1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
Commission file number 0-7818
INDEPENDENT BANK CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as speified in its charter)
Michigan 38-2032782
- ------------------------------ -------------------------------
(State or jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
230 West Main Street, P.O. Box 491, Ionia, Michigan 48846
- --------------------------------------------------------------------------------
(Address of principal executive offices)
(616) 527-9450
--------------
(Registrant's telephone number, including area code)
NONE
- --------------------------------------------------------------------------------
Former name, address and fiscal year, if changed since last report.
Indicate by check mark whether the registrant (1) has filed all documents
and reports required to be filed by Sections 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. YES /X/ NO
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at November 11, 1999
- -------------------------------- -----------------------------------
Common stock, par value $1 11,485,449
2
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
INDEX
----- Page
Number(s)
---------
PART I - Financial Information
---------------------
Item 1. Consolidated Statements of Financial Condition
September 30, 1999 and December 31, 1998 2
Consolidated Statements of Operations
Three- and nine-month periods ended September 30, 1999 and 1998 3
Consolidated Statements of Cash Flows
Nine-month periods ended September 30, 1999 and 1998 4
Consolidated Statements of Shareholders' Equity
Nine-month periods ended September 30, 1999 and 1998 5
Notes to Interim Consolidated Financial Statements
Three- and nine-month periods ended September 30, 1999 and 1998 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
PART II - Other Information
Item 4. Submission of Matters to a Vote of Security-Holders 21
Item 6. Exhibits & Reports on Form 8-K 21
3
Part I.
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, December 31,
1999 1998
--------------- ---------------
Assets (unaudited)
--------------- ---------------
Cash and due from banks $ 42,989,000 $ 53,943,000
Securities available for sale 190,997,000 155,624,000
Securities held to maturity (Fair value of $108,147,000 at September
30,1999; $161,944,000 at December 31, 1998) 108,686,000 161,301,000
Federal Home Loan Bank stock, at cost 19,612,000 19,612,000
Loans held for sale 15,910,000 45,699,000
Loans
Commercial and agricultural 306,025,000 277,024,000
Real estate mortgage 762,634,000 719,398,000
Installment 165,066,000 155,717,000
---------------- ----------------
Total Loans 1,233,725,000 1,152,139,000
Allowance for loan losses (12,607,000) (11,557,000)
---------------- ----------------
Net Loans 1,221,118,000 1,140,582,000
Property and equipment, net 37,335,000 35,272,000
Accrued income and other assets 51,780,000 48,860,000
================ ================
Total Assets $ 1,688,427,000 $ 1,660,893,000
================ ================
Liabilities and Shareholders' Equity
Deposits
Non-interest bearing $ 120,582,000 $ 123,457,000
Savings and NOW 550,370,000 523,580,000
Time 622,016,000 604,295,000
---------------- ----------------
Total Deposits 1,292,968,000 1,251,332,000
Federal funds purchased 37,700,000 22,650,000
Other borrowings 195,368,000 229,249,000
Guaranteed preferred beneficial interests in Company's subordinated
debentures 17,250,000 17,250,000
Accrued expenses and other liabilities 27,725,000 23,370,000
---------------- ----------------
Total Liabilities 1,571,011,000 1,543,851,000
---------------- ----------------
Shareholders' Equity
Preferred stock, no par value--200,000 shares authorized; none
outstanding
Common stock, $1.00 par value--14,000,000 shares authorized;
issued and outstanding: 11,477,315 shares at September 30, 1999
and 7,382,506 shares at December 31, 1998 11,477,000 10,815,000
Capital surplus 75,576,000 66,406,000
Retained earnings 32,428,000 38,639,000
Accumulated other comprehensive income (loss) (1,266,000) 1,981,000
Unearned employee stock ownership plan shares (799,000) (799,000)
---------------- ----------------
Total Shareholders' Equity 117,416,000 117,042,000
---------------- ----------------
Total Liabilities and Shareholders' Equity $ 1,688,427,000 $ 1,660,893,000
================ =================
See notes to interim consolidated financial statements.
2
4
Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------------- -------------- -------------- ----------------
(unaudited) (unaudited)
----------------------------- ------------------------------
Interest Income
Interest and fees on loans $ 27,029,000 $ 25,971,000 $ 79,237,000 $ 76,014,000
Securities
Taxable 3,125,000 4,509,000 10,270,000 15,289,000
Tax-exempt 1,080,000 727,000 2,754,000 1,941,000
Other investments 530,000 428,000 1,176,000 1,260,000
-------------- ------------- ------------- --------------
Total Interest Income 31,764,000 31,635,000 93,437,000 94,504,000
-------------- ------------- ------------- --------------
Interest Expense
Deposits 11,107,000 11,206,000 32,593,000 32,207,000
Other borrowings 3,518,000 4,953,000 10,977,000 16,945,000
-------------- ------------- ------------- --------------
Total Interest Expense 14,625,000 16,159,000 43,570,000 49,152,000
-------------- ------------- ------------- --------------
Net Interest Income 17,139,000 15,476,000 49,867,000 45,352,000
Provision for loan losses 645,000 1,035,000 1,966,000 2,568,000
-------------- ------------- ------------- --------------
Net Interest Income After
Provision for Loan Losses 16,494,000 14,441,000 47,901,000 42,784,000
-------------- ------------- ------------- --------------
Non-interest Income
Service charges on deposit accounts 1,481,000 1,211,000 4,051,000 3,299,000
Net gains (losses) on asset sales
Real estate mortgage loans 880,000 1,664,000 3,662,000 4,699,000
Securities (108,000) (93,000) 145,000
Other income 2,036,000 2,058,000 6,244,000 5,401,000
-------------- ------------- ------------- --------------
Total Non-interest Income 4,289,000 4,933,000 13,864,000 13,544,000
-------------- ------------- ------------- --------------
Non-interest Expense
Salaries and employee benefits 8,767,000 8,311,000 25,923,000 23,881,000
Occupancy, net 1,162,000 1,142,000 3,429,000 3,119,000
Furniture and fixtures 1,108,000 848,000 3,070,000 2,641,000
Merger related costs 4,623,000 4,623,000
Settlement of lawsuit 2,025,000 2,025,000
Other expenses 4,662,000 4,798,000 14,614,000 14,278,000
-------------- ------------- ------------- --------------
Total Non-interest Expense 22,347,000 15,099,000 53,684,000 43,919,000
-------------- ------------- ------------- --------------
Income (Loss) Before Federal Income Tax (1,564,000) 4,275,000 8,081,000 12,409,000
Federal income tax expense (benefit) (385,000) 1,256,000 2,488,000 3,681,000
------------- --------------
============== =============
Net Income (Loss) $ (1,179,000) $ 3,019,000 $ 5,593,000 $ 8,728,000
============== