tawas, MI 48730 125,935 Owned
209 South Main Street Standish, MI 48658 167,606 Owned
75 South Main Street Pigeon, MI 48755 173,164 Owned
8880 Unionville Road Sebewaing, MI 48759 2,998 Leased(4)
1615 West Center Avenue Essexville, MI 48732 422,423 Owned
745 North Euclid Avenue Bay City, MI 48706 287,395 Owned
800 Broadway Avenue Bay City, MI 48708 235,707 Owned
1004 West Midland Road Auburn, MI 48611 157,246 Owned
2151 West Columbia Avenue Battle Creek, MI 49105 307,534 Owned
2646 Henry Street Norton Shores, MI 49441 96,355 Leased(5)
1445 North Center Saginaw, MI 48603 221,440 Owned
404 Perry Street Big Rapids, MI 49307 621,104 Owned
701 North Avenue Battle Creek, MI 49017 200,771 Owned
720 Capital Avenue, S.W. Battle Creek, MI 49015 174,246 Owned
1001 East Columbia Avenue Battle Creek, MI 49014 365,561 Owned
Other:
Landmark Plaza
800 Washington Avenue Bay City, MI 48708 -- Leased(6)
----------------
$ 5,719,953
================
(1) Includes net book value of office annexes located at 600 Saginaw Street
and 615-617 Washington Avenue in Bay City, Michigan.
(2) Approximately 1,200 square feet of the 617 Washington Avenue office
building is leased as commercial space to parties unaffiliated with
MSB. The aggregate annual rent for such leased space totaled
approximately $7,158 for the year ended December 31, 1998.
(3) Approximately 5,600 square feet of MSB's office building at 427 Mable
Street, Pinconning, Michigan is leased as commercial space to parties
unaffiliated with MSB. The aggregate annual rent for such leased space
totaled approximately $20,641 for the year ended December 31, 1998.
(4) Lease expires on December 31, 2001. MSB holds one three-year renewal
option.
(5) Lease expires on July 31, 2002. MSB holds three five-year renewal
options.
(6) Lease expired on February 10, 1999. MSB purchased this office building
on February 26, 1999. At this date, the net book value of this building
was $255,000 (excluding furniture, fixtures and equipment).
40
ITEM 3. LEGAL PROCEEDINGS
MSB, together with certain present and former directors and officers and certain
others, had been a defendant in consolidated lawsuits in the United States
District Court for the Eastern District of Michigan (the "Federal Court"). The
consolidated action combined two class action lawsuits filed in the Federal
Court and one class action lawsuit originally filed in the Circuit Court for
Oakland County, Michigan (the "State Court"). The lawsuits alleged certain
violations of Federal securities law and Michigan Blue Sky Law. The lawsuit
filed in the State Court was dismissed upon being combined with the Federal
Court lawsuits. These lawsuits were all originally filed in 1995 and generally
alleged that certain disclosures made by MSB from late 1993 until late 1994,
including disclosures made by MSB in a Rights Offering Circular dated October
27, 1993, concerning its business plan and exposure to interest rate risk were
false and misleading or there were material omissions. A class consisting of
purchasers of MSB's stock during the period from November 30, 1993 to November
14, 1994 was certified by the Federal Court (the "Class").
On May 8, 1998, MSB entered into a Stipulation of Settlement (the "Settlement")
to resolve the consolidated class action lawsuit. Under the Settlement, MSB
agreed to make a cash payment of $12.000 million ($2.500 million of which MSB
received from its former directors' and officers' liability insurance carrier).
On July 8, 1998 the Federal Court entered a Final Judgment and Order approving
the Settlement and dismissing the action. There were no objections filed to the
Settlement and the time to appeal the Federal Court's approval of the Settlement
has expired with no appeal having been filed. Accordingly, the dismissal of the
case against all the defendants is final. MSB distributed the Settlement funds
to plaintiff's counsel on August 10, 1998. The funds, net of plaintiffs'
attorneys' fees and expenses, were distributed to the Class in December 1998.
MSB recorded a $9.650 million charge to earnings in the fourth quarter of 1997
for the Settlement of the consolidated class action lawsuit. The $9.650 million
charge covers the $9.500 million portion of the Settlement attributable to MSB
(the balance of the Settlement, $2.500 million, having been received by MSB from
its former directors' and officers' liability insurance carrier) and the
remaining $150,000 was accrued for MSB's legal expenses and any other costs
related to completion of the Settlement.
MSB, together with four present and former officers, remains as a defendant in a
separate lawsuit that was filed in 1995 on behalf of fourteen plaintiffs who
allegedly purchased MSB's common stock during 1992, 1993 and 1994. This lawsuit
similarly alleges that some of MSB's disclosures during that period concerning
its business plan and exposure to interest rate risk were false and misleading
in violation of state and federal securities laws and common law. Plaintiffs in
this lawsuit seek damages of approximately $3.000 million. That action was
pending in the United States District Court for the Eastern District of
Michigan, but has been transferred to the Northern District of Illinois, where
it was originally filed, in light of the Settlement.
MSB believes there are meritorious defenses to this lawsuit, has filed answers
denying the material allegations of all of the claims, and intends to continue
to pursue a vigorous defense. The ultimate outcome of this lawsuit and the
results of the legal process cannot be predicted with certainty. No provision
has been recorded for any potential loss for this lawsuit at the present time
because MSB does not believe it is reasonably probable that any material loss
will be
41
incurred as a result of the final disposition of this lawsuit and/or is unable
to reasonably estimate the amount of any potential loss.
Other pending legal proceedings and regulatory matters have occurred in the
ordinary course of business and do not involve amounts in the aggregate that are
believed by Management to be material to the financial condition of MSB.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information relating to the market for MSB's common equity and related
stockholder matters appears in MSB's 1998 Annual Report to Stockholders on page
65 and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data appears in MSB's 1998 Annual Report to Stockholders
on pages 4 and 5 and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION The above-captioned information appears under the caption
"Management's Discussion and Analysis of Operating Results and Financial
Condition" in MSB's 1998 Annual Report to Stockholders on pages 6 through 21 and
is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The above-captioned information appears under the caption "Quantitative and
Qualitative Disclosures About Market Risk" in MSB's 1998 Annual Report to
Stockholders on Pages 22 through 27 and is incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Mutual Savings Bank, f.s.b., A Stock
Company, and Subsidiaries, together with the Independent Auditors' Report
thereon by KPMG LLP appears in MSB's 1998 Annual Report to Stockholders on pages
29 through 63 and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to directors of the Registrant is incorporated herein
by reference to MSB's Proxy Statement for the Annual Meeting of Stockholders to
be held on April 27, 1999 ("Proxy Statement") under the caption "Election of
Directors -- Directors."
Information regarding compliance with Section 16(a) of the Securities Exchange
Act of 1934 as set forth under the caption "Section 16(a), Beneficial Ownership
Reporting Compliance" in the Proxy Statement is incorporated herein by
reference.
Information regarding executive officers of MSB is included in Part I, Item 1
Business of this Annual Report on Form 10-K under the caption "Executive
Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation is incorporated herein by
reference to the Proxy Statement under the captions - "Remuneration and
Transactions with Management and Others" and "Election of Directors --
Directors' Fees."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners and
management is incorporated herein by reference to the Proxy Statement under the
caption "Voting Securities and Principal Holders Thereof."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to this item is incorporated herein by reference to the
Proxy Statement under the caption "Remuneration and Transactions with Management
and Others -- Compensation Committee Interlocks and Insider Participation."
43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
I. The following documents are filed as a part of this report:
A. Consolidated Financial Statements of MSB are incorporated by
reference to the following indicated pages of MSB's 1998 Annual
Report to Stockholders:
Page
Independent Auditors' Report ...........................................................................29
Consolidated Statements of Financial Condition at
December 31, 1998 and 1997 ...........................................................................30
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 .....................................................................31
Consolidated Statements of Comprehensive Income (Loss)
for the Years Ended December 31, 1998, 1997 and 1996 .................................................32
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996 .................................................32
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1998, 1997 and 1996 ............................................................33-34
Notes to Consolidated Financial Statements ..........................................................35-63
B. All schedules are omitted because they are not required or
applicable, or the required information is shown in the
consolidated financial statements or the notes thereto.
C. Exhibits
1. The list of exhibits may be found on pages 45 and 46 of this
document.
II. Reports on Form 8-K
None.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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 on this 17th day of March,
1999.
Mutual Savings Bank, f.s.b.
A Stock Company
By: /s/ Robert N. Shuster
-----------------------------------
Robert N. Shuster
Director and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Name Title Date
---- ----- ----
By: /s/ Thomas T. Princing Chairman of the Board March 17, 1999
----------------------------------
Thomas T. Princing
By: /s/ William P. Brennan Director March 17, 1999
----------------------------------
William P. Brennan
By: /s/ E. James Barrett Director March 17, 1999
----------------------------------
E. James Barrett
By: /s/ Robert N. Shuster Director and Chief Executive Officer March 17, 1999
----------------------------------
Robert N. Shuster
By: /s/ Charles E. McCuistion Director, President and Chief March 17, 1999
---------------------------------- Operating Officer
Charles E. McCuistion
By: /s/ Bernard D. Williams Senior Vice President, Chief Financial March 17, 1999
---------------------------------- Officer and Treasurer (Principal Financial and
Bernard D. Williams Accounting Officer)
45
EXHIBIT INDEX
Exhibit No. Description Page
- ----------- ----------- ----
3.1 Charter as amended April 25, 1995 .....................................................................(2)
3.2 Bylaws as amended October 27, 1998 ...................................................................(9)
10.1 Severance Pay Agreement for Executive Officers dated September 24, 1996 ...............................(3)
10.2 Mutual Savings Bank, f.s.b. Long Term Incentive Plan
as amended April 29, 1997..............................................................................(6)
10.3 Mutual Savings Bank, f.s.b. Phantom Stock Plan for Non-Employee Directors .............................(7)
10.4 Mutual Savings Bank, f.s.b. 401(k) Profit Sharing Plan
as restated June 1, 1997...............................................................................(8)
10.5 Mutual Savings Bank, f.s.b. Employee Stock Ownership Plan .............................................(8)
10.6 Mutual Savings Bank, f.s.b. Employee Stock Ownership Trust ............................................(8)
10.7 Mutual Savings Bank, f.s.b. Employee Stock Ownership Plan Loan Agreement
Term Note and Pledge Agreement ........................................................................(5)
10.8 Supervisory Agreement dated May 8, 1992 between MSB and the OTS .......................................(1)
10.9 Amendment dated March 13, 1995 to Supervisory Agreement ...............................................(2)
10.10 Retail Office Automation Agreement ....................................................................(4)
10.11 Mutual Savings Bank, f.s.b. Defined Benefit Plan Summary Plan Description - Financial Institutions
Retirement Fund as amended January 1, 1999 ............................................................47
10.12 Amendment Dated December 15, 1998 to Mutual Savings Bank, f.s.b. Employee
Stock Ownership Plan ...................................................................................65
11.1 Computation of Earnings (Loss) Per Share ...............................................................66
13.1 Annual Report to Stockholders for the Year ended December 31, 1998 .....................................67
13.2 Independent Auditor's Report of KPMG LLP ..............................................................133
21.1 Incorporated by reference to Item No. 1 - "Business -- Subsidiaries" ..................................N/A
23.1 Consent of KPMG LLP....................................................................................134
46
FOOTNOTES FOR EXHIBITS INCORPORATED BY REFERENCE
(1) Incorporated by reference to MSB's Annual Report on Form 10-K for the
Year ended December 31, 1992.
(2) Incorporated by reference to MSB's Annual Report on Form 10-K for the
Year ended December 31, 1995.
(3) Incorporated by reference to MSB's Annual Report on Form 10-K for the
Year ended December 31, 1996.
(4) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended September 30, 1996.
(5) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended March 31, 1997.
(6) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended June 30, 1997.
(7) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended September 30, 1997.
(8) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended March 31, 1998.
(9) Incorporated by reference to MSB's Report on Form 10-Q for the quarter
ended September 30, 1998.
47
EXHIBIT 11.1
Computation of Earnings (Loss) Per Share
-----------------------------------------------------------------------------
Years Ended December 31, 1998, 1997 and 1996
-----------------------------------------------------------------------------
1998 1997
-----------------------------------------------------------------------------
Income Average Income Average
(Loss) Shares Per-Share (Loss) Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
(Dollars in thousands, except per share amounts)
Basic earnings per share ("EPS")
Income (loss) available to common
stockholders $ 2,657,843 4,289,248 $(9,154,504) 4,276,711
ESOP shares not committed to be
released -- (50,411) -- (65,884)
----------- ------------- ----------- -------------
2,657,843 4,238,837 $ 0.63 (9,154,504) 4,210,827 $ (2.17)
========= =========
Effect of dilutive securities
Options -- 86,990 -- 397
----------- ------------- ----------- -------------
Diluted EPS
Income (loss) available to
common stockholders
and assumed conversions $ 2,657,843 4,325,827 $ 0.61 $(9,154,504) 4,211,224 $ (2.17)
=========== ============= ========= =========== ============= =========
Computation of Earnings (Loss) Per Share
-------------------------------------------------
Years Ended December 31, 1998, 1997 and 1996
-------------------------------------------------
1996
-------------------------------------------------
Income Average
(Loss) Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Basic earnings per share ("EPS")
Income (loss) available to common
stockholders $ (112,306) 4,273,130
ESOP shares not committed to be
released -- (81,357)
----------- -------------
(112,306) 4,191,773 $ (0.03)
Effect of dilutive securities
Options -- 62
----------- -------------
Diluted EPS
Income (loss) available to
common stockholders
and assumed conversions $ (112,306) 4,191,835 $ (0.03)
=========== ============= =========
48
EXHIBIT 13.1
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Letter to Stockholders...............................................................................................2
5 Year Consolidated Financial Highlights.............................................................................4
Management's Discussion and Analysis of Operating Results and Financial Condition....................................6
Quantitative and Qualitative Disclosures About Market Risk..........................................................22
Statement of Management's Responsibility............................................................................28
Independent Auditors' Report .......................................................................................29
Consolidated Financial Statements...................................................................................30
Notes to Consolidated Financial Statements..........................................................................35
Directors and Executive Officers....................................................................................64
Stockholders' Information...........................................................................................65
Office Locations....................................................................................................66
CORPORATE PROFILE
- --------------------------------------------------------------------------------
Mutual Savings Bank, f.s.b., A Stock Company ("MSB" or the "Bank"), with total
assets of $564 million, serves central and southern Michigan with 22 retail
banking offices. MSB is a member of the Federal Home Loan Bank ("FHLB") System
and its deposits are insured to the maximum allowable amount by the Federal
Deposit Insurance Corporation ("FDIC"). Together with its two subsidiaries, MSB
Investment and Insurance Services, Inc. and MSB Service Corporation, MSB
provides a full range of financial products and services, including investments
and insurance.
Originally organized in 1890 as a Michigan-chartered building and loan
association, in 1928 MSB merged with another Michigan-chartered building and
loan association that was organized in 1887. MSB converted from the mutual to
stock form of ownership in 1992. MSB's common stock trades on The Nasdaq Stock
Market under the symbol "MSBK."
- --------------------------------------------------------------------------------
1
COMMUNITY BANKING FOR OVER A CENTURY
49
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
LETTER TO STOCKHOLDERS
- --------------------------------------------------------------------------------
To Our Stockholders:
1998 was marked by Mutual Savings Bank's return to profitability. MSB reported
net income of $2.658 million, or $0.61 per diluted share in 1998, compared to a
net loss of $9.155 million, or $2.17 per diluted share in 1997. 1997 results
include a $9.650 million charge for the settlement of the class action
securities lawsuit.
The road back to profitability has been a challenging one for MSB. Over the past
four years we have reported on the Bank's efforts to improve its core operating
results. These efforts have focused on increasing the Bank's net interest
income, moderating the Bank's level of interest rate risk, increasing fee income
opportunities by offering an expanded array of financial products and services,
reducing operating expenses and increasing productivity. We believe that the
1998 operating results reflect continued progress in each of these areas.
Net interest income increased $754,000, or 6.7%, in 1998, despite a decline in
average interest-earning assets of $49.209 million. The Bank's net interest
margin, although still well below industry standards, increased from 1.76% in
1997 to 2.03% in 1998. The decline in interest-earning assets was concentrated
in the Bank's mortgage-backed securities portfolio, as payments and prepayments
on mortgage-backed securities were utilized to pay off higher costing borrowings
that matured.
Our intent in allowing assets to decline has been to restore the Bank's tangible
and core capital ratios to the levels reached just prior to the impact of the
settlement of the class action securities lawsuit. This objective has been
accomplished in just one year as the Bank's tangible and core capital ratios
reached 6.39% at December 31, 1998. In order to achieve our long-term return on
equity objectives, we believe the Bank's core capital ratio must be maintained
in the 6% to 7% range. As a result, the Bank will need to appropriately leverage
future earnings through growth in interest-earning assets or pursue other
methods to manage capital such as the initiation of a stock repurchase plan or
the payment of cash dividends. The repurchase of stock or payment of a cash
dividend by MSB would require prior regulatory approval. Further, for tax
reasons, any stock repurchases would need to be done through a thrift holding
company, which MSB may consider forming in the future.
Loan origination volume increased dramatically in 1998 due primarily to a lower
interest rate environment which resulted in significant growth in mortgage loan
refinance activity. MSB originated $363.172 million in loans in 1998 compared to
$201.844 million in 1997. Despite the significant increase in loan origination
volume, loans receivable only increased by $12.587 million, or 4.0%. Growth in
the loan portfolio was restrained by the level of prepayment activity (due
primarily to mortgage loan refinancing) and the mix of mortgage loan origination
volume, with a higher concentration of longer-term fixed rate mortgage loans
that MSB generally sells because of interest rate risk considerations. The
increased volume of mortgage loan sales resulted in a significant jump in gains
and fees on loan sales in 1998. Future levels of gains and fees on loan sales
are dependent upon the volume of mortgage loan origination and sales volumes,
which are significantly influenced by the level of interest rates and general
economic conditions.
With the continuation of a relatively flat yield curve in early 1999, loan
portfolio growth, at least in the short-term, is likely to remain a challenge.
We expect to concentrate our efforts on expanding our commercial loan portfolio
and home equity lending, as well as continuing to seek expanded market share for
our residential mortgage lending. Commercial loan origination volume totaled
$33.337 million in 1998, a 70.0% increase over 1997. In December 1998 Thomas
Rinness joined MSB as our Director of Commercial Lending. Tom has fifteen years
of commercial lending experience with a large commercial bank.
- --------------------------------------------------------------------------------
2
COMMUNITY BANKING FOR OVER A CENTURY
50
- --------------------------------------------------------------------------------
Deposits increased $13.430 million, or 3.3%, in 1998. This increase was
broad-based as passbook and statement savings accounts increased $2.425 million,
checking accounts increased $7.241 million and money market accounts increased
$5.979 million. Certificates of deposit declined by $2.215 million, or less than
1%. We are pleased with the growth in deposits, particularly in core transaction
accounts. Our future promotional efforts will continue to focus on checking
account growth, which we believe represents a fundamental customer banking
relationship.
The Year 2000 issue has received increased attention in the media. Our
preparations and efforts related to the Year 2000 are nearing completion. MSB
utilizes an outside service bureau (Fiserv in Brookfield, Wisconsin) for nearly
all of its core data processing systems. MSB successfully tested its "mission
critical" data processing systems for Year 2000 compliance in October 1998. We
intend on completing additional testing in May 1999. Both MSB and Fiserv are
periodically examined by government regulators with respect to Year 2000
readiness. We are also regularly communicating with our customers to keep them
apprised of our Year 2000 efforts.
MSB has not had any formal investment research coverage from the time of its
initial public offering in July 1992 through the end of 1998. We are pleased
that Howe Barnes Investments, Inc. in Chicago, Illinois, initiated research
coverage of MSB in January 1999. We believe formal investment research coverage
of MSB will be of benefit to our shareholders.
There are two people each of whom deserve recognition for their extraordinary
contributions to our organization. On May 6, 1998 MSB lost a special friend when
Joseph Rombach, a Director of the Bank since 1992, passed away at the age of 49.
Joe's wisdom, humor and competitive spirit will be truly missed. We extend our
deepest sympathy to Joe's family. On April 1, 1999 Lee Ann Mast, the manager of
our Midland, Michigan office, will retire after 42 years of service to MSB. We
extend our best wishes to Lee Ann.
In closing, we encourage you to read the remainder of this Annual Report and
learn more about the financial and operational matters discussed in this letter.
We appreciate the dedication and efforts of our employees. We look forward to
the opportunities and challenges of 1999 and beyond and seek to reward your
confidence and investment in MSB.
Very truly yours,
/s/ Robert N. Shuster
Robert N. Shuster
Chief Executive Officer
February 12, 1999
- --------------------------------------------------------------------------------
COMMUNITY BANKING FOR OVER A CENTURY 3
51
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
5 YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
AT DECEMBER 31,
------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
FINANCIAL CONDITION DATA: (IN THOUSANDS)
Total assets....................................... $564,434 $644,740 $664,675 $720,335 $863,793
Loans receivable, net.............................. 327,692 315,105 250,648 193,760 158,615
Mortgage-backed securities......................... 181,339 293,346 382,656 449,931 573,893
Investment securities.............................. 14,055 199 199 37,915 96,719
Cash and cash equivalents.......................... 14,764 13,397 8,861 15,860 11,598
Deposits........................................... 420,818 407,388 410,307 427,133 461,605
Securities sold under agreements to repurchase
("Repurchase Agreements")......................... 45,000 85,000 127,000 169,965 262,790
FHLB advances...................................... 53,286 100,561 74,923 69,881 84,850
Stockholders' equity............................... 36,136 32,787 40,495 39,651 39,031
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
OPERATING DATA: (IN THOUSANDS)
Interest income.................................... $ 39,835 $ 42,497 $ 42,865 $ 47,576 $ 52,515
Interest expense .................................. 27,827 31,243 32,171 36,468 36,315
-------- -------- -------- -------- --------
Net interest income............................... 12,008 11,254 10,694 11,108 16,200
Provision for loan losses.......................... 585 225 180 169 50
-------- -------- -------- -------- --------
Net interest income after provision for
loan losses..................................... 11,423 11,029 10,514 10,939 16,150
-------- -------- -------- -------- --------
Other income (loss):
Settlement of class action lawsuit................. -- (9,650) -- -- --
Gain on sale of bulk mortgage loan servicing....... -- -- 549 -- --
Gain (loss) on sale of premises and equipment,
real estate owned and other repossessed assets.... 61 64 166 188 (394)
Net gain (loss) on sale of investment and
mortgage-backed securities ....................... -- -- (670) (3,056) 2,589
Gain on sale of branch offices..................... -- -- -- 1,160 --
Other non-interest income.......................... 5,212 3,709 3,833 3,973 5,066
-------- -------- -------- -------- --------
Total other income (loss) 5,273 (5,877) 3,878 2,265 7,261
-------- -------- -------- -------- --------
General and administrative expenses................ 14,038 14,307 14,504 15,090 21,500
-------- -------- -------- -------- --------
Income (loss) before income tax expense.......... 2,658 (9,155) (112) (1,886) 1,911
Income tax expense................................. -- -- -- -- 3,521
-------- -------- -------- -------- --------
Net income (loss)................................ $ 2,658 $ (9,155) $ (112) $ (1,886) $ (1,610)
======== ======== ======== ======== ========
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4
COMMUNITY BANKING FOR OVER A CENTURY
52
- ------------------------------------------------------------------------------------------------------------------------------------
AT OR FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ----------- ----------- -----------
OTHER DATA:
Return on average assets ....................... 0.43% (1.39)% (0.02)% (0.24)% (0.17)%
Return on average equity ....................... 7.76 (22.58) (0.29) (4.64) (3.49)
Average equity to average assets ............... 5.54 6.14 5.66 5.07 5.01
Interest rate spread ........................... 1.68 1.40 1.25 1.12 1.60
Net interest margin ............................ 2.03 1.76 1.58 1.42 1.82
Other income (loss) to average assets .......... 0.85 (0.89) 0.56 0.28 0.79
General and administrative expenses to
average assets ............................... 2.27 2.17 2.08 1.88 2.34
Average interest-earning assets to average
interest-bearing liabilities ................. 107.45 107.39 106.94 106.35 105.18
Allowance for loan losses to total loans at end
of period .................................... 0.56 0.62 0.73 0.88 0.98
Net charge-offs to average outstanding loans
during the period ............................ 0.23 0.04 0.02 0.01 0.61
Ratio of non-performing assets to total assets . 0.09 0.07 0.14 0.14 0.19
Ratio of non-performing loans to net loans ..... 0.06 0.08 0.16 0.23 0.42
Regulatory capital ratios:
Tangible capital ............................. 6.39 5.13 6.32 5.81 4.61
Core capital ................................. 6.39 5.13 6.32 5.81 4.61
Risk-based capital ........................... 13.17 12.24 17.57 18.22 16.17
Loans serviced for others (in thousands)........ $ 517,852 $ 504,010 $ 537,392 $ 633,124 $ 673,742
Number of:
Common shares outstanding .................... 4,290,414 4,281,914 4,274,154 4,271,394 4,251,892
Deposit accounts ............................. 55,173 54,938 54,932 55,960 61,515
Full service offices ......................... 22 22 22 22 25
Per common share:
Book value ................................... $ 8.42 $ 7.66 $ 9.47 $ 9.28 $ 9.18
Tangible book value .......................... 8.42 7.66 9.47 9.28 9.18
Dividends .................................... -- -- -- -- --
Basic earnings (loss) per common share ......... 0.63 (2.17) (0.03) (0.45) (0.39)
Diluted earnings (loss) per common share ....... 0.61 (2.17) (0.03) (0.45) (0.39)
- ------------------------------------------------------------------------------------------------------------------------------------
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5
COMMUNITY BANKING FOR OVER A CENTURY
53
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATING RESULTS AND FINANCIAL
CONDITION
- --------------------------------------------------------------------------------
Mutual Savings Bank, f.s.b., A Stock Company ("MSB"), is a federal stock savings
bank headquartered in Bay City, Michigan, and operates 22 retail banking offices
located primarily in central and southern Michigan. MSB also operates two
wholly-owned subsidiaries, MSB Service Corporation and MSB Investment and
Insurance Services, Inc. ("MSBi"). MSB's two subsidiaries have contracted with
unaffiliated third parties to provide various investment services including the
sale of mutual fund and annuity products. MSBi also sells life insurance,
long-term care insurance and group health and disability insurance. MSB is
subject to competition from other financial services providers with respect to
these services. MSB is regulated by certain federal agencies and is periodically
examined by certain regulatory authorities. MSB, in the course of normal
operations, is exposed to interest rate risk. The level of MSB's interest rate
risk is such that, in a rising interest rate environment, MSB's net interest
income and net portfolio value ("NPV") would be expected to decrease.
Management's Discussion and Analysis is designed to provide a more thorough
discussion of MSB's operating results and financial condition as well as to
provide additional information on MSB's asset/liability management strategies,
sources of liquidity and capital resources. Management's Discussion and Analysis
should be read in conjunction with the consolidated financial statements and
notes thereto and other financial data contained elsewhere in this report. The
operations of MSB, and the financial services industry generally, are influenced
by many factors, including the interest rate environment, competition in the
financial services industry, legislative and regulatory developments and general
economic conditions.
Except for the historical information contained in this report, certain
statements made herein are forward-looking statements that involve risks and
uncertainties and are subject to various factors that could cause actual results
to differ materially from these forward-looking statements, including, without
limitation, the effect of economic and market conditions and the impact of
competition.
OPERATING RESULTS
MSB's net income was $2,658,000, or $0.61 per diluted share, for 1998 compared
to a net loss of $9,155,000, or $2.17 per diluted share, for 1997. In 1996 MSB's
net loss was $112,000, or $0.03 per diluted share. The results for 1997 included
a $9,650,000 charge for the settlement of a class action lawsuit. (See "Other
Matters -- Status of Legal Proceedings.") The results for 1996 included a
$670,000 loss on the sale of a $38.920 million investment security and a
$549,000 gain on the sale of bulk mortgage loan servicing.
NET INTEREST INCOME
Net interest income is a function of an institution's interest rate spread, the
difference between the yields earned on its interest-earning assets and the
rates paid on its interest-bearing liabilities and the relative amount of
interest-earning assets and interest-bearing liabilities.
Net interest income was $12.008 million in 1998, a 6.7% increase from the
$11.254 million for 1997. MSB's net interest margin increased from 1.76% for
1997 to 2.03% for 1998.
During 1998 average interest-earning assets were $592.000 million as compared to
$641.209 million for 1997 reflecting a decline in lower yielding mortgage-backed
securities partially offset by an increase in higher yielding loans receivable.
Average loans increased $34.320 million while average mortgage-backed securities
declined $100.122 million. Average loans receivable represented 54.16% of
average interest-earning assets during 1998 compared to 44.65% during 1997. Due
to the decline in the lower yielding mortgage-backed securities, the average
yield on interest-earning assets increased from 6.63% in 1997 to 6.73% in 1998.
MSB has reduced total average interest-earning assets through a reduction of
mortgage-backed securities in an effort to increase MSB's capital ratios and
moderate its level of interest rate risk. (See "Financial Condition -- Asset and
Liability Mix.") The weighted-average yield on loans receivable declined from
7.98% in 1997 to 7.82% in 1998 due primarily to lower interest rates on loans
originated during the past year and the prepayment of higher yielding loans.
The cost of interest-bearing liabilities declined from 5.23% for 1997 to 5.05%
for 1998, primarily due to the repricing of interest-bearing deposits in the
lower interest rate environment and the payoff of higher costing borrowings in
1998. Average interest-bearing deposits increased $6.701 million and the average
cost of deposits decreased six basis points to 4.49% in 1998 as compared to
1997. Average borrowings declined $52.857 million in 1998 as compared to
- --------------------------------------------------------------------------------
6
COMMUNITY BANKING FOR OVER A CENTURY
54
- --------------------------------------------------------------------------------
1997. The average cost of borrowings increased from 6.59% in 1997 to 6.60% in
1998. Borrowings were reduced to 17.41% of total assets at December 31, 1998 as
compared to 28.78% of total assets at December 31, 1997.
MSB's net interest income increased from 1996 to 1997 primarily due to an
increase in net interest margin from 1.58% for 1996 to 1.76% for 1997. MSB
reduced total average interest-earning assets during 1997 in an effort to
increase its capital ratios and moderate its level of interest rate risk. During
1997 average interest-earning assets declined $36.721 million compared to 1996,
as average loans increased $58.323 million while average investments and
mortgage-backed securities declined $95.044 million. Due to the reduction of the
lower yielding investments and mortgage-backed securities, the average yield on
interest-earning assets increased from 6.32% in 1996 to 6.63% in 1997. Average
interest-bearing deposits decreased $13.085 million primarily due to a reduction
in the level of certificates of deposit. The average cost of deposits increased
fifteen basis points in 1997 as compared to 1996. Average borrowings declined
$23.761 million in 1997 as compared to 1996. The average cost of borrowings
increased from 6.31% in 1996 to 6.59% in 1997 due primarily to maturing
borrowings repricing at higher costs.
RATE/VOLUME ANALYSIS
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected MSB's interest income and interest expense during the
periods indicated. Information is provided in each category with respect to (i)
changes attributable to changes in volume (changes in volume multiplied by prior
rate); (ii) changes attributable to changes in rate (changes in rate multiplied
by prior volume); and (iii) changes attributable to changes in both volume and
rate (changes in rate multiplied by changes in volume). The changes attributable
to the combined impact of volume and rate have been allocated proportionately to
the changes due to volume and the changes due to rate.
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997
COMPARED TO COMPARED TO
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996
INCREASE (DECREASE) DUE TO: INCREASE (DECREASE) DUE TO:
---------------------------- ----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
(IN THOUSANDS)
Interest-earning assets:
Loans receivable $2,683 $(467) $2,216 $4,637 $ 300 $ 4,937
Mortgage-backed securities (5,453) (238) (5,691) (4,122) (126) (4,248)
Investment securities 601 (79) 522 (741) 303 (438)
Other investments 358 (67) 291 (735) 116 (619)
------ ----- ------ ------ ----- -------
Total interest-earning assets (1,811) (851) (2,662) (961) 593 (368)
------ ----- ------ ------ ----- -------
Interest-bearing liabilities:
Deposits 302 (240) 62 (594) 595 1
------ ----- ------ ------ ----- -------
Repurchase Agreements (3,350) 24 (3,326) (1,966) 522 (1,444)
FHLB advances 178 (299) (121) 775 (121) 654
Other borrowed money (31) -- (31) (138) (1) (139)
------ ----- ------ ------ ----- -------
Total borrowed money (3,203) (275) (3,478) (1,329) 400 (929)
------ ----- ------ ------ ----- -------
Total interest-bearing liabilities (2,901) (515) (3,416) (1,923) 995 (928)
------ ----- ------ ------ ----- -------
Net increase (decrease) in net interest income $1,090 $(336) $ 754 $ 962 $(402) $ 560
====== ===== ====== ====== ===== =======
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7
COMMUNITY BANKING FOR OVER A CENTURY
55
- --------------------------------------------------------------------------------
The following table sets forth, for the periods indicated, information regarding
(i) the total dollar amount of interest and dividend income from MSB's
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average costs; (iii) net interest income; (iv) interest rate spread; (v) net
interest margin; and (vi) gross balances.
Average balances are derived from average daily balances. The yields and costs
include only those fees that are considered adjustments to yields. Yields on
investments and mortgage-backed securities available-for-sale are determined
using amortized costs. Interest on non-accruing loans has only been included if
actually collected.
- --------------------------------------------------------------------------------
AVERAGE CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
CONSOLIDATED STATEMENT FOR THE YEARS ENDED DECEMBER 31,
OF FINANCIAL CONDITION --------------------------------------------------------------------------------
AT DECEMBER 31, 1998 1998 1997 1996
-------------------- ----------------------------- ---------------------------- --------------------
AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE
BALANCE COST BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST
------- ---- ------- -------- ---- ------- -------- ---- ------- --------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans receivable $ 335,493 7.59% $320,630 $25,060 7.82% $ 286,310 $ 22,844 7.98% $227,987 $17,907
Mortgage-backed
securities (1) 181,239 5.56 243,836 13,255 5.44 343,958 18,946 5.51 418,638 23,194
Investment
securities (1) 14,054 5.45 10,736 610 5.68 654 88 13.46 8,639 526
Other investments 10,690 6.32 16,798 910 5.42 10,287 619 6.02 2,666 1,238
------- ------- ------ ------- ------ ------- ------
Total interest-
earning assets 541,476 6.83 592,000 39,835 6.73 641,209 42,497 6.63 677,930 42,865
------ ------ ------
Loan loss reserves (1,843) (1,825) (1,936) (1,779)
Non-interest-
earning assets 24,801 27,495 21,336 19,914
------- ------- ------- -------
Total assets $ 564,434 $617,670 $ 660,609 $696,065
======= ======= ======= =======
Interest-bearing liabilities:
Deposits $ 410,291 4.32 $403,626 18,107 4.49 $ 396,925 18,045 4.55 $410,010 18,044
------- ------- ------ ------- ------ ------- ------
Repurchase Agreements 45,000 5.79 64,463 3,925 6.09 119,459 7,251 6.07 152,322 8,695
FHLB advances 53,286 6.32 82,853 5,795 6.99 80,403 5,916 7.36 69,914 5,262
Other borrowed money -- -- -- -- -- 311 31 9.97 1,698 170
------- ------- ------ ------- ------ ------- ------
Total borrowed money 98,286 6.08 147,316 9,720 6.60 200,173 13,198 6.59 223,934 14,127
------- ------- ------ ------- ------ ------- ------
Total interest-bearing
liabilities 508,577 4.66 550,942 27,827 5.05 597,098 31,243 5.23 633,944 32,171
------ ------ ------
Non-interest-bearing
deposits 10,527 12,236 10,249 8,456
Other non-interest-
bearing liabilities 9,194 20,258 12,721 14,262
------- ------- ------- -------
- -------
Total liabilities 528,298 583,436 620,068 656,662
Stockholders' equity 36,136 34,234 40,541 39,403
------- ------- ------- -------
Total liabilities and
stockholders' equity $ 564,434 $617,670 $ 660,609 $696,065
======= ======= ======= =======
Net interest income $ 12,008 $ 11,254 10,694
====== ====== ======
Interest rate spread 2.17% 1.68% 1.40%
==== ==== ====
Net interest margin 2.45% 2.03% 1.76%
==== ==== ====
Ratio of average interest-
earning assets to
average interest-
bearing liabilities 106.47% 107.45% 107.39%
====== ====== ======
AVERAGE
YIELD/
COST
------
Interest-earning assets:
Loans receivable 7.85%
Mortgage-backed
securities (1) 5.54
Investment
securities (1) 6.09
Other investments 5.46
Total interest-
earning assets 6.32
Loan loss reserves
Non-interest-
earning assets
Total assets
Interest-bearing liabilities:
Deposits 4.40
Repurchase Agreements 5.71
FHLB advances 7.53
Other borrowed money 10.01
Total borrowed money 6.31
Total interest-bearing
liabilities 5.07
Non-interest-bearing
deposits
Other non-interest-
bearing liabilities
Total liabilities
Stockholders' equity
Total liabilities and
stockholders' equity
Net interest income
Interest rate spread 1.25%
======
Net interest margin 1.58%
======
Ratio of average interest-
earning assets to
average interest-
bearing liabilities 106.94%
======
- --------------------------------------------------------------------------------
(1) Average yield calculations are based on average balance exclusive of average
net unrealized gain (loss) on available-for-sale securities.
- --------------------------------------------------------------------------------
8
COMMUNITY BANKING FOR OVER A CENTURY
56
- --------------------------------------------------------------------------------
PROVISION FOR LOAN LOSSES
Management provides for and determines the adequacy of the allowance for loan
losses based on MSB's past loan loss experience, review of individual problem
loans, inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of the underlying collateral
and current economic conditions. In the opinion of Management, the allowance,
when taken as a whole, is adequate to absorb losses in the portfolio. While
Management uses the best information available to make evaluations, the ultimate
repayment of all loans is susceptible to future market factors and events beyond
MSB's control. These factors and events may result in losses or recoveries
differing from those provided for in the consolidated financial statements.
These reviews resulted in a provision of $585,000 during 1998, $225,000 during
1997 and $180,000 during 1996.
During 1998 MSB's net loans receivable increased $12.587 million, or 3.99%, to
$327.692 million. This increase is comprised of a $14.519 million increase in
commercial loans and a $9.191 million increase in mortgage loans partially
offset by an $11.123 million decline in consumer loans. Net charge-offs of
$711,000 including a $297,000 specific reserve discussed below and the
additional loan growth reduced the ratio of MSB's allowance for loan losses to
total loans from 0.62% at December 31, 1997 to 0.56% at December 31, 1998. At
December 31, 1998 the allowance for loan losses includes $84,000 of specific
allowances.
The level of non-performing loans declined to $196,000 at December 31, 1998 from
$261,000 at December 31, 1997 and the ratio of non-performing loans to net loans
declined to 0.06% at December 31, 1998 from 0.08% at December 31, 1997. Net loan
charge-offs increased to $711,000 for 1998 as compared to $112,000 for 1997. The
majority of this increase is due to charge-offs on indirect automobile loans.
MSB phased out its indirect automobile lending operations beginning on October
1, 1998. At December 31, 1998 the outstanding balance of indirect consumer loans
totaled $14.285 million. The increase in the level of net loan charge-offs also
reflects the $297,000 charge-off recorded in the second quarter of 1998 related
to a commercial real estate loan participation which had been specifically
reserved for several years earlier. This property is now included in real estate
owned and other repossessed assets for $154,000. The ratio of non-performing
assets to total assets was 0.09% at December 31, 1998 and 0.07% at December 31,
1997. At December 31, 1998 the gross recorded investment in impaired loans (all
of which were commercial loans) was $508,000. These loans had allowances for
loan losses of $45,000. Loan loss reserves at December 31, 1998 equaled 351.11%
of non-performing assets.
Consumer loans, in particular indirect consumer loans, and commercial real
estate loans are generally considered to involve greater credit risk than
residential mortgage loans. The increase in MSB's provision for loan losses in
1997 and 1998 reflects the potential greater credit risk in the portfolio, the
increase in the level of net loan charge-offs, as well as the overall increase
in the size of the total loan portfolio.
OTHER INCOME (LOSS)
The following table summarizes the components of other income (loss) including
one-time income or loss items, such as the settlement of the class action
lawsuit, bulk mortgage loan servicing sales, real estate transactions or
security sales:
- ------------------------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Gains and fees on loans sold $2,237 $ 629 $ 609
Loan servicing fees 638 1,115 1,383
Other fees 1,674 1,473 1,326
Other, net 663 492 515
----- ------ -----
Other income, exclusive of items below 5,212 3,709 3,833
Settlement of class action lawsuit -- (9,650) --
Gain on sale of bulk mortgage loan servicing -- -- 549
Net gain on sale of premises and equipment,
real estate owned and other repossessed assets 61 64 166
Net loss on sale of investment securities -- -- (670)
----- ------ -----
Total other income (loss) $5,273 $ (5,877) $ 3,878
===== ====== ======
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9
COMMUNITY BANKING FOR OVER A CENTURY
57
- --------------------------------------------------------------------------------
Gains and fees on loans sold were $2,237,000, $629,000 and $609,000 for 1998,
1997 and 1996, respectively. Mortgage loan sales of $200.863 million during
1998, $65.087 million during 1997 and $66.653 million during 1996 generated
these gains. The increase in mortgage loan sales reflects an increase in
origination volume due primarily to lower mortgage loan interest rates in 1998
as compared to the year earlier period which has resulted in a significant
increase in mortgage loan refinance activity. Gains and fees on loans sold in
1997 include the sale of $780,000 of purchased mobile home loans at a gain of
$47,000. These mobile home loans were sold to the loan servicer who had
previously originated and sold the loans to MSB. Excluding this non-recurring
item, gains and fees on loans sold decreased from 1996. The decrease in gains
and fees on loans sold in 1997, compared to 1996, was primarily due to somewhat
lower margins on such sales principally as a result of increased competition.
Changes in the level of interest rates and the condition of the local and
national economies affect the amount of mortgage loans originated by MSB and the
volume of loan sales. Generally, MSB's mortgage loan origination and sale
activity and, therefore, the level of gains and fees on loans sold, may be
adversely affected by, among other things, an increasing interest rate
environment to the extent such environment results in decreased loan demand by
borrowers. Accordingly, the volume of loan originations and sales and the
profitability of this activity can vary significantly from period to period,
which can have significant effects on MSB's results of operations from period to
period.
Loan servicing income was $638,000, $1,115,000 and $1,383,000 for the years
ended December 31, 1998, 1997 and 1996, respectively. The decline in loan
servicing income is primarily due to a decline in the average balance of loans
serviced for others and additional amortization of capitalized originated
mortgage servicing rights. The average amount of mortgage loans serviced for
others was $511.917 million in 1998, $516.774 million in 1997, and $583.005
million in 1996. The decline in mortgage loans serviced for others from 1996 to
1997 is primarily due to the sale of $53.798 million of bulk mortgage loan
servicing rights in the third quarter of 1996 and principal amortization and
prepayments exceeding the level of servicing retained mortgage loan sales. MSB
recorded a gain on the sale of bulk mortgage loan servicing of $549,000 in the
third quarter of 1996. The sold mortgage loan servicing related to loans
primarily originated in Texas and Florida. MSB closed its loan production
offices located in Texas and Florida in May 1994. Originated mortgage servicing
rights amortization, which is recorded as a reduction of loan servicing income,
was $679,000 in 1998, $258,000 in 1997 and $176,000 in 1996. The increase in
amortization, in 1998 compared to 1997, is due to both an increase in the
balance of capitalized originated mortgage servicing rights and a significant
increase in prepayment activity. At December 31, 1998 and 1997 capitalized
originated mortgage servicing rights had carrying amounts of $1,880,000 and
$908,000, respectively, and estimated fair values of approximately $2,500,000
and $1,300,000, respectively. The amount of loans serviced for others related to
capitalized originated mortgage servicing rights was $284.045 million and
$154.219 million at December 31, 1998 and 1997, respectively. Lower mortgage
interest rates and an increase in the rate of prepayments may adversely affect
the level of mortgage loan servicing income in the future.
Other fees, which consist mainly of deposit and customer service related charges
increased $201,000 to $1,674,000 in 1998 from $1,473,000 in 1997. In 1996, other
fees were $1,326,000. Other fees increased from 1997 to 1998 primarily due to a
$127,000 increase in fee income paid to MSB for the issuance of third party
official checks. Official check fee income benefited from the increase in loan
disbursements in a mortgage refinance environment. In addition, ATM fee income
increased $63,000. The increase in other fees from 1996 to 1997 is principally
due to a $67,000 increase in fee income paid to MSB for the issuance of third
party official checks and a $42,000 increase in consumer loan fee income.
Other income, net, was $663,000, $492,000, and $515,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. The increase in 1998 from 1997
is primarily due to an increase of $157,000 in commission income earned on the
sale of investment and insurance products. The $23,000 decrease in 1997 from
1996 is primarily due to 1996 including a non-recurring $156,000 special
dividend
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on stock that MSB owns in a mortgage life reinsurance company, partially offset
by an $89,000 increase in income earned on the sale of investment and insurance
products in 1997. In 1997, MSB recorded a $9,650,000 charge for the settlement
of a class action lawsuit. (See "Other Matters -- Status of Legal Proceedings.")
MSB recorded a net gain on the sale of premises and equipment, real estate owned
and other repossessed assets of $61,000, $64,000 and $166,000 for the years
ended December 31, 1998, 1997 and 1996, respectively. The net gain of $61,000
during 1998 was primarily the result of the sale in September 1998 of a former
retail office site. The net gains during 1997 and 1996 were primarily due to the
sale of residential real estate acquired through foreclosure.
MSB recorded a gross loss of $670,000 on the sale of investment securities and
no gross gains for 1996. (See "Financial Condition -- Asset and Liability Mix.")
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $14.038 million in 1998, as compared to
$14.307 million in 1997 and $14.504 million in 1996. General and administrative
expenses decreased $269,000, or 1.9%, in 1998 compared to 1997. Excluding a
$260,000 one-time data processing charge related to the renegotiation of a data
processing services contract recorded in the third quarter of 1996, general and
administrative expenses increased $63,000, or less than 1%, in 1997 compared to
1996. The overall decline in general and administrative expenses principally
reflects continuing cost reduction efforts instituted in order to improve MSB's
long-term operating results.
The following table summarizes general and administrative expenses:
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FOR THE YEARS ENDED DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------
(IN THOUSANDS)
Salaries and employee benefits $ 6,375 $ 6,235 $ 5,946
Occupancy, equipment and supplies 2,309 2,462 2,271
Data processing 1,059 1,071 1,593
Federal deposit insurance premiums 1,318 1,451 1,267
Marketing and promotion 599 576 481
Professional fees 455 602 1,057
Other 1,923 1,910 1,889
------ ------ ------
Total general and administrative expenses $ 14,038 $ 14,307 $ 14,504
====== ====== ======
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The $140,000 increase in salaries and employee benefits in 1998 compared to 1997
is primarily due to annual salary increases that were effective at the beginning
of 1998. The increase in salaries and employee benefits expenses from 1996 to
1997 is primarily due to annual salary increases that were effective at the
beginning of 1997 and positions added in MSB's investment and insurance
subsidiary operations. The number of average full-time equivalent employees were
240 in 1998, 237 in 1997 and 231 in 1996.
Occupancy, equipment and supplies declined $153,000 in 1998 compared to 1997
primarily due to certain computer equipment that was fully depreciated in 1998
resulting in a decline in depreciation expense. The increase in occupancy,
equipment and supplies expenses from 1996 to 1997 is due primarily to the
purchase and installation of branch automation hardware and software. The total
cost of this system was approximately $1,500,000 and is being depreciated over a
five year time period. As a result, furniture, fixtures and equipment
depreciation expense increased $315,000 in 1997 as compared to 1996. This
increase in depreciation expense was partially offset by a decline in other
occupancy, equipment and supplies expenses.
The decline in data processing expense in 1998 and 1997 as compared to 1996 is
primarily due to a revised data processing services agreement with an unrelated
third party effective July 1, 1996. Under the provisions of the revised
agreement, the contract expiration date was extended from April 1998 to December
2001. The base monthly data processing fee, as specified in the contract, was
reduced by
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approximately $16,000 per month between July 1, 1996 and December 31, 1996 and
effective January 1, 1997 was reduced by approximately $30,000 per month. The
terms of the revised agreement required MSB to pay a one-time fee of $260,000
for the buy-out of certain remaining unamortized costs incurred by the
third-party data processing services provider under the original agreement. This
one-time fee was recorded as a data processing expense by MSB in the third
quarter of 1996.
The decline in federal deposit insurance premiums in 1998 compared to 1997 was
primarily a result of a decline in MSB's assessment rate. The increase in
federal deposit insurance premiums during 1997 as compared to 1996 was primarily
a result of an increase in the assessment rate partially offset by a decline in
the average balance of deposits. On October 21, 1996 MSB applied to the FDIC for
an exemption from a special assessment (in the amount of $3,041,000) mandated by
the Deposit Insurance Funds Act of 1996 (the "Funds Act"). The Funds Act
required the FDIC to impose a special assessment on institutions holding
deposits subject to assessment by the Savings Association Insurance Fund
("SAIF"). The FDIC granted the exemption. Therefore, MSB did not pay the special
assessment, but instead pays semiannual assessments to the SAIF according to the
rate schedule that was in effect for SAIF assessments on June 30, 1995 for the
period of 1997 through the end of 1999. An institution exempted from the SAIF
special assessment may later elect to make a pro rata payment equal to 16.7% of
the amount the institution would have owed for the special assessment
multiplied by the number of full semiannual periods remaining between the date
of payment of such pro rata amount and December 31, 1999. Upon payment of such
pro rata amount, the institution's rate schedule for SAIF assessments would
convert to the same schedule then in effect for all other institutions that paid
the full special assessment under the Funds Act. Management periodically
assesses the impact of making such a pro rata payment, and to date, has elected
to not make such payment.
In addition, effective January 1, 1997, the annual assessment rate for all
SAIF-insured institutions, including MSB, was increased by 6.48 basis points for
amounts assessed by the Financing Corporation. As a result of the above matters,
in January 1997 MSB's deposit insurance premiums increased from a rate of 29
basis points on SAIF-insured deposits to a rate of 35.48 basis points. MSB's
deposit insurance rate was 31.82 basis points for the three months ended
December 31, 1998. MSB anticipates a deposit insurance rate of 32.10 basis
points for the first quarter of 1999. Federal deposit insurance premium rates
are primarily based on a financial institution's capital ratios and supervisory
rating. Based upon MSB's current capital ratios and supervisory rating, its
federal deposit insurance premium rate is expected to decline by approximately
three basis points effective July 1, 1999 and by approximately an additional 23
basis points effective January 1, 2000. The expected changes in MSB's federal
deposit insurance premium rate are based on the current FDIC rate schedule.
Marketing and promotion expenses increased in 1998 as compared to 1997 and 1996
due primarily to the increased promotion of home equity loans and checking
accounts.
Professional fees include legal, accounting and consulting expenses. The changes
in professional fees are primarily due to legal expenses of $252,000, $390,000,
and $812,000, in 1998, 1997 and 1996, respectively. MSB's legal expenses have
been principally affected by the continuing costs related to defending various
securities suits and may increase in future periods depending on the level of
activity related to such suits. (See "Other Matters -- Status of Legal
Proceedings".)
INCOME TAXES
Based upon the Bank's recent historical operating results, the significant
contribution of gains and fees from loan sales to 1998 earnings (which benefited
from lower interest rates and a related increased level of mortgage loan
refinance volume) and the uncertainty related to the possible costs of a
remaining securities related lawsuit, Management believes realization of the
benefit of the net deferred tax asset is not more likely than not. Accordingly,
no federal income tax expense or benefit was recorded for the years ended
December 31, 1998, 1997 and 1996. Management will continue to review its
deferred tax asset valuation allowance on an ongoing basis. (See "Notes to
Consolidated Financial Statements, Note 12 - Income Taxes.")
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FINANCIAL CONDITION
ASSET AND LIABILITY MIX
An aspect of asset and liability management is the level and composition of
interest-earning assets and interest-bearing liabilities. The reduction and
change in composition of assets reflects MSB's objective of reducing its level
of mortgage-backed securities while increasing its loan portfolio in order to
attempt to manage its interest rate risk, increase its net interest income and
improve its capital ratios. At December 31, 1998 interest-earning assets were
$541.476 million while interest-bearing liabilities were $508.577 million. This
compares to interest-earning assets of $624.455 million and $647.182 million at
December 31, 1997 and 1996, respectively, and interest-bearing liabilities of
$583.139 million and $604.660 million at December 31, 1997 and 1996,
respectively.
Net loans (excluding loans held for sale) were $327.692 million at December 31,
1998, an increase of $12.587 million, or 3.99%, from the December 31, 1997 level
of $315.105 million. The increase reflects MSB's efforts to increase loans as a
percentage of assets, which increased to 58.06% at December 31, 1998 from 48.87%
at December 31, 1997. This increase is comprised of a $14.519 million increase
in commercial loans (including commercial real estate) and a $9.191 million
increase in mortgage loans partially offset by an $11.123 million decline in
consumer loans (primarily home equity loans and indirect automobile loans).
Commercial real estate loans generally entail significant additional risks as
compared to one- to four-family residential mortgage loans and typically involve
larger loan balances. The increased credit risk is a result of several factors,
including the concentration of principal in a smaller number of loans and
borrowers, the effects of general economic conditions on income producing
properties and the increased difficulty in evaluating and monitoring these types
of loans. Furthermore, the repayment of loans secured by commercial real estate
is typically dependent upon the successful operation of the related property. If
the cash flow from the property is reduced, the borrower's ability to repay the
loan may be impaired. Loans secured by commercial real estate may involve a
greater degree of environmental risk. Also, consumer lending is generally
considered to involve greater risk than residential mortgage lending,
particularly in the case of consumer loans that are unsecured or secured by
assets that depreciate rapidly, such as automobiles. In the latter case,
repossessed collateral for a defaulted consumer loan may not be sufficient for
repayment of the outstanding loan, and the remaining deficiency may not be
collectible. To the extent MSB continues to increase its originations of these
types of loans, the overall credit risk in its total loan portfolio may also
increase.
Overall loan origination volume totaled $363.172 million for 1998 compared to
$201.844 million for 1997. Residential real estate refinance loan originations
increased by $162.979 million in 1998 compared to 1997 due primarily to the
decline in mortgage loan interest rates. This increase in mortgage loan
refinance volume was also accompanied by an increase of $5.458 million (or 7.2%)
in residential real estate loan originations for purchases and construction.
Commercial loan origination volume increased to $33.337 million for 1998
compared to $19.604 million for 1997. Consumer loan origination volume declined
$20.842 million principally as a result of a decline in indirect consumer
lending. MSB's indirect consumer lending program that was initiated in the
fourth quarter of 1996 resulted in indirect loan originations of $20.085 million
in 1997 and $3.690 million in 1998. MSB phased out its indirect automobile
lending operations beginning on October 1, 1998.
The current interest rate environment presents several challenges to MSB's
efforts to increase loans receivable during 1999. Because MSB is predominantly a
residential mortgage lender, it is somewhat dependent on mortgage loan
origination volumes to grow its loan portfolio. There is presently only a slight
difference between short- and long-term interest rates resulting in most
borrowers selecting long-term fixed rate mortgage loans. MSB generally sells its
long-term fixed rate mortgage loans in order to attempt to manage its interest
rate risk. As a result, MSB is currently retaining a smaller percentage of its
mortgage loan origination volume for investment. In addition, the current lower
interest rates for long-term fixed rate mortgage loans have resulted in an
increased level of mortgage loan refinancing activity in MSB's existing mortgage
loan portfolio. This refinance activity has also resulted in an increase in the
level of prepayments in MSB's
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existing home equity loan portfolio as many borrowers are combining existing
first and second (home equity) mortgage loans into one new lower fixed interest
rate first mortgage loan.
Deposits at December 31, 1998 totaled $420.818 million, representing an increase
of 3.30%, or $13.430 million, from December 31, 1997. The increase in overall
deposit levels from December 31, 1997 is comprised of a $12.503 million increase
in money market and NOW accounts, a $2.425 million increase in savings accounts,
a $717,000 increase in non-interest bearing deposits and a $2.215 million
decrease in certificates of deposit ("CD's"). The decline in CD's primarily
reflects outflows to competitors paying higher interest rates. At the present
time, MSB has elected to not match the higher interest rates being paid by
certain competitors for CD's because of MSB's higher FDIC deposit insurance
premium rates and the availability of lower costing borrowings (when considering
MSB's FDIC insurance costs). As a result, MSB may continue to experience a
decline in its CD's in the future. Management believes that MSB has adequate
liquidity and borrowing capacity to offset any further declines in CD's.
Borrowings were reduced to 17.41% of total assets at December 31, 1998 as
compared to 28.78% of total assets at December 31, 1997. This decline is
primarily the result of utilizing mortgage-backed securities payments and
prepayments (in excess of loans originated and retained for the portfolio) to
reduce borrowings.
The combination of reducing mortgage-backed securities, reducing short-term
liabilities, extending certain liability maturities and expanding certain loan
programs represent the primary means by which MSB is attempting to manage its
level of interest rate risk.
INTEREST SENSITIVITY GAP AT DECEMBER 31, 1998
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate "gap." An asset or liability is said
to be interest rate sensitive within a specific time period if it will mature or
reprice within that time period. The interest rate sensitivity gap is defined as
the difference between the amount of interest-earning assets anticipated, based
upon certain assumptions, to mature or reprice within a specific time period and
the amount of interest-bearing liabilities anticipated, based upon certain
assumptions, to mature or reprice within that time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. During a period of rising interest rates, a negative gap
would tend to adversely affect net interest income while a positive gap would
tend to result in an increase in net interest income. During a period of
declining interest rates, a negative gap would tend to result in an increase in
net interest income while a positive gap would tend to adversely affect net
interest income.
At December 31, 1998 total rate sensitive liabilities maturing or repricing
within one year exceeded total rate sensitive assets maturing or repricing in
the same time period by $70.467 million, representing a negative cumulative one
year gap ratio of 12.48% of total assets. This negative one year gap was
$133.175 million, or 20.66%, of total assets at December 31, 1997. The
cumulative three year gap is a positive $1,714,000, or 0.30%, of total assets,
at December 31, 1998 compared to a negative cumulative three year gap of $78.083
million, or 12.11%, of total assets, at December 31, 1997. This change from 1997
to 1998 in the one year gap and cumulative three year gap primarily reflects
increased prepayment speeds anticipated for mortgage loans and mortgage-backed
securities due principally to lower interest rates, an increased level of
mortgage-backed securities now contractually maturing within three years as of
December 31, 1998 and a decline in the level of short-term borrowings.
MSB's cumulative one year negative gap position is such that, in a rising
interest rate environment, MSB's net interest income and MSB's net portfolio
value would be expected to decline. Future interest rate risk management
strategies will attempt to balance MSB's level of interest rate risk with its
efforts to improve net interest income.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1998 that are expected
to reprice, prepay or mature in each of the future time periods shown, based on
certain assumptions. Fixed rate loans and mortgage-backed securities are shown
on the basis of contractual amortization adjusted for prepayment at rates
derived from available industry sources. The prepayment rates range from 9% to
46% and are based on the instrument's interest rate. Adjustable rate loans,
investments and mortgage-backed securities are shown to reprice at the earlier
of the next contractual repricing date, call date or maturity. Repurchase
Agreements and FHLB advances are shown to reprice at the earliest call date.
The maturity or repricing of money market, interest checking and savings
accounts are based on forecasted decay rates. Asset prepayment and liability
decay rates are selected after considering the current interest rate
environment, industry prepayment and decay rates, and MSB's historical
experience. Management believes these assumptions are reasonable.
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INTEREST SENSITIVITY GAP AT DECEMBER 31, 1998
------------------------------------------------------------------------------------
NON-
EARNING
YIELD/ WITHIN 6 6 MONTHS 1 - 3 3 - 5 OVER OR NON-
COST MONTHS TO 1 YEAR YEARS YEARS 5 YEARS COSTING TOTAL
------ -------- --------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Interest-earning assets:
Mortgage loans 7.21% $ 43,006 $ 35,049 $ 76,684 $ 39,677 $ 44,838 $ -- $239,254
Commercial loans 8.88 8,689 7,303 12,892 5,454 3,664 -- 38,002
Consumer loans 8.32 21,114 6,921 19,368 10,658 176 -- 58,237
Mortgage-backed securities 5.56 21,620 33,955 112,742 5,722 7,200 -- 181,239
Investment securities 5.45 13,920 30 104 -- -- -- 14,054
Other investments 6.32 10,690 -- -- -- -- -- 10,690
-------- --------- -------- -------- -------- -------- --------
Total interest-earning assets 6.83% 119,039 83,258 221,790 61,511 55,878 -- 541,476
Loan loss reserves -- -- -- -- -- (1,843) (1,843)
Non-interest-earning assets -- -- -- -- -- 24,801 24,801
-------- --------- -------- -------- -------- -------- --------
Total assets $119,039 $ 83,258 $221,790 $ 61,511 $ 55,878 $ 22,958 $564,434
======== ========= ======== ======== ======== ======== ========
Interest-bearing liabilities:
Interest checking and
savings accounts 2.01% $ 9,204 $ 9,204 $ 17,146 $ 5,439 $ 35,287 $ -- $ 76,280
Money market accounts 3.85 17,427 17,427 17,427 17,428 -- -- 69,709
Certificates of deposit 5.11 133,468 60,914 59,757 10,163 -- -- 264,302
-------- --------- -------- -------- -------- -------- --------
Total deposits 4.32 160,099 87,545 94,330 33,030 35,287 -- 410,291
-------- --------- -------- -------- -------- -------- --------
Repurchase Agreements 5.79 20,000 -- 25,000 -- -- -- 45,000
FHLB advances 6.32 14 5,106 30,279 5,327 12,560 -- 53,286
-------- --------- -------- -------- -------- -------- --------
Total borrowed money 6.08 20,014 5,106 55,279 5,327 12,560 -- 98,286
-------- --------- -------- -------- -------- -------- --------
Total interest-bearing liabilities 4.66% 180,113 92,651 149,609 38,357 47,847 -- 508,577
Non-interest-bearing deposits -- -- -- -- -- 10,527 10,527
Other non-interest-bearing liabilities -- -- -- -- -- 9,194 9,194
-------- --------- -------- -------- -------- -------- --------
Total liabilities 180,113 92,651 149,609 38,357 47,847 19,721 528,298
Stockholders' equity -- -- -- -- -- 36,136 36,136
-------- --------- -------- -------- -------- -------- --------
Total liabilities and stockholders' equity $180,113 $ 92,651 $149,609 $ 38,357 $ 47,847 $ 55,857 $564,434
======== ========= ======== ======== ======== ======== ========
Excess (deficiency) of interest-earning
assets over interest-bearing liabilities $(61,074) $ (9,393) $ 72,181 $ 23,154 $ 8,031
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities (61,074) (70,467) 1,714 24,868 32,899
Interest sensitivity gap to total assets -10.82% -1.66% 12.78% 4.11% 1.42%
Cumulative interest sensitivity gap
to total assets -10.82% -12.48% 0.30% 4.41% 5.83%
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Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. While gap analysis is one of the most commonly used indicators
of interest rate risk in the thrift industry, there is no single interest rate
risk measurement system that takes into consideration all of the factors which
influence the net interest margin. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market interest rates. Also, 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 that 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, prepayment and early withdrawal levels would 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 an interest
rate increase.
MSB is subject to net interest income fluctuations to the degree that its
interest-bearing liabilities mature or reprice more rapidly, or on a different
basis, than its interest-earning assets. While having liabilities that mature or
reprice more frequently than assets may be beneficial in times of declining
interest rates, such an asset and liability structure will likely reduce net
interest income during periods of rising interest rates. The level of
prepayments on mortgages and mortgage-backed securities is a major assumption
affecting the repricing period of these assets. In addition to the level of
prepayments, the trend in net interest income will be dependent upon the shape
of the U.S. Treasury yield curve, the volume and composition of loan
originations, MSB's balance sheet profile, including asset size, composition of
assets, composition of liabilities and maturity/repricing activity, as
influenced by changes in, and levels of, interest rates.
LIQUIDITY AND CAPITAL RESOURCES
MSB's primary sources of funds are deposits, Repurchase Agreements, FHLB
advances, and proceeds from principal and interest payments on loans and
mortgage-backed and investment securities. While maturities and scheduled
amortization of loans and mortgage-backed securities are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
guaranteed securities and CD's. MSB is required to maintain specific minimum
levels of liquid investments as defined by the Office of Thrift Supervision
("OTS") regulations. This requirement may be varied at the direction of the OTS.
Regulations currently in effect require MSB to maintain liquid assets at least
equal to 4.0% of the sum of its average daily balance of net withdrawable
accounts and borrowed funds due in one year or less. MSB's liquidity ratios were
22.97%, 18.14% and 27.25% at December 31, 1998, 1997 and 1996, respectively. At
December 31, 1998, 1997 and 1996, liquid assets totaled $100.428 million,
$93.186 million and $128.706 million, respectively. The levels of these assets
are dependent on MSB's operating, financing, lending and investing activities
during any given period. At December 31, 1998, $49.065 million in liquid assets
were held-to-maturity and, thus, could not be sold to meet unexpected cash
outflows without significant financial statement ramifications.
MSB intends to retain for the portfolio certain originated residential mortgage
loans (primarily adjustable rate, balloon mortgage and fifteen year fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. MSB
will from time to time participate in or originate commercial real estate loans,
including real estate development loans. During 1998 MSB originated $297.536
million in residential mortgage loans. Of this amount, $105.631 million was
retained in MSB's portfolio, while the remainder was sold in the secondary
market. This compares to $129.099 million in originations during 1997 and
$150.219 million in originations during 1996. MSB also originated $33.337
million of commercial loans and $32.299 million of consumer loans in 1998. (See
"Notes to Consolidated Financial Statements, Note 14 - Commitments and
Contingencies" for information regarding commitments and contingencies at
December 31, 1998.)
Deposits are a primary source of MSB's funds for use in lending and for other
general business purposes. At December 31, 1998 deposits constituted 74.56% of
MSB's total assets compared to 63.19% at
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December 31, 1997 and 61.73% at December 31, 1996. Deposits that are scheduled
to mature or reprice in one year or less at December 31, 1998 totaled $247.644
million. Management believes that a significant portion of such deposits will
remain with MSB. Borrowings may be used to compensate for seasonal or other
reductions in normal sources of funds or for deposit outflows at more than
projected levels. Borrowings may also be used on a longer-term basis to support
increased lending or investment activities. At December 31, 1998 MSB had $45.000
million in Repurchase Agreements and $53.286 million in FHLB advances. Total
borrowings as a percentage of assets were reduced to 17.41% of total assets at
December 31, 1998 as compared to 28.78% of total assets at December 31, 1997.
MSB has sufficient available collateral to obtain additional advances from the
FHLB and, based upon current FHLB stock ownership, could obtain up to a total of
approximately $140 million in such advances.
Stockholders' equity at December 31, 1998 was $36.136 million, or 6.40% of total
assets, compared to $32.787 million, or 5.09% of total assets, at December 31,
1997. (See "Consolidated Statements of Changes in Stockholders' Equity.") MSB
exceeded all regulatory capital requirements at December 31, 1998. (See "Notes
to Consolidated Financial Statements, Note 2 - Regulatory Matters.")
OTS regulations do not permit MSB to pay dividends on its common stock if its
regulatory capital would be reduced below the level required by OTS regulations
or the amount required for the liquidation account established in connection
with its conversion from the mutual to stock form of ownership in 1992. In
addition, capital distribution regulations limit MSB's ability, based on its
capital level and supervisory rating, to make certain capital distributions such
as dividends and stock redemptions or repurchases.
OTHER MATTERS
REGULATION
In May 1992, MSB and the OTS executed a Supervisory Agreement which, as
subsequently amended, requires MSB to: (i) comply with the business plan filed
by Management and approved by the OTS; (ii) file additional three-year business
plans with the OTS on an annual basis, which are subject to OTS approval; (iii)
maintain its board of directors at a minimum of five directors with a majority
of outside directors; and (iv) fulfill certain reporting requirements. MSB
believes that it has substantially complied with each of the Supervisory
Agreement requirements during 1998 and 1997. On November 30, 1998 MSB received
approval of its 1999 Business Plan from the OTS.
STATUS OF LEGAL PROCEEDINGS
MSB, together with certain present and former directors and officers and certain
others, had been a defendant in consolidated lawsuits in the United States
District Court for the Eastern District of Michigan (the "Federal Court"). The
consolidated action combined two class action lawsuits filed in the Federal
Court and one class action lawsuit originally filed in the Circuit Court for
Oakland County, Michigan (the "State Court"). The lawsuits alleged certain
violations of federal securities law and Michigan Blue Sky Law. The lawsuit
filed in the State Court was dismissed upon being combined with the Federal
Court lawsuits. These lawsuits were all originally filed in 1995 and generally
alleged that certain disclosures made by MSB from late 1993 until late 1994,
including disclosures made by MSB in a Rights Offering Circular dated October
27, 1993, concerning its business plan and exposure to interest rate risk were
false and misleading or there were material omissions. A class consisting of
purchasers of MSB's stock during the period from November 30, 1993 to November
14, 1994 was certified by the Federal Court (the "Class").
On May 8, 1998, MSB entered into a Stipulation of Settlement (the "Settlement")
to resolve the consolidated class action lawsuit. Under the Settlement, MSB
agreed to make a cash payment of $12.000 million ($2.500 million of which MSB
received from its former directors' and officers' liability insurance carrier).
On July 8, 1998, the Federal Court entered a Final Judgment and Order approving
the Settlement and dismissing the action. There were no objections filed to the
Settlement and the time to appeal the Federal Court's approval of the Settlement
has expired with no appeal having been filed. Accordingly, the dismissal of the
case against all the defendants is final. MSB distributed the Settlement funds
to plaintiff's counsel on August 10, 1998. The funds, net of plaintiffs'
attorneys' fees and expenses, were distributed to the Class in December 1998.
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MSB recorded a $9.650 million charge to earnings in the fourth quarter of 1997
in anticipation of the Settlement of the consolidated class action lawsuit. The
$9.650 million charge covered the $9.500 million portion of the Settlement
attributable to MSB (the balance of the Settlement, $2.500 million, having been
received by MSB from its former directors' and officers' liability insurance
carrier) and the remaining $150,000 was accrued for MSB's legal expenses and any
other costs related to completion of the Settlement.
MSB, together with four present and former officers, remains as a defendant in a
separate lawsuit that was filed in 1995 on behalf of fourteen plaintiffs who
allegedly purchased MSB's common stock during 1992, 1993 and 1994. This lawsuit
similarly alleges that some of MSB's disclosures during that period concerning
its business plan and exposure to interest rate risk were false and misleading
in violation of state and federal securities laws and common law. Plaintiffs in
this lawsuit seek damages of approximately $3,000,000. That action was pending
in the United States District Court for the Eastern District of Michigan, but
has been transferred to the Northern District of Illinois, where it was
originally filed, in light of the Settlement.
MSB believes there are meritorious defenses to this lawsuit, has filed answers
denying the material allegations of all of the claims, and intends to continue
to pursue a vigorous defense. The ultimate outcome of this lawsuit and the
results of the legal process cannot be predicted with certainty. No provision
has been recorded for any potential loss for this lawsuit at the present time
because MSB does not believe it is reasonably probable that any material loss
will be incurred as a result of the final disposition of this lawsuit and/or is
unable to reasonably estimate the amount of any potential loss.
Other pending legal proceedings and regulatory matters have occurred in the
ordinary course of business and do not involve amounts in the aggregate that are
believed by Management to be material to the financial condition of MSB.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("Statement 130"). Statement 130 establishes standards for reporting and display
of comprehensive income and its components in a full set of financial
statements. Comprehensive income is the total of reported net income and all
other revenues, expenses, gains and losses that under generally accepted
accounting principles bypass reported net income. Statement 130 permits the
statement of changes in stockholders' equity to be used to meet this
requirement. Companies are also required to report comparative totals for
comprehensive income in interim reports. Management adopted the provisions of
this Statement, which are only of a disclosure nature, effective January 1,
1998.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("Statement 131"). This Statement
supersedes FASB SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." Statement 131 introduces a new model for segment reporting called
the "management approach." The management approach is based on the way the chief
operating decision-maker organizes segments within a company for making
operating decisions and assessing performance. Based on the "management
approach" model, MSB has determined that its business is comprised of a single
operating segment and that Statement 131 therefore has no impact on its
financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This statement revises employers'
disclosures about pension and other postretirement benefit plans. MSB is a
participant in a multi-employer pension plan and therefore MSB's disclosures
regarding pensions will not change materially. MSB adopted the provisions of
this statement, which are only of a disclosure nature, effective January 1,
1998.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("Statement 133"). Statement 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. Statement 133 requires companies to record derivatives on
the balance sheet as assets or
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liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. Statement 133 is
effective for all fiscal years beginning after June 15, 1999. Upon initial
application, hedging relationships must be designated anew and documented
pursuant to the provisions of Statement 133. Statement 133 may not be applied
retroactively to financial statements of prior periods. Management does not
expect the implementation of this statement to have a material impact on its
financial statements.
In November 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" ("Statement 134"). Statement 134 changes the way
mortgage banking firms account for certain securities and other interests
retained after securitizing mortgage loans. Statement 134 is effective for the
first fiscal quarter beginning after December 15, 1998. MSB generally does not
securitize mortgage loans prior to sale to the secondary mortgage market.
YEAR 2000 COMPLIANCE
A significant issue has emerged in the banking industry and for the economy
overall regarding how existing application software programs and operating
systems can accommodate the date value for the year 2000. The Year 2000 issue is
pervasive and presents both technical and business risks affecting MSB. Many
existing computer programs use only two digits to identify a year in the date
field. These programs were designed and developed without considering the impact
of the upcoming change in the century. If not corrected, many computer
applications could fail or create erroneous results by or at the year 2000. The
Year 2000 issue affects virtually all companies to varying degrees. MSB's
material risk in this area arises principally from its purchase of data
processing services from outside vendors. MSB has contacted its major computer
service vendors and has received assurances that those computer services will
properly function on January 1, 2000. However, in the event a major vendor of
MSB is unable to fulfill its contractual obligation, MSB could experience
material costs.
Management is undertaking an ongoing evaluation of the Year 2000 issue,
including a review of both internal and external risks presented by providers of
data processing products and services, business partners, counterparties and
major loan customers. MSB began to address the Year 2000 issue in July 1997 and
formally established the Year 2000 Steering Committee (the "Committee") in
January 1998 to monitor MSB's activities. This Committee is responsible for
communicating with MSB's service providers and software vendors in order to
determine the extent to which MSB can rely on their services and products to
perform effectively with respect to Year 2000. The Committee periodically
reports to MSB's Board of Directors. The Committee has completed its assessment
of MSB's data processing systems. Individual system analysis includes target
dates for completion of the renovation phase, validation phase and
implementation phase. The Committee has developed contingency plans in the event
that efforts to remediate individual systems are not completely successful. The
target dates established are in compliance with regulatory guidelines
established by the Federal Financial Institutions Examination Council.
MSB's Year 2000 project costs are embedded in most continuing data processing
expenditures such as monthly service bureau processing costs and computer
equipment replacement costs. The following table summarizes certain data
processing expenses:
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FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997
----------- ----------
Data processing $ 1,059,000 $1,071,000
Computer equipment depreciation 590,000 718,000
Information Technology Department
salaries and employee benefits 110,000 95,000
- --------------------------------------------------------------------------------
Data processing costs consisting primarily of service bureau expense for 1998
and 1997 were relatively similar. Computer equipment net book value at December
31, 1998 was $1,228,000 compared to $1,609,000 at December 31, 1997. During
1998, MSB has purchased $210,000 of computer equipment. Prior to purchase, the
vendor certified the computer equipment as Year 2000 compliant. MSB's
Information Technology Department salaries and employee benefits have increased
in 1998 compared to the year earlier due to an increase in full-time equivalent
employees from two to three effective September 1, 1997. Because internal staff
is primarily completing the Year 2000 project, MSB does not expect to incur any
significant costs with outside contractors relative to this project. Other than
the Information Technology Department total compensation costs, management and
staff costs have not been delineated for Year 2000 projects. Anticipated future
data processing expenses are not expected to materially differ from current
expense.
Management will continue to monitor the progress of its outside vendors in
addressing Year 2000 issues. Applications and systems are now in place at nearly
all of these outside vendors to address Year 2000 issues. Significant testing of
such applications and systems will be conducted to insure that they are adequate
to meet the needs of MSB at January 1, 2000. The testing of all data processing
systems that have been identified by MSB as "mission critical" has been
completed and the results of such testing have been satisfactory.
The discussion above incorporates MSB's best estimates of the costs and
completion date of the Year 2000 project. MSB derived these estimates using
numerous assumptions of future events, including the continued availability of
certain resources and other factors. There can be no guarantee that MSB will
achieve these estimates. Therefore, actual results could differ materially from
those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
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MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
MSB's market risk arises primarily from interest rate risk inherent in its
lending, investing and deposit taking activities. MSB's interest rate risk is
measured quarterly by use of a report generated by the OTS and provided to MSB
that is based on data provided by MSB to the OTS. While there are many models
for analyzing interest rate risk employing varying assumptions, MSB prefers to
analyze and report its interest rate risk relying in a larger part on the OTS
generated model. Reporting interest rate risk in reliance on the OTS model
provides investors with useful information as to how MSB's primary federal
regulator evaluates MSB's interest rate risk and also aids investors in doing a
peer group comparison because many of MSB's peers analyze and report interest
rate risk using an OTS generated model.
On December 1, 1998, the OTS adopted comprehensive guidance, in the form of
Thrift Bulletin 13a ("TB 13a"), covering interest rate risk, investment
securities and use of financial derivatives. TB 13a replaces seven prior OTS
thrift bulletins covering these and related topics. The OTS also updated its
regulations with a new rule (effective January 1, 1999) on forward commitments,
futures transactions and financial options transactions. The new rule, which is
designed to work with TB 13a, establishes general requirements applicable to all
derivative instruments, sets forth responsibilities of the board of directors
and management with respect to financial derivatives and makes clear that
reducing risk exposure should be the primary reason for entering into a
derivatives transaction. TB 13a provides guidelines for evaluating an
institution's risk management, identifies a set of "sound practices" for
consideration of management and describes the qualitative and quantitative
guidelines the OTS will use in assessing an institution's current exposure to
interest rate changes and its ability to manage that exposure effectively. The
OTS will use the results of its net portfolio value ("NPV") model to measure an
institution's current exposure. Under TB 13a, an institution's board of
directors should establish interest rate risk limits in terms of its capital
position (its economic capital-to-assets ratio). Investment securities and
derivatives, especially those with the potential to alter significantly an
institution's risk profile, should be evaluated on the basis of their impact on
the institution's economic capital. Institutions with greater capacity to absorb
potential losses will have greater latitude in using derivatives and other
complex financial instruments. MSB's Board of Directors has established interest
rate risk limits under TB 13a. As of December 31, 1998 MSB is in compliance with
these Board established limits.
The business of MSB and the composition of its balance sheet consists of
investments in interest-earning assets (primarily loans, mortgage-backed
securities, investment securities, and FHLBstock) 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 MSB are for other than trading
purposes. Generally, such loans held-for-sale are "pre-sold," in that the loans
are originated against and in conformity with existing commitments MSB has made
with FHLMC, FNMA or another approved investor. Because MSB's portfolio of
trading assets is limited to loans held-for-sale that are "pre-sold," MSB is not
exposed to significant market risk from trading activities.
Interest rate risk results when the maturity or repricing intervals and interest
rate indices of the interest-earning assets, interest-bearing liabilities, and
off-balance sheet financial instruments are different, creating a risk that
changes in the level of market interest rates will result in disproportionate
changes in the value of, and the net earnings generated from, MSB's
interest-earning assets, interest-bearing liabilities, and off-balance sheet
financial instruments. MSB's exposure to
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interest rate risk is managed primarily through MSB's strategy of selecting the
types and terms of interest-earning assets and interest-bearing liabilities
which generate favorable earnings, while limiting the potential negative effects
of changes in market interest rates. Since MSB's primary source of
interest-bearing liabilities is customer deposits, MSB's ability to manage the
types and terms of such deposits may be somewhat limited by customer preferences
in the market areas in which MSB operates. Borrowings, which include FHLB
advances and Repurchase Agreements, are generally structured with specific terms
which in Management's judgment, when aggregated with the terms for outstanding
deposits and matched with interest-earning assets, mitigate MSB's exposure to
interest rate risk. The rates, terms and interest rate indices of MSB's
interest-earning assets result primarily from MSB's strategy of investing in
loans and securities (a portion of which have adjustable rate terms) which
permit MSB to reduce its exposure to interest rate risk, together with credit
risk, while at the same time achieving a positive interest rate spread from the
difference between the income earned on interest-earning assets and the cost of
interest-bearing liabilities. The level of MSB's interest rate risk is such
that, in a rising interest rate environment, MSB's net interest income and net
portfolio value would be expected to decrease.
At December 31, 1998, MSB was a party to certain fixed rate FHLB advances and
Repurchase Agreements that include an option for the counterparty to convert the
borrowing into an adjustable rate or require repayment of the borrowing. MSB is
party to financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit.
These instruments involve to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the Consolidated Statements of
Financial Condition.
SIGNIFICANT ASSUMPTIONS UTILIZED IN MANAGING INTEREST RATE RISK
Managing MSB's exposure to interest rate risk involves significant assumptions
about the exercise of imbedded options and the relationship of various interest
rate indices of certain financial instruments.
IMBEDDED OPTIONS
A substantial portion of MSB's loans receivable and mortgage-backed securities
are comprised of residential mortgage loans containing significant imbedded
options which permit the borrower to prepay the principal balance of the loan
prior to maturity ("prepayments") without penalty. A loan's propensity for
prepayment is dependent upon a number of factors, including, the current
interest rate and interest rate index (if any) on the loan, the financial
ability of the borrower to refinance, the economic benefit to be obtained from
refinancing, availability of refinancing at attractive terms, as well as
economic and other factors in specific geographic areas which affect the sales
and price levels of residential property. In a changing interest rate
environment, prepayments may increase or decrease on fixed and adjustable rate
loans depending on the current relative levels and expectations of future short-
and long-term interest rates. Since a significant portion of MSB's mortgage and
home equity loans are adjustable rate loans, prepayments on such loans generally
increase when long-term interest rates fall or are at historically low levels
relative to short-term interest rates making fixed rate loans more desirable.
Investment securities, other than those with early call provisions, generally do
not have significant imbedded options and repay pursuant to specific terms until
maturity. While savings and checking deposits generally may be withdrawn upon
the customer's request without prior notice, a continuing relationship with
customers resulting in future deposits and withdrawals is generally predictable.
Time deposits generally have early withdrawal penalties, while term FHLB
advances and other borrowings have prepayment penalties, which discourage
customer withdrawal of time deposits and prepayment of FHLB advances and other
borrowings prior to maturity.
INTEREST RATE INDICES
MSB's adjustable rate mortgage ("ARM") loans and mortgage-backed securities are
primarily indexed to the One Year Constant Maturity Treasury Index. When loans
and mortgage-backed securities are funded by interest-bearing liabilities such
as deposits, FHLB advances and other borrowings which may have interest rates
determined by other indices, a changing interest rate environment may result in
different levels of change in the different indices leading to disproportionate
changes in the value of, and the net earnings generated from, MSB's financial
instruments. Each index is unique and is influenced by different external
factors, therefore, the historical relationships in various indices may not
necessarily be indicative of the actual change which may result in a changing
interest rate environment.
INTEREST RATE RISK MEASUREMENT
In addition to periodic gap reports (see "Management's Discussion and Analysis
of Operating Results and Financial Condition -- Financial Condition -- Interest
Sensitivity Gap at December 31, 1998") comparing the sensitivity of
interest-earning assets and interest-bearing liabilities to changes in interest
rates, Management also utilizes a quarterly report ("model") prepared for MSB by
the OTS based on information provided by MSB which measures MSB's exposure to
interest rate risk. The model calculates the present value of assets,
liabilities, off-balance sheet financial instruments, and equity at current
interest rates, and at hypothetical higher and lower interest rates at one
percent intervals. The present value of each major category of financial
instruments is calculated by the model using estimated cash flows based on
weighted-average contractual interest rates and terms at discount rates
representing the estimated current market interest rate for similar financial
instruments.
The resulting present value of longer term fixed rate financial instruments are
more sensitive to change in a higher or lower market interest rate scenario,
while adjustable rate financial instruments largely reflect only a change in
present value representing the difference between the contractual and discounted
rates until the next interest rate repricing date.
The following tables reflect the estimated present value of interest-earning
assets, interest-bearing liabilities and loan commitments as calculated by the
OTS for MSB as of December 31, 1998 and 1997, at interest rates as of those
respective dates and at hypothetical higher and lower interest rates of one and
two percent.
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AT DECEMBER 31, 1998
------------------------------------------------------------------------------
PRESENT VALUE
------------------------------------------------------------------------------
-2% -1% CURRENT +1% +2%
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Interest-earning assets:
Investments, FHLB deposits,
FHLB stock and other
interest-earning assets $ 24,818 $ 24,799 $ 24,781 $ 24,762 $ 24,745
Mortgage loans and
mortgage-backed securities 507,847 501,281 493,100 482,658 471,133
Non-mortgage loans 28,306 27,874 27,456 27,050 26,655
--------- --------- --------- --------- ---------
Total interest-earning assets $ 560,971 $ 553,954 $ 545,337 $ 534,470 $ 522,533
========= ========= ========= ========= =========
Interest-bearing liabilities:
Money market and NOW accounts $ 106,201 $ 106,201 $ 106,201 $ 106,201 $ 106,201
Passbook and statement savings
accounts 39,786 39,786 39,786 39,786 39,786
Certificate accounts 270,206 268,032 265,892 263,805 261,749
--------- --------- --------- --------- ---------
Total deposits 416,193 414,019 411,879 409,792 407,736
Borrowings 105,705 102,768 100,074 97,595 95,307
--------- --------- --------- --------- ---------
Total interest-bearing liabilities $ 521,898 $ 516,787 $ 511,953 $ 507,387 $ 503,043
========= ========= ========= ========= =========
Commitments to originate and
sell loans, net $ 1,419 $ 926 $ 225 $ (661) $ (1,595)
========= ========= ========= ========= =========
AT DECEMBER 31, 1997
------------------------------------------------------------------------------
PRESENT VALUE
------------------------------------------------------------------------------
-2% -1% CURRENT +1% +2%
--------- --------- --------- --------- ---------
(IN THOUSANDS)
Interest-earning assets:
Investments, FHLB deposits,
FHLB stock and other
interest-earning assets $ 11,767 $ 11,740 $ 11,717 $ 11,695 $ 11,676
Mortgage loans and
mortgage-backed securities 603,420 594,841 582,879 569,403 555,265
Non-mortgage loans 29,234 28,798 28,374 27,962 27,561
--------- --------- --------- --------- ---------
Total interest-earning assets $ 644,421 $ 635,379 $ 622,970 $ 609,060 $ 594,502
========= ========= ========= ========= =========
Interest-bearing liabilities:
Money market and NOW accounts $ 93,778 $ 93,778 $ 93,778 $ 93,778 $ 93,778
Passbook and statement savings
accounts 37,362 37,362 37,362 37,362 37,362
Certificate accounts 271,461 268,996 266,584 264,220 261,924
--------- --------- --------- --------- ---------
Total deposits 402,601 400,136 397,724 395,360 393,064
Borrowings 191,291 188,650 186,102 183,643 181,267
--------- --------- --------- --------- ---------
Total interest-bearing liabilities $ 593,892 $ 588,786 $ 583,826 $ 579,003 $ 574,331
========= ========= ========= ========= =========
Commitments to originate and
sell loans, net $ 1,096 $ 684 $ 224 $ (327) $ (923)
========= ========= ========= ========= =========
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The calculations of present value have certain shortcomings. The discount rates
utilized for loans and mortgage-backed securities are based on estimated market
interest rate levels for similar loans and securities nationwide, with projected
prepayment levels. The unique characteristics of MSB's loans and mortgage-backed
securities may not necessarily parallel those assumed in the model, and
therefore, would likely result in different discount rates, prepayment
experiences and present values. The discount rates utilized for deposits and
borrowings are based upon available alternative types and sources of funds which
are not necessarily indicative of the present value of MSB's deposits and FHLB
advances since such deposits and FHLB advances are unique to, and have certain
price and customer relationship advantages for, depository institutions. The
present values are determined based on the discounted cash flows over the
remaining estimated lives of the financial instruments and assumes that the
resulting cash flows are reinvested in financial instruments with virtually
identical terms. The total measurement of MSB's exposure to interest rate risk
as presented in the above tables may not be representative of the actual values
which might result from a higher or lower interest rate environment. A higher or
lower interest rate environment will most likely result in different investment
and borrowing strategies by MSB to further mitigate the effect on the value of,
and the net earnings generated from, MSB's net assets from any change in
interest rates.
NET PORTFOLIO VALUE
An institution's NPV is calculated as the net discounted cash flows from assets,
liabilities and off-balance sheet contracts. The fair value of certain items
(e.g., value of deposit intangibles) may significantly differ from the OTS
model's valuation.
The following tables present MSB's ratio of NPV to the present value of its
total assets as of December 31, 1998 and 1997 as calculated by the OTS, based on
information provided to the OTS by MSB.
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AT DECEMBER 31, 1998
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CHANGE IN INTEREST RATES RATIO OF NPV TO
IN BASIS POINTS PRESENT VALUE OF THE PRESENT VALUE
(RATE SHOCK) NPV TOTAL ASSETS OF TOTAL ASSETS CHANGE
------------ --- ------------ --------------- ------
(DOLLARS IN THOUSANDS)
+200 $34,051 $558,721 6.09% (1.31)%
+100 38,925 567,004 6.87 (0.53)
Static 42,506 574,266 7.40 --
-100 44,414 580,306 7.65 0.25
-200 44,953 585,464 7.68 0.28
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AT DECEMBER 31, 1997
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CHANGE IN INTEREST RATES RATIO OF NPV TO
IN BASIS POINTS PRESENT VALUE OF THE PRESENT VALUE
(RATE SHOCK) NPV TOTAL ASSETS OF TOTAL ASSETS CHANGE
------------ --- ------------ --------------- ------
(DOLLARS IN THOUSANDS)
+200 $ 26,329 $ 633,309 4.16% (1.90)%
+100 33,599 644,656 5.21 (0.85)
Static 39,719 655,048 6.06 --
-100 44,163 663,991 6.65 0.59
-200 46,000 670,522 6.86 0.80
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 of repricing, they may react in different degrees
to changes in market interest rates. Also, 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 ARM loans, have features that
restrict changes in interest rates on a short-term basis and over the life of
the loan. Further, in the event of a change in interest rates, prepayment and
early withdrawal levels could deviate significantly from those assumed in
calculating the tables. Finally, the ability of many borrowers to service their
debt may decrease in the event of a significant interest rate increase.
In addition, the previous table does not necessarily indicate the impact of
general interest rate movements on MSB's net interest income because the
repricing of certain categories of assets and liabilities are subject to
competitive and other pressures beyond MSB's control. As a result, certain
assets and liabilities expected to mature or otherwise reprice within a stated
period may in fact mature or reprice at different times and at different
volumes.
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MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
STATEMENT OF MANAGEMENT'S RESPONSIBILITY
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FINANCIAL STATEMENTS
The Bank is responsible for the preparation, integrity, and fair presentation of
its published financial statements as of December 31, 1998, and for the year
then ended. The financial statements have been prepared in accordance with
generally accepted accounting principles, and as such, include amounts, some of
which are based on judgments and estimates of Management.
INTERNAL CONTROL STRUCTURE OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting presented in conformity with
generally accepted accounting principles and the reporting requirements of the
OTS. The structure contains monitoring mechanisms, and actions are taken to
correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control
structure, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.
Management assessed the Bank's internal control structure over financial
reporting presented in conformity with both generally accepted accounting
principles and the reporting requirements of the OTS as of December 31, 1998.
This assessment was based on criteria for effective internal control over
financial reporting described in "Internal Control-Integrated Framework" issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on this assessment, Management believes that, as of December 31, 1998, the Bank
maintained an effective internal control structure over financial reporting
presented in conformity with generally accepted accounting principles and the
reporting requirements of the OTS.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with federal and state laws and
regulations concerning loans to insiders and dividend restrictions designated by
the FDIC as safety and soundness laws and regulations.
Management assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, Management believes
that the Bank complied, in all significant respects, with the designated laws
and regulations relating to safety and soundness for the year ended December 31,
1998.
Robert N. Shuster Bernard D. Williams
Robert N. Shuster Bernard D. Williams
Chief Executive Officer Senior Vice President,
Chief Financial Officer and Treasurer
- --------------------------------------------------------------------------------
24
COMMUNITY BANKING FOR OVER A CENTURY
72
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
[KPMG LLP LOGO]
Board of Directors and Stockholders
Mutual Savings Bank, f.s.b. and Subsidiaries
Bay City, Michigan
We have audited the accompanying consolidated statements of financial condition
of Mutual Savings Bank, f.s.b. and Subsidiaries (the "Bank") as of December 31,
1998 and 1997, and the related consolidated statements of operations,
comprehensive income (loss), changes in stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mutual Savings Bank, f.s.b. and
Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Detroit, Michigan
February 2, 1999
- --------------------------------------------------------------------------------
25
COMMUNITY BANKING FOR OVER A CENTURY
73
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AT
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
1998 1997
------------- --------------
ASSETS
Cash on hand and on deposit .................................................... $ 11,097,267 $ 8,901,861
Interest-bearing deposits ...................................................... 3,666,821 4,494,895
------------- --------------
Cash and cash equivalents .................................................... 14,764,088 13,396,756
Investment securities available-for-sale ....................................... 166,484 198,544
Investment securities held-to-maturity
(fair value of $13,888,000 in 1998) ......................................... 13,888,050 --
Mortgage-backed securities available-for-sale .................................. 52,275,259 71,954,660
Mortgage-backed securities held-to-maturity
(fair value of $129,027,000 in 1998 and $218,359,000 in 1997) ............... 129,063,968 221,391,456
Loans held for sale ............................................................ 5,957,504 1,871,240
Loans, net of allowance for loan losses of $1,843,000 in 1998 and
$1,969,000 in 1997 ......................................................... 327,692,406 315,105,206
Real estate owned and other repossessed assets ................................. 328,896 191,645
Federal Home Loan Bank stock, at cost .......................................... 7,022,900 7,022,900
Premises and equipment, net .................................................... 8,017,347 8,572,649
Accrued interest receivable .................................................... 2,542,370 3,167,291
Capitalized originated mortgage servicing rights ............................... 1,880,194 908,272
Prepaid expenses and other assets .............................................. 834,648 959,539
------------- --------------
TOTAL ASSETS ................................................................... $ 564,434,114 $ 644,740,158
============= ==============
LIABILITIES & STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits ....................................................................... $ 420,817,972 $ 407,387,907
Securities sold under agreements to repurchase ................................. 45,000,000 85,000,000
Federal Home Loan Bank advances ................................................ 53,285,899 100,560,652
Accrued liability for settlement of class action lawsuit ....................... -- 9,650,000
Advance payments by borrowers for taxes and insurance .......................... 4,451,737 4,296,754
Accrued interest payable ....................................................... 2,018,723 2,395,495
Accrued expenses and other liabilities ......................................... 2,723,507 2,662,653
------------- --------------
TOTAL LIABILITIES .............................................................. $ 528,297,838 611,953,461
------------- --------------
Commitments and contingencies .................................................. -- --
STOCKHOLDERS' EQUITY:
Preferred stock ($.01 par value, 5,000,000 shares authorized,
no shares issued and outstanding in 1998 and 1997) ........................... -- --
Common stock ($.01 par value, 20,000,000 shares authorized,
4,290,414 shares issued and outstanding in 1998 and
4,281,914 shares issued and outstanding in 1997) ............................ 42,904 42,819
Additional paid-in capital ..................................................... 32,136,522 32,196,361
Retained earnings -- substantially restricted .................................. 4,655,084 1,997,241
Accumulated other comprehensive income (loss) .................................. 100,602 (446,763)
Unearned employee stock ownership plan shares .................................. (798,836) (1,002,961)
------------- --------------
TOTAL STOCKHOLDERS' EQUITY ..................................................... 36,136,276 32,786,697
------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ..................................... $ 564,434,114 $ 644,740,158
============= ==============
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
26
COMMUNITY BANKING FOR OVER A CENTURY
74
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1998 1997 1996
----------- ----------- -----------
INTEREST INCOME:
Interest and fees on loans ...................................... $25,059,786 $22,843,678 $17,906,658
Interest on mortgage-backed securities .......................... 13,255,179 18,946,315 23,193,783
Interest on investment securities ............................... 610,116 87,749 525,907
Other interest income ........................................... 909,710 619,257 1,238,177
----------- ----------- -----------
TOTAL INTEREST INCOME ............................................. 39,834,791 42,496,999 42,864,525
----------- ----------- -----------
Interest expense:
Interest on deposits ............................................ 18,106,530 18,044,982 18,043,929
Interest on securities sold under agreements to repurchase ...... 3,925,295 7,250,928 8,694,632
Interest on FHLB advances ....................................... 5,795,227 5,916,156 5,261,849
Interest on other borrowed money -- 31,127 170,066
----------- ----------- -----------
Total interest expense ............................................ 27,827,052 31,243,193 32,170,476
----------- ----------- -----------
Net interest income ............................................... 12,007,739 11,253,806 10,694,049
PROVISION FOR LOAN LOSSES ......................................... 585,000 225,000 180,000
----------- ----------- -----------
Net interest income after provision for loan losses ............... 11,422,739 11,028,806 10,514,049
----------- ----------- -----------
OTHER INCOME (LOSS):
Settlement of class action lawsuit .............................. -- (9,650,000) --
Gains and fees on loans sold .................................... 2,236,574 628,862 609,170
Gain on sale of bulk mortgage loan servicing -- -- 549,164
Loan servicing fees ............................................. 638,567 1,115,248 1,382,761
Other fees ...................................................... 1,674,039 1,473,636 1,325,551
Net gain on sale of premises and equipment, real
estate owned and other repossessed assets ..................... 60,711 63,766 166,237
Net loss on sale of investment securities -- -- (670,000)
Other, net ...................................................... 662,732 491,822 515,172
----------- ----------- -----------
Total other income (loss) ......................................... 5,272,623 (5,876,666) 3,878,055
----------- ----------- -----------
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits .................................. 6,374,583 6,234,634 5,946,298
Occupancy, equipment and supplies ............................... 2,309,252 2,462,360 2,270,794
Data processing ................................................. 1,058,639 1,070,783 1,593,176
Federal deposit insurance premiums .............................. 1,317,746 1,451,112 1,267,560
Marketing and promotion ......................................... 598,547 576,209 481,410
Professional fees ............................................... 455,286 601,341 1,056,691
Other ........................................................... 1,923,466 1,910,205 1,888,481
----------- ----------- -----------
Total general and administrative expenses ......................... 14,037,519 14,306,644 14,504,410
----------- ----------- -----------
Income (loss) before income tax expense ........................... 2,657,843 (9,154,504) (112,306)
Income tax expense ................................................ -- -- --
----------- ----------- -----------
NET INCOME (LOSS) ................................................. $ 2,657,843 $(9,154,504) $ (112,306)
=========== =========== ===========
- ------------------------------------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) PER SHARE: 1998 1997 1996
---- ---- ----
Basic earnings (loss) per share ................................. $ 0.63 $ (2.17) $ (0.03)
==== ===== =====
Diluted earnings (loss) per share ............................... $ 0.61 $ (2.17) $ (0.03)
==== ===== =====
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
27
COMMUNITY BANKING FOR OVER A CENTURY
75
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1998 1997 1996
---------- ------------ ----------
Net income (loss) ................................ $2,657,843 $ (9,154,504) $ (112,306)
Other comprehensive income:
Changes in unrealized gain (loss) on
available-for-sale securities ................. 547,365 1,178,933 775,730
---------- ------------ ----------
Comprehensive income (loss) ...................... $3,205,208 $ (7,975,571) $ 663,424
========== ============ ==========
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
RETAINED ACCUMULATED
ADDITIONAL EARNINGS- OTHER UNEARNED
COMMON PAID-IN SUBSTANTIALLY COMPREHENSIVE ESOP
STOCK CAPITAL RESTRICTED INCOME (LOSS) SHARES TOTAL
------- ----------- ------------- ------------- ------------ -----------
Balance at January 1, 1996 ................ $42,714 $32,444,323 $11,264,051 $(2,401,426) $(1,698,711) $39,650,951
Stock issued upon exercise of stock
options (2,760 shares) ................... 28 12,047 -- -- -- 12,075
Net loss for 1996 ......................... -- -- (112,306) -- -- (112,306)
Change in unrealized gain (loss) on
available-for-sale securities ............ -- -- -- 775,730 -- 775,730
ESOP loan guarantee payment and
valuation adjustment ..................... -- (179,108) -- -- 347,875 168,767
------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1996 .............. 42,742 32,277,262 11,151,745 (1,625,696) (1,350,836) 40,495,217
Stock issued upon exercise of stock
options (7,760 shares) ................... 77 35,247 -- -- -- 35,324
Net loss for 1997 ......................... -- -- (9,154,504) -- -- (9,154,504)
Changes in unrealized gain (loss) on
available-for-sale securities ............ -- -- -- 1,178,933 -- 1,178,933
ESOP loan guarantee payment and
valuation adjustment ..................... -- (116,148) -- -- 347,875 231,727
------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1997 .............. 42,819 32,196,361 1,997,241 (446,763) (1,002,961) 32,786,697
Stock issued upon exercise of stock
options (8,500 shares) ................... 85 43,290 -- -- -- 43,375
Net income for 1998 ....................... -- -- 2,657,843 -- -- 2,657,843
Changes in unrealized gain (loss) on
available-for-sale securities ............ -- -- -- 547,365 -- 547,365
ESOP loan guarantee payment
and valuation adjustment ................. -- (103,129) -- -- 204,125 100,996
------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1998 .............. $42,904 $32,136,522 $ 4,655,084 $ 100,602 $ (798,836) $36,136,276
======= =========== =========== =========== =========== ===========
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
28
COMMUNITY BANKING FOR OVER A CENTURY
76
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1998 1997 1996
------------- ------------- -------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) .................................................... $ 2,657,843 $ (9,154,504) $ (112,306)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED
BY (USED IN)OPERATING ACTIVITIES:
Loss on sale of investment securities ................................ -- -- 670,000
Gain on sale of bulk mortgage loan servicing ......................... -- -- (549,164)
Stock compensation amortized to expense .............................. 244,746 231,727 168,766
Depreciation ......................................................... 1,077,538 1,184,919 870,052
Capitalized originated mortgage servicing rights, net ................ (971,922) (216,412) (281,717)
(Gain) loss on sale of premises and equipment,
real estate owned and other repossessed assets .................... (60,711) (63,766) (166,237)
Accretion of discounts, amortization of premiums, and other
deferred yield items, net ......................................... (642,868) (111,042) (18,922)
Provision for loan losses ............................................ 585,000 225,000 180,000
Originations of loans held for sale .................................. (204,949,085) (65,941,529) (65,263,270)
Principal amount of loans sold ....................................... 200,862,821 65,867,036 66,653,140
(Increase) decrease in accrued interest receivable ................... 624,921 181,096 549,437
(Increase) decrease in prepaid expenses and other assets ............. 124,891 164,784 (134,332)
Increase (decrease) in accrued liability for settlement of class
action lawsuit .................................................... (9,650,000) 9,650,000 --
Increase (decrease) in accrued interest payable ...................... (376,772) (140,191) (59,751)
Increase (decrease) in accrued expenses and other liabilities ........ 60,854 (1,752,831) 749,200
Increase (decrease) in other, net .................................... 27,210 432,169 524,351
------------- ------------ ------------
Net cash provided by (used in) operating activities .................. (10,385,534) 556,456 3,779,247
------------- ------------ ------------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Proceeds from sales of:
Investment securities available-for-sale ............................. -- -- 38,250,000
Premises and equipment ............................................... 1,407 3,400 1,400
Real estate owned and other repossessed assets ....................... 540,102 623,424 483,377
Bulk mortgage loan servicing ......................................... -- -- 549,164
Purchases of:
Investment securities held-to-maturity ............................... (850,057,158) (78,750,000) (14,000,000)
Premises and equipment ............................................... (518,741) (1,147,919) (1,955,057)
(Increase) decrease in net loans receivable .............................. (13,240,032) (65,511,933) (57,097,936)
Principal payments received on:
Investment securities ................................................ 836,522,030 78,750,000 14,500,000
Mortgage-backed securities ........................................... 112,180,738 90,002,456 65,713,866
------------- ------------ ------------
Net cash provided by (used in) investing activities .................. 85,428,346 23,969,428 46,444,814
------------- ------------ ------------
- --------------------------------------------------------------------------------
29
COMMUNITY BANKING FOR OVER A CENTURY
77
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996-CONTINUED
- --------------------------------------------------------------------------------
1998 1997 1996
------------ ------------- -------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from Federal Home Loan Bank advances ........................... 22,748,076 71,124,600 5,000,000
Repayments of Federal Home Loan Bank advances ........................... (70,051,979) (45,529,083) --
Increase (decrease) in securities sold under agreements to repurchase ... (40,000,000) (42,000,000) (42,965,000)
Increase (decrease) in other borrowed money ............................. -- (1,350,836) (347,875)
Increase (decrease) in deposits ......................................... 13,430,065 (2,919,540) (16,825,907)
Increase (decrease) in advances by borrowers for taxes and insurance .... 154,983 649,179 (2,096,477)
Issuance of common stock ................................................ 43,375 35,324 12,075
----------- ------------ ------------
Net cash provided by (used in) financing activities ..................... (73,675,480) (19,990,356) (57,223,184)
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents ........................ 1,367,332 4,535,528 (6,999,123)
Cash and cash equivalents at beginning of period ............................ 13,396,756 8,861,228 15,860,351
----------- ------------ ------------
Cash and cash equivalents at end of period .................................. $14,764,088 $13,396,756 $ 8,861,228
=========== ============ ============
Cash paid during the year for interest ...................................... $28,203,824 $31,383,384 $32,230,227
=========== ============ ============
Cash paid for federal income taxes .......................................... $ -- $ -- $ --
=========== ============ ============
Supplemental disclosure of cash flow information:
Transfer of loans, at fair value, to real estate owned and
other repossessed assets .............................................. $ 652,832 $ 274,243 $ 209,681
=========== ============ ============
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
30
COMMUNITY BANKING FOR OVER A CENTURY
78
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------1~SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES------------------
NATURE OF BUSINESS
Mutual Savings Bank, f.s.b., A Stock Company ("MSB"), is a federal stock savings
bank, headquartered in Bay City, Michigan, and operates 22 retail banking
offices located primarily in central and southern Michigan. MSB also operates
two wholly-owned subsidiaries, MSB Service Corporation and MSB Investment and
Insurance Services, Inc. ("MSBi"). MSB's two subsidiaries have contracted with
unaffiliated third parties to provide various investment services including the
sale of mutual fund and annuity products. MSBi also sells life insurance,
long-term care insurance and group health and disability insurance. MSB is
subject to competition from other financial services providers with respect to
these services. MSB is regulated by certain federal agencies and is periodically
examined by certain regulatory authorities.
MSB, in the course of normal operations, is exposed to interest rate risk. The
level of MSB's interest rate risk is such that, in a rising interest rate
environment, MSB's net interest income and net portfolio value would be expected
to decrease.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of MSB
and its two wholly-owned subsidiaries. All significant intercompany transactions
and balances are eliminated in consolidation.
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 at the date of the
financial statements and the reported amounts of revenues and expenses during
each reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For purposes of financial reporting, cash and cash equivalents consist of cash
on hand and on deposit, funds due from banks, money market funds and all highly
liquid debt instruments with original maturities of three months or less.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
Management determines the appropriate classification of investment securities
and mortgage-backed securities at time of purchase, as "held-to-maturity,"
"trading" or "available-for-sale." Securities that Management has the positive
intent and ability to hold to maturity are classified as "held-to-maturity."
These securities are carried at amortized cost, net of any unaccreted discounts
or unamortized premiums, which are accreted or amortized over the expected life
(adjusted for prepayments) of the underlying security using the interest method.
Securities that may be sold in response to various unforeseen circumstances are
classified as "available-for-sale." These securities are carried at fair value,
with unrealized gains and losses being reported as a separate component of
stockholders' equity. Gains and losses from the sale of these securities are
computed based on the specific identification method. Any associated discounts
or premiums are accreted or amortized over the expected life (adjusted for
prepayments) of the underlying security using the interest method. Securities
that are purchased for the purpose of selling in the short-term to generate a
profit are classified as "trading" securities. Trading securities are carried at
fair value with unrealized gains and losses included in current operating
results.
LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income.
LOANS
Loans are reported at their outstanding principal adjusted for any charge-offs,
the allowance for loan losses, and any deferred fees or costs on originated
loans, and unamortized premiums or discounts on purchased loans.
Discounts and premiums on purchased loans are amortized to income using the
interest method or methods that approximate the interest method over the
remaining period to contractual maturity, adjusted for anticipated prepayments.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment to the yield of the related loan.
Effective January 1, 1995, MSB adopted Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 114,
- --------------------------------------------------------------------------------
31
COMMUNITY BANKING FOR OVER A CENTURY
79
- ----------------1~SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-continued--------
"Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures" (collectively the "Statements"), which MSB applies to its business
and commercial real estate loans. As defined by the Statements, a loan is
considered impaired when, based on current information and events, it is
probable that a creditor will be unable to collect all amounts due according to
the contractual terms of the loan agreement. As a result, certain impaired loans
are reported at the present value of future cash flows or the fair value of the
collateral.
Accrued interest on loans that are contractually ninety days or more past due or
for which collection of interest appears doubtful is reversed and charged
against interest income. Income on nonaccrual and other impaired loans is
subsequently recognized only to the extent cash payments are received and the
principal balance is expected to be recovered. Such loans are restored to an
accrual status only if the loan is brought contractually current and the
borrower has demonstrated the ability to make future payments of principal and
interest.
ALLOWANCE FOR LOAN LOSSES
Management provides for and determines the adequacy of the allowance for loan
losses based on MSB's past loan loss experience, review of individual problem
loans, known and inherent risks in the portfolio, adverse situations that may
affect the borrower's ability to repay, the estimated value of the underlying
collateral and current economic conditions. A charge is made to the allowance at
the time that Management determines that all or part of the loan is
uncollectible.
The allowance is periodically increased by a provision, which is charged to the
consolidated statements of operations and by recoveries of loans that have been
previously charged to the allowance. In addition, various regulatory agencies as
an integral part of their examination process, periodically review MSB's
allowance for losses on loans. Such agencies may require MSB to recognize
additions to the allowance based on their judgments about information available
to them at the time of their examination. In the opinion of Management, the
allowance, when taken as a whole, is adequate to absorb losses in the portfolio.
While Management uses the best information available to make evaluations, the
ultimate repayment of all loans is susceptible to future market factors and
events beyond MSB's control. These factors and events may result in losses or
recoveries differing from those provided for in the consolidated financial
statements.
REAL ESTATE OWNED AND OTHER REPOSSESSED ASSETS
Real estate properties acquired through, or in lieu of, loan foreclosure and
other repossessed assets are recorded at the lower of cost or fair value less
expected sales costs. These properties and other repossessed assets are
periodically reviewed and declines in fair value are recognized through a charge
to current operating results. The cost of improvements to real estate owned are
capitalized if the improvements increase the estimated fair value.
PREMISES AND EQUIPMENT
Land is carried at cost. Buildings and improvements, land improvements and
furniture, fixtures and equipment are carried at cost, less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful life of the asset. Lives of buildings range from 25 to 50
years. Lives of furniture, fixtures and equipment range from 3 to 10 years.
Leasehold improvements are depreciated over the lesser of the lease term or the
useful life of the improvements. As changing events necessitate, MSB reviews
long lived assets for impairment.
MORTGAGE SERVICING RIGHTS AND LOAN SERVICING
Effective April 1, 1995, MSB adopted FASB SFAS No. 122, "Accounting for Mortgage
Servicing Rights" subsequently superseded by FASB SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("Statement 125"). This Statement requires that a mortgage banking enterprise
recognize as separate assets the rights to service mortgage loans for others
that have been acquired through either the purchase or origination of a loan. A
mortgage banking enterprise that sells or securitizes those loans with the
servicing rights retained should allocate the total cost of the mortgage loans
to the mortgage servicing rights and the loans based on their relative fair
values.
The fair value of capitalized originated mortgage servicing rights is determined
based on the estimated discounted net cash flows to be received. In applying
this valuation method, MSB uses assumptions that market participants would use
in estimating future net
- --------------------------------------------------------------------------------
32
COMMUNITY BANKING FOR OVER A CENTURY
80
- --------------------------------------------------------------------------------
servicing income, which includes estimates of the cost of servicing per loan,
the discount rate, float value, an inflation rate, ancillary income per loan,
prepayment speeds and default rates. Originated mortgage servicing rights are
amortized in proportion to and over the period of estimated net loan servicing
income. These capitalized mortgage servicing rights are periodically reviewed
for impairment based on the fair value of those rights. MSB conducts its
periodic impairment analysis using a discounted, disaggregated method, based
upon current coupon rates. For purposes of measuring impairment of capitalized
originated mortgage servicing rights, the risk characteristics used by MSB
include the underlying loans' interest rates, prepayment speeds and loan types.
MSB services for investors mortgage loans that are not included in the
Consolidated Statements of Financial Condition. Fees earned for servicing loans
owned by investors are reported as income when the related mortgage loan
payments are collected reduced by the amortization of capitalized originated
mortgage servicing rights. Loans servicing costs are charged to expense as
incurred.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
MSB enters into sales of securities under agreements to repurchase ("Repurchase
Agreements"). These transactions are treated as financings and the obligations
to repurchase securities sold are reflected as a liability in the accompanying
Consolidated Statements of Financial Condition. The dollar amount of securities
underlying the Repurchase Agreements remains in the investment securities and
mortgage-backed securities accounts.
ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE
Included in this category are amounts relating to the collection of principal
and interest on loans serviced by MSB for third parties. These amounts were
$3,583,000 and $3,616,000 at December 31, 1998 and 1997, respectively. Amounts
relating to advance payments by borrowers for taxes and insurance were $869,000
and $681,000 at December 31, 1998 and 1997, respectively.
STOCK-BASED COMPENSATION
FASB SFAS No. 123, "Accounting for Stock-Based Compensation" ("Statement 123")
encourages, but does not require companies to record compensation cost for
stock-based employee compensation plans at fair value. MSB has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion 25, "Accounting for
Stock Issued to Employees." Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of MSB's stock at the
date of the grant over the amount an employee must pay to acquire the stock.
Note 13 to the consolidated financial statements contains a summary of the pro
forma effects to reported net income (loss) and earnings (loss) per share if MSB
had elected to recognize compensation cost based on the fair value of the
options granted at grant date as prescribed by Statement 123.
DERIVATIVE FINANCIAL INSTRUMENTS
At December 31, 1998, MSB was a party to certain fixed rate Federal Home Loan
Bank ("FHLB") advances and Repurchase Agreements that include an option for the
counterparty to convert the borrowing into an adjustable rate or require
repayment of the borrowing. MSB is party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the Consolidated Statements of Financial Condition.
INCOME TAXES
Deferred income tax assets and liabilities are recorded for differences between
the financial statement and tax bases of assets and liabilities that will result
in taxable or deductible amounts in the future based on enacted tax laws and
rates applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount that more likely than not, will be realized.
COMPREHENSIVE INCOME
Effective January 1, 1998, MSB adopted FASB SFAS No. 130, "Reporting
Comprehensive Income." In addition to net income from operations, comprehensive
income is reported for all periods presented. Comprehensive income is a more
inclusive financial reporting methodology that includes disclosure of certain
financial information that historically has not
- --------------------------------------------------------------------------------
33
COMMUNITY BANKING FOR OVER A CENTURY
81
- -----------------1~SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-continued--------
been recognized in the calculation of net income. Comprehensive income includes
net income and other comprehensive income such as the change in unrealized gains
and losses on securities available-for-sale. The change in unrealized gain
(loss) on available-for-sale securities during 1996 includes a reclassification
adjustment for a $670,000 loss realized in income from the sales of securities.
FINANCIAL REPORTING OF SEGMENTS
In June 1997 the FASB issued SFAS No. 131 ("Statement 131"), "Disclosures About
Segments of an Enterprise and Related Information." Statement 131 establishes
standards for the way public business enterprises report information about
operating segments in annual financial statements. Operating segments are
components of an enterprise for which separate financial information is
available, and is evaluated regularly by management in deciding how to allocate
resources and in assessing performance. Statement 131 establishes standards for
related disclosures about products, services, geographic areas and major
customers. The Bank operates as a single segment.
RECLASSIFICATIONS
Certain reclassifications were made to prior year financial statements to
conform to the 1998 presentation.
================================================================================
- --------------------------------------------------------------------------------
34
COMMUNITY BANKING FOR OVER A CENTURY
82
- -----------------------------2~REGULATORY MATTERS------------------------------
MSB is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on MSB's
financial statements. Regulations of the Office of Thrift Supervision ("OTS")
set forth minimum capital standards applicable to all savings institutions.
These standards include a tangible capital requirement, a core capital
requirement and a risk-based capital requirement. Savings institutions must meet
or exceed all three requirements at all times to be considered in capital
compliance. The following table presents MSB's capital position with respect to
the three requirements at December 31, 1998.
AS A % OF REQUIRED AS A % OF EXCESS EXCESS
AMOUNT ASSETS (1) CAPITAL ASSETS (1) CAPITAL % CAPITAL
------------ ---------- ------------ ---------- ------------- -------
Stockholders' equity $ 36,136,276
Unrealized gain on
available-for-sale securities (100,602)
------------
Total tangible capital $ 36,035,674 6.39% $ 8,465,003 1.50% $ 27,570,671 4.89%
============
Total core capital 36,035,674 6.39% 22,573,340 4.00% 13,462,334 2.39%
General valuation allowances 1,759,549
------------
Total risk-based capital $ 37,795,223 13.17% 22,964,880 8.00% 14,830,343 5.17%
============
- --------------------------------------------------------------------------------
(1) Tangible and core capital levels are shown as a percentage of total
adjusted assets. The risk-based capital level is shown as a percentage of
risk-weighted assets.
- --------------------------------------------------------------------------------
As indicated in the table, MSB exceeded all three of these regulatory capital
requirements at December 31, 1998.
In addition, under capital adequacy guidelines and the regulatory framework for
prompt corrective action, MSB must meet specific capital guidelines that involve
quantitative measures of MSB's liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. MSB's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors. Quantitative measures established
by regulation to ensure capital adequacy require MSB to maintain minimum amounts
and ratios (set forth in the following table) of total and Tier 1 capital (as
defined in the regulations ) to risk-weighted assets (as defined), and of Tier 1
capital (as defined) to total assets (as defined). Management believes, as of
December 31, 1998, that MSB meets all capital adequacy requirements to which it
is subject. To be categorized as well-capitalized, MSB must maintain minimum
total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in
the following table.
MSB's actual capital amounts and ratios are also presented in the following
table.
- --------------------------------------------------------------------------------
35
COMMUNITY BANKING FOR OVER A CENTURY
83
- -----------------------------2~REGULATORY MATTERS-continued--------------------
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSE ACTION PROVISIONS
----------------------- ---------------------- ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ------ ----------- ------ ----------- ------
(IN THOUSANDS)
AS OF DECEMBER 31, 1998
Total capital (to risk-weighted assets) $37,795,223 13.17% $22,964,880 8.00% $28,706,100 10.00%
Tier 1 capital (to risk-weighted assets) $36,035,674 12.55% $11,482,440 4.00% $17,223,660 6.00%
Tier 1 capital (to total assets) $36,035,674 6.39% $22,573,340 4.00% $28,216,676 5.00%
AS OF DECEMBER 31, 1997
Total capital (to risk-weighted assets) $34,904,584 12.24% $22,815,760 8.00% $28,519,700 10.00%
Tier 1 capital (to risk-weighted assets) $33,233,460 11.65% $11,407,880 4.00% $17,111,820 6.00%
Tier 1 capital (to total assets) $33,233,460 5.13% $25,907,477 4.00% $32,384,346 5.00%
As of December 31, 1998, the most recent notification of the OTS categorized MSB
as well capitalized under the regulatory framework for prompt corrective action.
In May 1992, MSB and the OTS executed a Supervisory Agreement which, as
subsequently amended, requires MSB to (i) comply with the business plan filed by
Management and approved by the OTS; (ii) file additional three-year business
plans with the OTS on an annual basis, which are subject to OTS approval; (iii)
maintain its board of directors at a minimum of five directors with a majority
of outside directors; and (iv) fulfill certain reporting requirements. MSB
believes that it has substantially complied with each of the Supervisory
Agreement requirements during 1997 and 1998. On November 30, 1998, MSB received
approval of its 1999 Business Plan from the OTS.
At periodic intervals, both the OTS and the Federal Deposit Insurance
Corporation ("FDIC") routinely examine MSB's financial condition. Based on these
examinations, regulatory authorities can direct that MSB's financial statements
be adjusted in accordance with their findings. Such regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
the depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities. Any change in such regulation, whether by the OTS, the FDIC, or
Congress, could have a material effect on MSB and its operations.
On October 21, 1996, MSB applied to the FDIC for an exemption from a special
assessment (in the amount of $3,041,000) mandated by the Deposit Insurance Funds
Act of 1996 (the "Funds Act"). The Funds Act required the FDIC to impose a
special assessment on institutions holding deposits subject to assessment by the
Savings Association Insurance Fund ("SAIF"). The FDIC granted the exemption.
Therefore, MSB did not pay the special assessment, but instead pays semiannual
assessments to the SAIF according to the rate schedule that was in effect for
SAIF assessments on June 30, 1995 for the period of 1997 through the end of
1999. An institution exempted from the SAIF special assessment may later elect
to make a pro rata payment equal to 16.7% of the amount the institution would
have owed for the special assessment multiplied by the number of full semiannual
periods remaining between the date of payment of such pro rata amount and
December 31, 1999. Upon payment of such pro rata amount, the institution's rate
schedule for SAIF assessments would convert to the same schedule then in effect
for all other institutions that paid the full special assessment under the Funds
Act. Management periodically assesses the impact of making such a pro rata
payment, and to date, has elected to not make such payment.
In addition, effective January 1, 1997, the annual assessment rate for all
SAIF-insured institutions, including MSB, was increased by 6.48 basis points for
amounts assessed by the Financing Corporation. As a result of the above matters,
in January 1997, MSB's deposit insurance premiums increased from a rate of 29
basis points on SAIF-insured deposits to a rate of 35.48 basis points. MSB's
deposit insurance rate was 31.82 basis points for the three months ended
December 31, 1998. MSB anticipates a deposit insurance rate of 32.10 basis
points for the first quarter of 1999. Federal deposit insurance premium rates
are primarily based on a financial institution's capital ratios and supervisory
rating. Based upon MSB's current capital ratios and supervisory rating, its
federal deposit insurance premium rate is expected to decline by approximately
three basis points effective July 1, 1999 and by approximately an additional 23
basis points effective January 1, 2000. The expected changes in MSB's federal
deposit insurance premium rate are based on the current FDIC rate schedule.
OTS regulations do not permit MSB to pay dividends on its common stock if its
regulatory capital would be reduced below the level required by OTS regulations
or the amount required for the liquidation account established in connection
with its conversion from mutual to stock form of ownership in 1992 (the
"Conversion"). In addition, capital distribution regulations limit MSB's
ability, based on its capital level and supervisory rating, to make certain
capital distributions such as dividends and stock redemptions or repurchases.
- --------------------------------------------------------------------------------
36
COMMUNITY BANKING FOR OVER A CENTURY
84
- ----------------------------3~INVESTMENT SECURITIES----------------------------
The following table summarizes the amortized cost and estimated fair value of
investment securities at the dates indicated. At December 31, 1997, all
investment securities were classified as available-for-sale.
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ----------------- ----------- ---------- ---------- ------------
Available-for-sale:
Collateralized Mortgage Obligation
("CMO") residual $ 166,484 $ -- $ -- $ 166,484
----------- ---------- ---------- ------------
Total investment securities available-for-sale $ 166,484 $ -- $ -- $ 166,484
=========== ========== ========== ============
Weighted average yield 8.97%
===========
Held-to-maturity:
Commercial paper $13,888,050 $ -- $ -- $ 13,888,050
----------- ---------- ---------- ------------
Total investment securities held-for-maturity 13,888,050 $ -- $ -- $ 13,888,050
=========== ========== ========== ============
Weighted average yield 5.41%
DECEMBER 31, 1997
CMO residual $ 198,544 $ -- $ -- $ 198,544
----------- ---------- ---------- ------------
Total investment securities available-for-sale $ 198,544 $ -- $ -- $ 198,544
=========== ========== ========== ============
Weighted average yield 37.91%
===========
- --------------------------------------------------------------------------------
There were no investment security sales during 1998 or 1997. Proceeds from the
sale of investment securities in 1996 were $38.250 million. The 1996 sales
resulted in no gross realized gains and gross realized losses of $670,000. In
January 1994, MSB purchased the entire outstanding principal amount of a $40
million FHLB debenture. The debenture's maturity was January 27, 1999 and it had
an initial 7.5% coupon through January 26, 1995. Subsequent interest rates were
computed semi-annually and were based on the rate for 10-year Constant Maturity
Treasuries plus 2% less the 6-month London Interbank Offering Rate ("LIBOR").
The subsequent interest rate adjustments were subject to a 24% interest rate cap
and a 3% interest rate floor. In January and July 1995, the debenture's interest
rate reset at 3%. From inception and through January 1995, MSB deferred
$1,440,000 of the initial coupon as a means of attempting to level the yield at
3.90% over the life of the security. In January of 1996, MSB settled a lawsuit
it had commenced against a government securities dealer for alleged damages in
connection with the purchase by MSB of the debenture. Under the settlement, the
government securities dealer purchased the debenture from MSB on January 30,
1996 for $38.250 million plus accrued and unpaid interest. The fair value of the
debenture (based upon an average of current broker-dealer quotes) as of January
30, 1996 was approximately $37.400 million. MSB had recorded a $1,678,000
unrealized loss as a reduction of stockholders' equity as of December 31, 1995
related to the debenture. The sale resulted in a net realized loss of $670,000.
In 1997, MSB began to enter into purchases of securities under agreements to
resell substantially identical securities. During 1998 the maximum amount
outstanding at any month-end was $8,502,000. During 1997 there were no
securities purchased under agreements to resell outstanding at any month-end.
The amounts advanced under these agreements represent short-term loans.
Securities purchased under agreements to resell averaged approximately
$4,461,000 and $456,000 during 1998 and 1997, respectively.
At December 31, 1998 the commercial paper matures within ninety days. The CMO
residual remaining at December 31, 1998 has a final stated maturity of October
20, 2018. The estimated fair value of the CMO residual is based on future
expected cash flows. Accrued interest receivable on investment securities at
December 31, 1998 and 1997 was $2,000 and $5,000, respectively.
- --------------------------------------------------------------------------------
37
COMMUNITY BANKING FOR OVER A CENTURY
85
- -------------------------4~MORTGAGE-BACKED SECURITIES---------------------------
The following table summarizes the amortized cost and estimated fair value of
mortgage-backed securities at the dates indicated:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ----------------- ------------ ------------ ------------ ------------
Available-for-sale:
Federal Home Loan Mortgage Corporation
("FHLMC") participation certificates $ 35,767,955 $ 90,223 $ 44,715 $ 35,813,463
Federal National Mortgage Association
("FNMA") pass-through certificates 16,406,701 92,676 37,581 16,461,796
------------ ------------ ------------ ------------
Total mortgage-backed securities
available-for-sale $ 52,174,656 $ 182,899 $ 82,296 $ 52,275,259
============ ============ ============ ============
Weighted average yield 5.82%
============
Held-to-maturity:
FHLMC participation certificates $ 55,488,577 $ 72,998 $ 84,287 $ 55,477,288
FNMA pass-through certificates 73,575,391 732 26,867 73,549,256
------------ ------------ ------------ ------------
Total mortgage-backed securities
held-to-maturity $129,063,968 $ 73,730 $ 111,154 $129,026,544
============ ============ ============ ============
Weighted average yield 5.46%
============
DECEMBER 31, 1997
Available-for-sale:
FHLMC participation certificates $ 51,518,712 $ 11,067 $ 444,608 $ 51,085,171
FNMA pass-through certificates 20,882,711 38,374 51,596 20,869,489
------------ ------------ ------------ ------------
Total mortgage-backed securities
available-for-sale $ 72,401,423 $ 49,441 $ 496,204 $ 71,954,660
============ ============ ============ ============
Weighted average yield 6.00%
============
Held-to-maturity:
FHLMC participation certificates $125,021,101 $ 1,075 $ 1,501,097 $123,521,079
FNMA pass-through certificates 96,370,355 -- 1,532,002 94,838,353
------------ ------------ ------------ ------------
Total mortgage-backed securities
held-to-maturity $221,391,456 $ 1,075 $ 3,033,099 $218,359,432
============ ============ ============ ============
Weighted average yield 5.40%
============
- --------------------------------------------------------------------------------
There were no sales of mortgage-backed securities in 1998, 1997 and 1996.
- --------------------------------------------------------------------------------
43
COMMUNITY BANKING FOR OVER A CENTURY
86
- --------------------4~MORTGAGE-BACKED SECURITIES-CONTINUED---------------------
The following table sets forth information regarding the contractual maturities
of MSB's mortgage-backed securities at December 31, 1998:
HELD-TO-MATURITY AVAILABLE-FOR-SALE TOTAL
------------------ ------------------- -----------------
FOR THE TWELVE WEIGHTED WEIGHTED WEIGHTED
MONTHS ENDING AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
DECEMBER 31, COST YIELD COST YIELD (2) COST YIELD (2)
- ------------ --------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
1999 $ 9,767 5.94% $ 11,043 6.08% $ 20,810 6.01%
2000 37,879 5.40 11,551 5.38 49,430 5.40
2001 76,794 5.39 -- -- 76,794 5.39
2002-2004 4,624 5.99 -- -- 4,624 5.99
After 2004 (1) -- -- 29,581 5.89 29,581 5.89
-------- -------- --------
Total $129,064 5.46% $ 52,175 5.82% $181,239 5.56%
======== ======== ========
- --------------------------------------------------------------------------------
(1) Includes $10.035 million of adjustable rate mortgage-backed securities.
(2) Yield calculations are based on balance exclusive of net unrealized gain
(loss) on available-for-sale securities.
- --------------------------------------------------------------------------------
At December 31, 1998 and 1997, accrued interest receivable on mortgage-backed
securities was $887,000 and $1,417,000, respectively.
- --------------------------------------------------------------------------------
44
COMMUNITY BANKING FOR OVER A CENTURY
87
- ------------------------------------5~LOANS-------------------------------------
The following table summarizes loans at December 31, 1998 and 1997:
1998 1997
---- ----
1 to 4 family mortgage loans:
Conventional 227,087,847 $216,178,854
Construction 12,021,429 12,515,336
Insured by the Federal Housing Administration or
partially guaranteed by the Veteran's Administration 370,957 569,687
----------- ------------
239,480,233 229,263,877
Commercial loans: ------------ ------------
Secured by real estate 42,577,280 21,658,932
Other 5,909,489 1,968,818
Consumer loans 57,250,415 68,238,940
Loans on savings deposits 356,448 262,525
----------- ------------
106,093,632 92,129,215
----------- ------------
Total gross loans 345,573,865 321,393,092
Unearned loan discounts (34,423) (63,503)
Deferred loan costs, net of fees 903,126 1,100,536
Loans in process (16,907,046) (5,356,319)
Allowance for loan losses (1,843,116) (1,968,600)
--------- ---------
Loans, net 327,692,406 315,105,206
Loans held-for-sale - conventional 1 to 4 family mortgage loans 5,957,504 1,871,240
----------- ------------
Total loans, net $333,649,910 $316,976,446
============ ============
Weighted average yield 7.59% 7.96%
============ ============
- --------------------------------------------------------------------------------
MSB originates both adjustable and fixed rate (including balloons) loans. The
following table presents at December 31, 1998 the composition and maturity
structure of the gross loan portfolio including loans held-for-sale. All loans
are shown at their contractual maturity or earliest repricing date.
FIXED RATE ADJUSTABLE RATE
- ---------------------------------- -----------------------------------------
TERM TO MATURITY BOOK VALUE TERM TO RATE ADJUSTMENT BOOK VALUE
- ---------------- ---------- ----------------------- ----------
1 month - 1 year $ 6,247,259 1 month - 1 year $71,083,992
1 year - 2 years 10,930,670 1 year - 2 years 11,380,684
2 years - 3 years 13,906,558 2 years - 3 years 16,684,001
3 years - 5 years 49,908,978 3 years - 5 years 22,777,695
5 years - 10 years 29,037,570 5 years - 10 years 31,341,061
Over 10 years 88,232,901 Over 10 years --
------------ ------------
$198,263,936 $153,267,433
============ ============
- --------------------------------------------------------------------------------
DECEMBER 31,
-----------------------------------------------
1998 1997 1996
---- ---- ----
Loans serviced for others at: $517,852,000 $504,010,000 $537,392,000
============ ============ ============
- --------------------------------------------------------------------------------
COMMUNITY BANKING FOR OVER A CENTURY 45
88
- -------------------------------5~LOANS-CONTINUED--------------------------------
MSB's primary market area is the state of Michigan. At December 31, 1998,
approximately 96% of the total loan portfolio consisted of borrowers within this
region. The diversity of the region's economic base tends to provide a stable
lending environment.
Real estate lending constitutes a significant concentration of credit risk.
Real estate-related loans comprised 92% of all loans of MSB and approximately
80% were consumer-related in the form of residential real estate mortgages and
home equity loans.
MSB is, in general, a secured lender. At December 31, 1998, over 99% of the loan
portfolio was secured. Collateral is required in accordance with the normal
credit evaluation process based upon the credit-worthiness of the customer and
the credit risk associated with the particular transaction. Adjustable rate
loans generally have interest rate adjustment limitations and are indexed to
various rates such as the 1-year Treasury Bill.
Loans serviced for others sold with recourse were approximately $4,753,000 and
$7,534,000 at December 31, 1998 and 1997, respectively.
Non-accruing loans totaled $196,000 and $261,000 at December 31, 1998 and 1997,
respectively. Accrued interest receivable on loans at December 31, 1998 and 1997
was $1,651,000 and $1,740,000, respectively.
The average recorded investment in impaired loans during 1998, 1997 and 1996 was
$664,000, $446,000 and $1,130,000, respectively. The average recorded investment
in net impaired loans during 1998, 1997 and 1996 was $498,000, $147,000 and
$731,000, respectively. Interest income on impaired loans of $54,000, $32,000
and $95,000 was recognized for cash payments received in 1998, 1997 and 1996,
respectively. The amount of additional interest income that would have been
recorded on impaired loans if such loans had performed in accordance with their
contractual terms during 1998, 1997 and 1996 was $17,000, none and $1,000,
respectively.
At December 31, 1998, 1997 and 1996, all impaired loans had allocated reserves.
The following table summarizes impaired loans (all of which were commercial
loans) at December 31, 1998, 1997 and 1996:
- --------------------------------------------------------------------------------
1998 1997 1996
------- ------- -------
Gross recorded investment $508,000 $414,000 $461,000
Less allowance for loan losses related to impaired loans 45,000 299,000 299,000
-------- -------- --------
Net recorded investment in impaired loans $463,000 $115,000 $162,000
======== ======== ========
- --------------------------------------------------------------------------------
The application of the provisions of Statement 122, as amended by Statement 125
(see "Notes to Consolidated Financial Statements, Note 1 - Summary of
Significant Accounting Policies") resulted in a net increase in income of
approximately $972,000, $216,000 and $282,000 for the years ended December 31,
1998, 1997 and 1996, respectively. MSB capitalized approximately $1,651,000,
$474,000 and $458,000 of originated mortgage servicing rights during the years
ended December 31, 1998, 1997 and 1996, respectively. Capitalized originated
mortgage servicing rights amortization was $679,000, $258,000 and $176,000 for
1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, capitalized
originated mortgage servicing rights had carrying amounts of $1,880,000 and
$908,000, respectively, and estimated fair values of $2,500,000 and $1,300,000,
respectively. No valuation allowances for capitalized originated mortgage
servicing rights were considered necessary as of December 31, 1998 or 1997. The
amount of mortgage loans serviced for others related to capitalized originated
mortgage servicing rights was $284.045 million and $154.219 million at December
31, 1998 and 1997, respectively. At December 31, 1998 and 1997 the fair values
of mortgage servicing rights not capitalized on the Consolidated Statements of
Financial Condition were $1,500,000 and $2,500,000, respectively. The fair value
of mortgage servicing rights is determined based on the estimated discounted net
cash flows to be received. MSB obtains an independent third-party valuation of
its mortgage servicing rights each year. The use of different market assumptions
and/or estimation methodologies may have a material effect on the valuation of
mortgage servicing rights. The ongoing impact of Statement 125 is dependent
upon, among other things, the volume of loan originations, the general levels of
market interest rates and the rate of estimated loan prepayments. Accordingly,
Management is unable to predict with any reasonable certainty what effect
Statement 125 will have on MSB's future results of operations or its financial
condition.
- --------------------------------------------------------------------------------
46
COMMUNITY BANKING FOR OVER A CENTURY
89
- --------------6~REAL ESTATE OWNED AND OTHER REPOSSESSED ASSETS------------------
Real estate and other repossessed assets held by MSB at December 31, 1998 and
1997 are as follows:
1998 1997
------- -------
Real estate in judgment, subject to redemption $ 96,080 $ --
Real estate acquired through foreclosure 175,670 88,082
Premises held for sale 19,000 19,000
Other repossessed assets 38,146 84,563
------- -------
Total real estate owned and other repossessed assets $328,896 $191,645
======= =======
- --------------------------------------------------------------------------------
- ----------------------- 7~ALLOWANCE FOR LOSSES ON LOANS-------------------------
The activity in the allowances for losses on loans for the periods indicated is
as follows:
Balance at January 1, 1996 $1,723,409
Provision for losses 180,000
Charge-offs (52,568)
Recoveries 4,532
---------
Balance at December 31, 1996 1,855,373
Provision for losses 225,000
Charge-offs (116,135)
Recoveries 4,362
---------
Balance at December 31, 1997 1,968,600
Provision for losses 585,000
Charge-offs (724,301)
Recoveries 13,817
---------
Balance at December 31, 1998 $1,843,116
=========
- --------------------------------------------------------------------------------
Management is of the opinion that the allowance for loan losses at December 31,
1998 is adequate to absorb losses in the portfolios. However, there are inherent
risks and uncertainties related to the operation of a financial institution. By
necessity, MSB's financial statements are dependent upon estimates, appraisals
and evaluations of loans and real estate owned. Therefore, the possibility
exists that changes in such estimates, appraisals and evaluations might be
required due to changing economic conditions and the economic prospects of
borrowers. Actual results could differ significantly from those estimated. MSB
manages credit risk associated with its lending activities through underwriting
policies and procedures and loan monitoring practices.
- --------------------------------------------------------------------------------
COMMUNITY BANKING FOR OVER A CENTURY
47
90
- ----------------------------8~PREMISES AND EQUIPMENT----------------------------
Premises and equipment at December 31, 1998 and 1997, are as follows:
1998 1997
---------- ----------
Buildings and improvements $ 7,036,370 $ 6,857,911
Furniture, fixtures and equipment 4,203,301 5,411,798
Land improvements 134,047 121,872
---------- ----------
11,373,718 12,391,581
Accumulated depreciation (5,163,801) (5,626,362)
---------- ----------
6,209,917 6,765,219
Land 1,807,430 1,807,430
---------- ----------
Total premises and equipment $ 8,017,347 $ 8,572,649
========== ==========
- --------------------------------------------------------------------------------
During 1998 and 1997, fully depreciated assets were removed from MSB's accounts.
- --------------------------------------------------------------------------------
- ---------------------------------9~-DEPOSITS------------------------------------
The following table summarizes deposits at December 31, 1998 and 1997:
1998 1997
--------------------------- ---------------------------
WEIGHTED WEIGHTED
AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE
------ ------------ ------ ------------
Passbook $ 17,873,436 2.25% $17,604,101 2.25%
Statement savings 21,913,209 2.25 19,758,038 2.25
NOW accounts 36,493,328 1.74 29,969,790 1.74
Money market variable rate accounts 69,708,400 3.85 63,729,240 4.00
Jumbos and mini-jumbos 19,776,027 5.12 16,820,220 5.52
Certificates:
Within 1 year 93,588,600 4.34 97,069,207 4.66
After 1 year, but within 2 years 53,857,158 5.43 49,274,715 5.52
After 2 years, but within 10 years 61,999,164 5.72 67,150,040 5.93
IRA accounts 35,081,454 5.59 36,202,818 5.88
Demand deposit 10,527,196 -- 9,809,738 --
----------- -----------
Total deposits $420,817,972 4.21% $407,387,907 4.47%
=========== ===========
- --------------------------------------------------------------------------------
The aggregate amount of jumbo certificates of deposit, each with a minimum
denomination of $100,000, was $10,327,000 and $8,926,000 at December 31, 1998
and 1997, respectively. Interest expense on certificates of deposit over
$100,000 was $560,000, $438,000 and $428,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
- --------------------------------------------------------------------------------
48
COMMUNITY BANKING FOR OVER A CENTURY
91
- --------------------------------------------------------------------------------
A summary of certificate and IRA accounts at December 31, 1998 by year of
maturity follows:
WEIGHTED
AMOUNT AVERAGE RATE
----------- ------------
1999 $194,382,896 4.93%
2000 45,865,874 5.64
2001 13,890,694 5.55
2002 9,232,766 5.64
2003 930,173 5.46
-----------
Total $264,302,403 5.11%
===========
- --------------------------------------------------------------------------------
The following table presents, by various rate categories, the amount of
certificate and IRA accounts outstanding at December 31, 1998 and 1997:
1998 1997
----------- -----------
2.99% or less $ 11,906,894 $ --
3.00% to 3.99% 20,561,634 38,636,277
4.00% to 4.99% 37,184,079 1,367,790
5.00% to 5.99% 173,350,779 195,380,913
6.00% to 6.99% 21,180,014 30,021,604
7.00% or greater 119,003 1,110,416
----------- -----------
Total $264,302,403 $266,517,000
=========== ===========
- --------------------------------------------------------------------------------
Interest expense on deposits is summarized as follows:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
---------- ---------- ----------
Time deposits $14,066,691 $14,192,009 $14,647,943
Money market 3,182,548 2,984,311 2,434,744
Savings 857,291 868,662 961,242
----------- ----------- -----------
Total $18,106,530 $18,044,982 $18,043,929
=========== =========== ===========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
49
COMMUNITY BANKING FOR OVER A CENTURY
92
- ----------------------10 FEDERAL HOME LOAN BANK ADVANCES------------------------
FHLB advances at December 31, 1998 are secured by MSB's investment in the stock
of the FHLB of Indianapolis and mortgage-backed securities aggregating $58.875
million. At December 31, 1998 and 1997, FHLB advances (all of which were fixed
rate) by year of maturity consisted of the following:
1998 1997
------------------------------ ----------------------------
WEIGHTED WEIGHTED
AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE
---------- ------------ ----------- ------------
1998 $ -- --% $ 50,000,000 7.25%
1999 5,000,000 5.91 15,000,000 7.44
2000 (1) 30,000,000 6.61 30,000,000 6.61
2003 5,000,000 5.05 -- --
Thereafter (2) 13,291,614 6.30 5,595,517 6.74
---------- -----------
Gross FHLB advances 53,291,614 6.32% 100,595,517 7.06%
Unamortized commitment fees (5,715) (34,865)
---------- -----------
Net FHLB advances $53,285,899 $100,560,652
========== ===========
- --------------------------------------------------------------------------------
(1) Includes a $10.000 million FHLB advance with a stated maturity of October
15, 2002. This FHLB advance has a fixed interest rate of 5.65% through
January 17, 2000. On that date (and quarterly thereafter), the FHLB has the
option to convert the advance to an adjustable rate at three month LIBOR,
adjusted quarterly. MSB has the option to prepay this advance, without
penalty, if the FHLB converts the advance to an adjustable rate.
(2) These FHLB advances have a 30 year amortization with either a 15 or 20 year
balloon. The maturity dates range from February 15, 2012 to August 15, 2018.
- --------------------------------------------------------------------------------
MSB has sufficient available collateral to obtain additional advances from the
FHLB, and based on its current FHLB stock ownership, MSB could obtain up to a
total of approximately $140.000 million in advances. For the years ended
December 31, 1998, 1997 and 1996, MSB's interest expense on FHLB advances was
$5,795,000, $5,916,000 and $5,262,000, respectively.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
50
COMMUNITY BANKING FOR OVER A CENTURY
93
- ---------------11~SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE----------------
Repurchase Agreements were $45.000 million and $85.000 million at December 31,
1998 and 1997, respectively. FHLMC and FNMA mortgage-backed securities with
approximate book values (including accrued interest) of $47.375 million and
$98.846 million and fair values of $47.218 million and $97.167 million at
December 31, 1998 and 1997, respectively, were pledged as collateral under these
agreements.
Repurchase Agreements averaged $64.463 million and $119.459 million for the
years ended December 31, 1998 and 1997, respectively. The maximum amounts
outstanding at any month-end during the years ended December 31, 1998 and 1997
were $85.000 million and $140.000 million, respectively.
The securities pledged as collateral under the Repurchase Agreements were
delivered to the primary dealers who arranged, or were party to, the
transactions. At December 31, 1998 and 1997, Repurchase Agreements were held by
the following primary dealers:
1998 1997
------ ------
Merrill Lynch 66.7% 82.4%
Lehman Brothers 33.3 17.6
------ ------
100.0% 100.0%
====== ======
- --------------------------------------------------------------------------------
At December 31, 1998 and 1997, Repurchase Agreements (all of which were fixed
rate) by year of maturity consisted of the following:
1998 1997
--------------------------- ---------------------------
WEIGHTED WEIGHTED
AMOUNT AVERAGE RATE AMOUNT AVERAGE RATE
---------- ------------ ---------- ------------
1998 (1) $ -- --% $70,000,000 6.21%
1999 (1) 20,000,000 5.69 -- --
2000 10,000,000 5.69 -- --
2001 15,000,000 5.99 15,000,000 5.99
---------- ----------
Total Repurchase Agreements $45,000,000 5.79% $85,000,000 6.17%
========== ==========
- --------------------------------------------------------------------------------
(1) Includes a $20.000 million Repurchase Agreement with a stated maturity of
June 12, 2002. This Repurchase Agreement has a fixed interest rate of 5.685%
and included an initial call option for the other party on June 12, 1998
followed by quarterly call options thereafter.
- --------------------------------------------------------------------------------
For the years ended December 31, 1998, 1997 and 1996, MSB's interest expense on
Repurchase Agreements was $3,925,000, $7,251,000 and $8,695,000, respectively.
- --------------------------------------------------------------------------------
51
COMMUNITY BANKING FOR OVER A CENTURY
94
- --------------------------------12~INCOME TAXES---------------------------------
MSB did not record income tax expense (benefit) for 1998, 1997 and 1996. Income
tax expense (benefit) from operations differs from the amount computed by
applying the statutory federal corporate tax rate of 34% to income (loss) before
income tax expense (benefit) due to the following items:
1998 1997 1996
----------------------- ----------------------- -----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
Tax expense (benefit) computed
at statutory rate $ 904,000 34.00% $(3,113,000) (34.00)% $(38,000) (34.00)%
Change in valuation allowance
for deferred tax assets (3,440,000) (129.42) 3,243,000 35.43 109,000 97.32
Nondeductible expenses,
primarily settlement costs 2,560,000 96.32 -- -- -- --
Other, net (24,000) (0.90) (130,000) (1.43) (71,000) (63.32)
---------- ------- ---------- ------ -------- ------
$ -- --% $ -- --% $ -- --%
========== ======= ========== ====== ======== ======
- --------------------------------------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
1998 1997
-------------- ---------------
Deferred tax assets:
Net operating loss ("NOL") carryforward $ 11,429,000 $ 10,624,000
Accrued liability for settlement of class action lawsuit -- 3,281,000
Unrealized loss on available-for-sale securities -- 152,000
CMO residual 180,000 225,000
Loan loss reserves 627,000 669,000
Alternative minimum tax credit carryforwards 617,000 617,000
Other 99,000 81,000
-------------- --------------
Gross deferred tax assets 12,952,000 15,649,000
Less: Valuation allowance 11,236,000 14,828,000
-------------- --------------
Deferred tax assets net of valuation allowance 1,716,000 821,000
-------------- --------------
Deferred tax liabilities:
Deferred originated mortgage servicing rights 639,000 309,000
Unrealized gain on available-for-sale securities 34,000 --
Excess of net book value of fixed assets over tax basis 225,000 138,000
Deferred loan fees 308,000 374,000
Accrued liabilities 170,000 --
Other 340,000 --
-------------- --------------
Gross deferred tax liabilities 1,716,000 821,000
-------------- --------------
Net deferred tax asset $ -- $ --
============== ===============
- ----------------------------------------------------------------------------------------------------------------
52
COMMUNITY BANKING FOR OVER A CENTURY
95
- --------------------------------------------------------------------------------
Changes in the valuation allowance for deferred tax assets, allocated between
operations and stockholders' equity, are as follows:
STOCKHOLDERS' EQUITY FOR
ACCUMULATED OTHER
COMPREHENSIVE
OPERATIONS (INCOME) LOSS TOTAL
---------- ------------------------ -----
Balance at January 1, 1997 $11,433,000 $ 553,000 $11,986,000
Change for 1997 3,243,000 (401,000) 2,842,000
----------- --------- -----------
Balance at December 31, 1997 14,676,000 152,000 14,828,000
Change for 1998 (3,440,000) (152,000) (3,592,000)
----------- --------- -----------
Balance at December 31, 1998 11,236,000 $ -- 11,236,000
=========== ========= ===========
- --------------------------------------------------------------------------------
Based upon the Bank's recent historical operating results, the significant
contribution of gains and fees from loan sales to 1998 earnings (which benefited
from lower interest rates and a related increased level of mortgage loan
refinance volume) and the uncertainty related to the possible costs of a
remaining securities related lawsuit, the valuation allowance has been
established because, in the opinion of Management, realization of the benefit of
the deferred tax assets is not more likely than not.
At December 31, 1998, MSB has approximately $33.616 million of NOL
carryforwards, of which $7,688,000 will expire if not utilized against taxable
income in the year 2004, $164,000 in the year 2007, $15.260 million in the year
2008, $81,000 in the year 2009, $6,779,000 in the year 2010, $929,000 in the
year 2011, $411,000 in the year 2012, and $2,304,000 in the year 2018. Future
utilization of $7,776,000 of the NOL's is limited to approximately $700,000 per
year as a result of the Conversion, which resulted in a change of control as
defined in section 382 of the Internal Revenue Code.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
53
COMMUNITY BANKING FOR OVER A CENTURY
96
- -------------13~EMPLOYEE, OFFICER AND DIRECTOR BENEFIT AND AWARD PLANS----------
PENSION PLAN
MSB is a participant in the multi-employer Financial Institutions Retirement
Fund ("FIRF"), and substantially all of its officers and employees are covered
by this plan with the exception of employees who are compensated on an hourly
basis. This plan provides benefits based on base compensation and years of
service for employees age 21 and over after completing at least 1,000 hours of
service in a consecutive twelve month period. MSB's contributions are determined
by FIRF and generally represent the normal cost of the plan. There was no
pension expense or contribution required for the years ended December 31, 1998,
1997 and 1996. FIRF does not segregate the assets, liabilities, or costs by
participating employer. Significant actuarial assumptions include a 5.5% rate of
compensation increase for the plan years 1998, 1997 and 1996. The return on plan
assets and the weighted-average discount rate for 1998, 1997 and 1996 was 8%,
8%, and 7.5%, respectively.
The current plan provides benefits of approximately 2% of the average of the
five highest years of defined compensation times the number of years of service.
Pension costs and funding include normal costs and amortization of prior service
costs over ten years. As of June 30, 1998, 1997 and 1996, the market value of
the fund's assets exceeded the value of vested benefits in the aggregate. It is
unknown when FIRF will require MSB to make additional contributions.
PROFIT SHARING PLAN
MSB has established a 401(k) profit sharing plan whereby employees may make
voluntary, tax deferred contributions up to 15% of their annual compensation
(subject to IRS maximum contribution limits). MSB provides, at its discretion
from annual operating profits, matching funds up to 3% of compensation. There
were no such matching contributions in 1998, 1997 or 1996.
EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")
MSB established an ESOP in July 1992 in connection with converting to a
federally chartered stock savings bank. The ESOP is a non-discriminatory plan
intended as a benefit for all employees who have attained the age of 21, have
rendered at least one year of service and have completed 1,000 hours of credited
service. Allocations of shares to the accounts of the participants are based on
their relative compensation in the year of allocation. Plan participants become
100% vested in their ESOP account after completing three years of credited
service.
In July 1992, the ESOP purchased 230,000 Conversion shares of MSB's common stock
through a loan of $1,006,000 from an unrelated third party. As part of the
November 1993 rights offering ("Rights Offering"), the ESOP purchased an
additional 106,500 shares of MSB's stock through a loan of $1,837,000 from the
same unrelated third party. On March 26, 1997, the ESOP borrowed $1,350,836 from
MSB to repay the loans outstanding to the unrelated third party. The repayment
schedule for the new loan is the same as that contained in the prior loan
agreement. At December 31, 1998, the outstanding loan balance is reflected as a
reduction in stockholders' equity. MSB makes annual contributions to the ESOP
equal to the ESOP's debt service. As the loan is repaid, shares are released
from collateral based on the proportion of the loan payment to the original loan
balance, and allocated to active employees.
MSB accounts for its ESOP Conversion shares in accordance with the American
Institute of Certified Public Accountants ("AICPA") Statement of Position 76-3
and its ESOP Rights Offering shares in accordance with the AICPA Statement of
Position 93-6. Accordingly, the shares pledged as collateral are reported as
unearned ESOP shares and reported as a component of stockholders' equity in the
Consolidated Statements of Financial Condition. As Conversion shares are
released from collateral, MSB reports compensation expense equal to the cost of
the Conversion shares. For earnings per share computations, all Conversion
shares are considered outstanding. As Rights Offering shares are released from
collateral, MSB reports compensation expense equal to the average fair value of
the shares and the difference between the original cost of the Rights Offering
shares and the average fair value upon release from collateral is charged or
credited to additional paid-in-capital. Unreleased Rights Offering shares are
not considered outstanding for earnings per share computations.
- --------------------------------------------------------------------------------
54
COMMUNITY BANKING FOR OVER A CENTURY
97
- --------------------------------------------------------------------------------
The ESOP shares as of December 31, 1998 and 1997 are indicated in the following
table:
1998 1997
------- -------
Allocated shares 204,807 169,732
Unreleased Conversion shares 62,008 83,514
Unreleased Rights Offering shares 44,608 60,081
-------- ----------
Total ESOP shares 311,423 313,327
======== ==========
Fair value of unreleased shares at December 31 $919,563 $1,866,735
======== ==========
- --------------------------------------------------------------------------------
Compensation and interest expense relating to the ESOP were $245,000 and none in
1998, $232,000 and $31,000 in 1997 and $169,000 and $170,000 in 1996,
respectively.
STOCK OPTION AWARDS
MSB has issued stock options to certain officers and directors under the Mutual
Savings Bank Long Term Incentive Plan. All of the options' exercise prices were
at least equal to 100% of the fair market value of MSB's common stock on the
date of grant, and the option term cannot exceed ten years.
A summary of the status of MSB's fixed stock option plan as of December 31,
1998, 1997 and 1996 and changes during the years ending on those dates is
presented below:
1998 1997 1996
---------------------- ---------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
Fixed Options: SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ -------------- ------ -------------- ------ --------------
Outstanding at beginning of year 290,116 $10.20 271,876 $ 9.75 249,656 $10.40
Granted 26,750 8.69 26,000 13.25 30,500 5.66
Exercised (8,500) 5.10 (7,760) 4.55 (2,760) 4.38
Forfeited -- -- -- -- (5,520) 19.25
------- ------- -------
Outstanding at end of year 308,366 10.21 290,116 10.20 271,876 9.75
======= ======= =======
Options exercisable at year end 281,616 264,116 241,376
Unallocated options 24,830 51,580 77,580
- --------------------------------------------------------------------------------
The following table summarizes information about fixed stock options outstanding
at December 31, 1998:
WEIGHTED-AVERAGE
REMAINING WEIGHTED-
NUMBER OF CONTRACTUAL LIFE AVERAGE
Range of Exercise Prices: SHARES (IN YEARS) EXERCISE PRICE
------ ---------- --------------
$4.25 to $5.75 162,428 5.30 $ 4.79
$8.6875 26,750 9.96 8.69
$13.25 26,000 8.96 13.25
$19.00 to $19.25 93,188 3.57 19.24
-------
Total 308,366 5.49 10.21
=======
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
55
COMMUNITY BANKING FOR OVER A CENTURY
98
- ------13~ EMPLOYEE, OFFICER AND DIRECTOR BENEFIT AND AWARD PLANS-CONTINUED------
MSB adopted the disclosure-only provisions of Statement 123. Accordingly, no
compensation expense has been recognized for the stock option plan. Had
compensation expense for MSB's stock option plan been determined based on the
fair value at the grant date for awards in 1998, 1997 and 1996 consistent with
the provisions of Statement 123, MSB's net income (loss) and earnings (loss) per
share would have been changed to the pro forma amounts indicated in the
following table (in thousands except per share amounts):
1998 1997 1996
------ ------ ------
Net income (loss):
As reported $2,658 $(9,155) $ (112)
Pro forma 2,552 (9,313) (191)
Basic earnings (loss) per share:
As reported $ 0.63 $ (2.17) $(0.03)
Pro forma 0.60 (2.21) (0.05)
Diluted earnings (loss) per share:
As reported $ 0.61 $ (2.17) $(0.03)
Pro forma 0.59 (2.21) (0.05)
- --------------------------------------------------------------------------------
The effects of applying Statement 123 on the pro forma net income may not be
representative of the effects on pro forma net income for future years. The
weighted average fair value at date of grant for options granted during 1998,
1997 and 1996 was $3.96, $6.08 and $2.60 per option, respectively. The fair
value of stock options at date of grant was estimated with the following
weighted-average assumptions:
1998 1997 1996
------ ------ ------
Expected life (years) of options 5 5 5
Risk-free interest rate 4.54% 5.76% 6.17%
Expected stock price volatility 45% 43% 42%
Expected dividend yield -- -- --
- --------------------------------------------------------------------------------
PHANTOM STOCK PLAN
During 1997 MSB adopted a Phantom Stock Plan for non-employee directors to
provide deferred compensation to non-employee directors of MSB to encourage
their continued service on MSB's Board of Directors. Such deferred compensation
shall be based upon the award of phantom stock units, the value of which is
related to the value of the common stock of MSB. Non-employee directors may be
allocated phantom stock units if certain financial and regulatory objectives are
met by MSB. No units were allocated for the plan years ended December 31, 1998
or 1997.
- --------------------------------------------------------------------------------
56
COMMUNITY BANKING FOR OVER A CENTURY
99
- -------------------------14~COMMITMENTS AND CONTINGENCIES-----------------------
MSB, together with certain present and former directors and officers and certain
others, had been a defendant in consolidated lawsuits in the United States
District Court for the Eastern District of Michigan (the "Federal Court"). The
consolidated action combined two class action lawsuits filed in the Federal
Court and one class action lawsuit originally filed in the Circuit Court for
Oakland County, Michigan (the "State Court"). The lawsuits alleged certain
violations of federal securities law and Michigan Blue Sky Law. The lawsuit
filed in the State Court was dismissed upon being combined with the Federal
Court lawsuits. These lawsuits were all originally filed in 1995 and generally
alleged that certain disclosures made by MSB from late 1993 until late 1994,
including disclosures made by MSB in a Rights Offering Circular dated October
27, 1993, concerning its business plan and exposure to interest rate risk were
false and misleading or there were material omissions. A class consisting of
purchasers of MSB's stock during the period from November 30, 1993 to November
14, 1994 was certified by the Federal Court (the "Class").
On May 8, 1998, MSB entered into a Stipulation of Settlement (the "Settlement")
to resolve the consolidated class action lawsuit. Under the Settlement, MSB
agreed to make a cash payment of $12.000 million ($2.500 million of which MSB
received from its former directors' and officers' liability insurance carrier).
On July 8, 1998 the Federal Court entered a Final Judgment and Order approving
the Settlement and dismissing the action. There were no objections filed to the
Settlement and the time to appeal the Federal Court's approval of the Settlement
has expired with no appeal having been filed. Accordingly, the dismissal of the
case against all the defendants is final. MSB distributed the Settlement funds
to plaintiff's counsel on August 10, 1998. The funds, net of plaintiffs'
attorneys' fees and expenses, were distributed to the Class in December 1998.
MSB recorded a $9.650 million charge to earnings in the fourth quarter of 1997
in anticipation of the Settlement of the consolidated class action lawsuit. The
$9.650 million charge covered the $9.500 million portion of the Settlement
attributable to MSB (the balance of the Settlement, $2.500 million, having been
received by MSB from its former directors' and officers' liability insurance
carrier) and the remaining $150,000 was accrued for MSB's legal expenses and any
other costs related to completion of the Settlement.
MSB, together with four present and former officers, remains as a defendant in a
separate lawsuit that was filed in 1995 on behalf of fourteen plaintiffs who
allegedly purchased MSB's common stock during 1992, 1993 and 1994. This lawsuit
similarly alleges that some of MSB's disclosures during that period concerning
its business plan and exposure to interest rate risk were false and misleading
in violation of state and federal securities laws and common law. Plaintiffs in
this lawsuit seek damages of approximately $3,000,000. That action was pending
in the United States District Court for the Eastern District of Michigan, but
has been transferred to the Northern District of Illinois, where it was
originally filed, in light of the Settlement.
MSB believes there are meritorious defenses to this lawsuit, has filed answers
denying the material allegations of all of the claims, and intends to continue
to pursue a vigorous defense. The ultimate outcome of this lawsuit and the
results of the legal process cannot be predicted with certainty. No provision
has been recorded for any potential loss for this lawsuit at the present time
because MSB does not believe it is reasonably probable that any material loss
will be incurred as a result of the final disposition of this lawsuit and/or is
unable to reasonably estimate the amount of any potential loss.
Other pending legal proceedings and regulatory matters have occurred in the
ordinary course of business and do not involve amounts in the aggregate that are
believed by Management to be material to the financial condition of MSB.
Certain facilities and equipment are leased under agreements that expire on
various dates through the year 2003. Included with equipment leases is the
estimated cost of a renewable data processing contract. The minimum estimated
payments under these agreements are as follows:
- --------------------------------------------------------------------------------
57
COMMUNITY BANKING FOR OVER A CENTURY
100
- -------------------14~COMMITMENTS AND CONTINQENCIES-CONTINUED-------------------
FOR THE YEARS ENDING DECEMBER 31, PREMISES EQUIPMENT TOTAL
--------------------------------- -------- --------- ----------
1999 $ 80,000 $ 854,000 $ 934,000
2000 61,000 858,000 919,000
2001 61,000 858,000 919,000
2002 30,000 -- 30,000
2003 5,000 -- 5,000
-------- ---------- ----------
$237,000 $2,570,000 $2,807,000
======== ========== ==========
- --------------------------------------------------------------------------------
Expenses charged to operations for facilities, equipment and data processing
leases in 1998, 1997 and 1996 were approximately $1,131,000, $1,146,000 and
$1,846,000, respectively.
MSB 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 and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to sell mortgage loans, commitments to extend
credit, and standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the Consolidated Statements of Financial Condition. MSB's exposure
to credit loss in the event of non-performance by the other party to the
financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual amount of those instruments. MSB uses
the same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer based on
compliance with contractual conditions. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
The total commitment amounts do not necessarily represent future cash
requirements since some of the commitments may expire without being drawn upon.
MSB evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary upon extension of credit, is
based on Management's credit evaluation of the counterparty.
At December 31, 1998, MSB had outstanding commitments to originate mortgage
loans of $12.239 million. These outstanding commitments have interest rates
ranging from 5.75% to 8.00%. At that same date, MSB had commitments to sell
mortgage loans of $11.556 million to the FHLMC or the FNMA, and of the loans
committed to be sold, commitments had not been issued to borrowers with respect
to $2,285,000 of these loans. Any fees associated with these commitments have
not been recognized in income. MSB has committed $12.021 million for
construction loans on 1 to 4 family dwellings of which $6,606,000 had not been
funded at December 31, 1998. Also, at December 31, 1998, MSB had no outstanding
commitments to purchase or sell investment or mortgage-backed securities. At
December 31, 1998 MSB had no firm commitment for an FHLB advance or other
borrowing. MSB had commitments to borrowers on undrawn home equity lines of
credit of $12.288 million, and originated commercial loan commitments of $17.247
million. Standby letters of credit are conditional commitments issued by MSB to
guarantee the performance of a customer to a third party. Those guarantees are
issued to support private borrowing arrangements. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan commitments to customers. At December 31, 1998, unused lines of credit were
$1,170,000 and standby letters of credit were $5,000. MSB anticipates that it
will have sufficient funds available to meet its current commitments. Management
believes that the market risk associated with the commercial loan commitments,
construction loan commitments, and commitments on undrawn home equity lines of
credit is not significant.
- --------------------------------------------------------------------------------
58
COMMUNITY BANKING FOR OVER A CENTURY
101
- ------------------------------15~EARNINGS PER SHARE-----------------------------
Effective December 31, 1997, MSB adopted FASB SFAS No. 128, "Earnings Per Share"
("Statement 128"). Statement 128 replaced primary earnings per share ("EPS")
with basic EPS and fully diluted EPS with diluted EPS. Basic EPS excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted from issuance of common stock that then shared in earnings.
The following table is a reconciliation of the numerators and denominators of
the basic and diluted EPS computations for the years ended December 31, 1998,
1997 and 1996.
1998 1997 1996
----------------------------------- ----------------------------------- -----------------------------------
INCOME AVERAGE INCOME AVERAGE INCOME AVERAGE
(LOSS) SHARES PER SHARE (LOSS) SHARES PER SHARE (LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------ ----------- ------------- ------ ----------- ------------- ------
Basic EPS:
Income (loss) available
to common
stockholders $2,657,843 4,289,248 $(9,154,504) 4,276,711 $(112,306) 4,273,130
ESOP shares not
committed to be
released -- (50,411) -- (65,884) -- (81,357)
---------- --------- ----------- --------- --------- ---------
2,657,843 4,238,837 $0.63 (9,154,504) 4,210,827 $(2.17) (112,306) 4,191,773 $(0.03)
===== ====== ======
Effect of dilutive securities:
Options -- 86,990 -- 397 -- 62
---------- --------- ----------- --------- --------- ---------
Diluted EPS:
Income (loss) available
to common stock-
holders and assumed
conversions $2,657,843 4,325,827 $0.61 $(9,154,504) 4,211,224 $(2.17) $(112,306) 4,191,835 $(0.03)
========== ========= ===== =========== ========= ====== ========= ========= ======
- --------------------------------------------------------------------------------
The following table summarizes granted options to purchase shares of common
stock that were outstanding at December 31, 1998, 1997 and 1996, but were not
included in the computation of diluted EPS because either the options' exercise
price was greater than the average market price of the common shares or MSB had
a net loss:
1998 1997 1996
------------ ----------- -----------
Weighted-average price of common stock $ 10.57 $ 9.76 $ 5.67
Weighted-average exercise price of options 17.94 10.20 9.75
Range of exercise prices $13.25-19.25 $4.25-19.25 $4.25-19.25
Number of shares 119,188 290,116 271,876
Weighted-average remaining contractual life (in years) 4.75 6.07 6.67
- --------------------------------------------------------------------------------
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COMMUNITY BANKING FOR OVER A CENTURY
102
- --------------16~FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK--------------
MSB is a party to financial instruments with off-balance sheet risk in the
normal course of its business. These instruments include commitments to extend
credit and commitments to sell loans. These instruments carry varying degrees of
credit and interest rate risk in excess of amounts, if any, recorded in the
financial statements. The contractual amounts of credit-related financial
instruments, such as commitments to extend credit, represent the amounts of
potential accounting loss should the contract be fully drawn upon, the customer
default, and the value of any existing collateral become worthless.
Commitments to originate mortgage loans of $12.239 million at December 31, 1998
represent amounts that MSB plans to fund within the normal commitment period of
thirty to ninety days. Because the creditworthiness of each customer is reviewed
prior to the extension of the commitment, MSB attempts to control the credit
risk on these commitments, as it does for loans recorded on the balance sheet.
As part of its effort to attempt to control interest rate risk on these
commitments, MSB generally sells fixed rate mortgage loans at a specified price
for delivery at a specified future date. Such commitments for future delivery
present a risk to MSB in the event it cannot deliver the loans during the
delivery period. This could lead to MSB incurring a fee for non-performance, or
repricing the mortgage loans at a lower rate and could cause a loss to MSB.
Forward commitments to sell mortgage loans for future delivery were $11.556
million at December 31, 1998.
Additionally, MSB's customers have approved, but not used, home equity lines of
credit of $12.288 million at December 31, 1998. Approval of equity lines is
based on underwriting standards that do not generally allow total real estate
secured debt, including the equity line of credit, to exceed 90% of the current
market value of the customer's home. These underwriting standards are similar to
guidelines used when MSB originates first mortgage loans and are a means of
attempting to control its credit risk on the loan.
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COMMUNITY BANKING FOR OVER A CENTURY
103
- -------------------------17~DISCLOSURE OF FAIR VALUE----------------------------
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of FASB's SFAS No. 107, "Disclosures
about Fair Value of Financial Instruments." The estimated fair value amounts
have been determined by MSB using available market information and valuation
methodologies. However, considerable judgment is required to interpret market
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts MSB could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following table presents the disclosure of estimated fair values as of
December 31, 1998 and 1997:
1998 1997
---------------------------- --------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ------------ ----------- -----------
Assets:
Cash on hand and on deposit $ 11,097,000 $ 11,097,000 $ 8,902,000 $ 8,902,000
Interest-bearing deposits 3,667,000 3,667,000 4,495,000 4,495,000
------------ ------------ ----------- ----------
Cash and cash equivalents 14,764,000 14,764,000 13,397,000 13,397,000
Investment securities 14,055,000 14,055,000 199,000 199,000
Mortgage-backed securities 181,339,000 181,302,000 293,346,000 290,314,000
Loans receivable, net 333,650,000 336,728,000 316,976,000 318,495,000
FHLB stock, at cost 7,023,000 7,023,000 7,023,000 7,023,000
Accrued interest receivable 2,542,000 2,542,000 3,167,000 3,167,000
Liabilities:
Deposits 420,818,000 423,108,000 407,388,000 408,446,000
Repurchase Agreements 45,000,000 46,069,000 85,000,000 85,205,000
FHLB advances 53,286,000 55,169,000 100,561,000 102,043,000
Advance payments by borrowers
for taxes and insurance 4,452,000 4,452,000 4,297,000 4,297,000
Accured interest payable 2,019,000 2,019,000 2,395,000 2,395,000
- -----------------------------------------------------------------------------------------------------------------
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104
- -----------------17~DISCLOSURE OF FAIR VALUE-CONTINUED--------------------------
CASH AND CASH EQUIVALENTS
For cash and cash equivalents, the carrying value approximates the fair value.
INVESTMENT SECURITIES
For investment securities (other than mortgage-backed securities)
and marketable equity securities, fair values are based on quoted market prices
or dealer quotes, if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities. The
estimated fair value of the CMO residual is based on future expected cash flows.
MORTGAGE-BACKED SECURITIES
Estimated fair value for mortgage-backed securities is based on quoted market
prices.
LOANS RECEIVABLE
For certain homogeneous categories of loans, such as certain residential
mortgage loans and consumer loans, fair value is estimated using the quoted
market prices for securities backed by similar loans, adjusted for differences
in loan characteristics. The fair value of other types of loans is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for similar remaining
maturities. The carrying value and fair value of commitments to originate and
sell loans is not significant.
FEDERAL HOME LOAN BANK STOCK
The carrying value of the FHLB stock approximates the fair value.
ACCRUED INTEREST RECEIVABLE
The carrying value of accrued interest receivable approximates the fair value.
DEPOSITS
The fair value of demand deposits, savings accounts, and certain money market
deposits is the amount payable at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated using the rates currently
offered for certificates of deposit of similar remaining maturities. The fair
value estimates do not include the benefit that results from the low-cost
funding generally provided by retail deposits compared to the cost of
alternative borrowing sources.
REPURCHASE AGREEMENTS
Rates currently available to MSB for Repurchase Agreements with similar terms
and remaining maturities are used to estimate the fair value of the existing
Repurchase Agreements.
FEDERAL HOME LOAN BANK ADVANCES
Rates currently available to MSB for FHLB advances with similar terms and
remaining maturities are used to estimate the fair value of the existing
advances.
ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE
The carrying value of advance payments by borrowers for taxes and insurance
approximates the fair value.
ACCRUED INTEREST PAYABLE
The carrying value of accrued interest payable approximates the fair value.
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62
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105
- ---------------------18~QUARTERLY FINANCIAL DATA (UNAUDITED)--------------------
The following is a summary of selected quarterly results of operations for the
years ended December 31, 1998 and 1997:
(IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE THREE MONTHS ENDED
------------------------------------------------
1998 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ----------------------------------------------- -------- ------- ------------ -----------
Interest income $10,479 $10,331 $ 9,691 $ 9,334
Net interest income 2,915 2,957 3,059 3,077
Provision for loan losses 110 120 120 235
Gains and fees on loans sold 604 475 446 712
General and administrative expenses 3,557 3,564 3,494 3,423
Income before income tax expense 543 591 672 852
Income tax expense -- -- -- --
Net income 543 591 672 852
Basic and diluted earnings per common share* 0.13 0.14 0.16 0.20
*For the year ended December 31, 1998 diluted earnings per share were $0.61.
This is different than the sum of the four quarters due to rounding.
(IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE THREE MONTHS ENDED
------------------------------------------------
1997 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ----------------------------------------------- -------- ------- ------------ -----------
Interest income $10,477 $10,645 $10,739 $10,636
Net interest income 2,772 2,782 2,848 2,852
Provision for loan losses 45 60 60 60
Settlement of class action lawsuit -- -- -- (9,650)
Gains and fees on loans sold 79 152 169 229
General and administrative expenses 3,525 3,588 3,543 3,651
Income (loss) before income tax expense 29 129 192 (9,505)
Income tax expense -- -- -- --
Net income (loss) 29 129 192 (9,505)
Basic and diluted earnings (loss) per common share 0.01 0.03 0.04 (2.25)
- --------------------------------------------------------------------------------
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63
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106
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
DIRECTORS AND EXECUTIVE OFFICERS
- --------------------------------------------------------------------------------
BOARD OF DIRECTORS
THOMAS T. PRINCING
Chairman of the Board - Mutual Savings Bank, f.s.b.
Owner, President and Chief Executive Officer -
Scientific Brake and Equipment Co.
E. JAMES BARRETT
President and Chief Executive Officer - Michigan Chamber of Commerce
WILLIAM P. BRENNAN
Secretary, Treasurer and Director - Brennan Cruiser Sales Company
CHARLES E. MCCUISTION
President and Chief Operating Officer - Mutual Savings Bank, f.s.b.
ROBERT N. SHUSTER
Chief Executive Officer - Mutual Savings Bank, f.s.b.
IN MEMORIAM
JOSEPH M. ROMBACH
September 23, 1948-May 6, 1998
EXECUTIVE OFFICERS
ROBERT N. SHUSTER
Chief Executive Officer
CHARLES E. MCCUISTION
President and Chief Operating Officer
BERNARD D. WILLIAMS
Senior Vice President, Chief Financial Officer and Treasurer
JAMES P. GORZINSKI
First Vice President and Director of Loan Operations
BURL C. HOWELL
First Vice President, Director of Human Resources and Assistant Secretary
THOMAS A. RINNESS
First Vice President and Director of Commercial Lending
GARY W. WILDS
First Vice President, General Counsel and Secretary
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64
COMMUNITY BANKING FOR OVER A CENTURY
107
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
STOCKHOLDERS' INFORMATION
- --------------------------------------------------------------------------------
STOCK LISTING
MSB's common stock trades on The Nasdaq Stock Market under the symbol "MSBK."
Daily closing prices can be followed by referring to the "Mutual Svg Bk" listing
in most newspapers.
INVESTOR INFORMATION
MSB's annual report to stockholders, annual report on Form 10-K, quarterly
reports and other information can be obtained by writing:
INVESTOR RELATIONS
MUTUAL SAVINGS BANK, F.S.B.
623 WASHINGTON AVENUE
BAY CITY, MICHIGAN 48708
Stockholders may also contact MSB by calling:
(800) 292-9948
MSB's internet address is: WWW.MUTUALSB.COM
Stockholders can obtain recent MSB news releases and current stock quotes on the
Internet at:
WWW.NASDAQ.COM
REGISTRAR AND TRANSFER AGENT
Harris Trust and Savings Bank
Attention: Shareholder Services
311 West Monroe, 14th Floor
PO Box A 3504
Chicago, Illinois 60690-3504
Stockholders may also contact MSB's transfer agent directly by calling
(312) 360-5340.
ANNUAL MEETING
MSB's annual meeting of stockholders will be held at 10:00 a.m. on Tuesday,
April 27, 1999, at the Delta College Planetarium and Learning Center, Space
Explorers Hall, 100 Center Avenue, Bay City, Michigan, 48708.
MARKET PRICE RANGE OF COMMON STOCK
SALES PRICE RANGE
----------------------------------------------
1998 1997
------------------- ------------------
HIGH LOW HIGH LOW
------- ------- ------- -------
First quarter $14.313 $11.250 $ 8.000 $ 5.500
Second quarter 13.000 11.063 10.125 6.500
Third quarter 12.000 6.750 15.000 9.750
Fourth quarter 9.625 5.563 14.625 11.250
AT DECEMBER 31,
-----------------------
1998 1997
-----------------------
Number of common shares
outstanding (1) 4,290,414 4,281,914
Holders of record 441 471
- --------------------------------------------------------------------------------
(1) No cash dividends have been paid to date on MSB's stock. For dividend
restrictions, see "Notes to Consolidated Financial Statements, Note 2 -
Regulatory Matters."
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108
MUTUAL SAVINGS BANK, F.S.B. AND SUBSIDIARIES
OFFICE LOCATIONS
- --------------------------------------------------------------------------------
CORPORATE HEADQUARTERS
623 Washington Avenue - Bay City, Michigan - 48708 - 517/892-3511 - 800/292-9948
www.mutualsb.com
RETAIL BANKING OFFICES
AUBURN
- 1004 W. Midland Road
Lynne Noneman, Manager
517/662-4403
BATTLE CREEK
- 2151 W. Columbia Avenue
Roberta Wetherill-Zull,
Manager
616/965-9344
- 701 North Avenue
Denise Steele,Manager
616/965-9342
- 720 Capital Avenue, S.W.
James Burgess, Manager
616/965-9340
- 1001 E. Columbia Avenue
Launa Farley, Manager
616/965-9343
BAY CITY
- 623 Washington Avenue
Cheryl Ratynski, Manager
517/892-3511
- 745 N. Euclid Avenue
Kay Richardson-Burks,
Manager
517/684-6021
- 800 Broadway Avenue
Mark Delestowicz, Manager
517/892-0553
BIG RAPIDS
- 404 Perry Street
Sueann Walz, Manager
616/796-5865
CASS CITY
- 6241 Main Street
Linda Gaymer,Manager
517/872-2105
EAST TAWAS
- 228 Newman Street
Mary Doak, Manager
517/362-6151
ESSEXVILLE
- 1615 W. Center Avenue
Lisa Foy, Manager
517/893-4563
MIDLAND
- 210 S. Saginaw Street
Lee Ann Mast, Manager
Loraine Davila, Manager
517/631-5860
MT. PLEASANT
- 319 E. Broadway
James Simcox, Manager
517/772-9405
MUSKEGON
- 2646 Henry Street
Kenneth Craigie, Manager
616/733-2595
PIGEON
- 75 S. Main Street
Stephen Langford, Manager
517/453-2900
PINCONNING
- 427 Mable Street
Daniel Couveau, Manager
517/879-2747
SAGINAW
- 3520 Davenport Avenue
Terri Paris, Manager
517/799-1881
- 1445 N. Center Road
Shelly Noble, Manager
517/799-1673
SEBEWAING
- 8880 Unionville Road
Connie Scharich, Manager
517/883-3310
STANDISH
- 209 S. Main Street
Terri Marx, Manager
517/846-4595
WEST BRANCH
- 700 W. Houghton Avenue
Michael Berry, Manager
517/345-3930
SUBSIDIARIES
MSB INVESTMENT AND INSURANCE SERVICES, INC.
623 Washington Avenue
Bay City, Michigan 48708
517/892-3511
Daniel E. Engelhardt, President
MSB SERVICE CORPORATION
623 Washington Avenue
Bay City, Michigan 48708
517/894-7037
Robert N. Shuster, President
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COMMUNITY BANKING FOR OVER A CENTURY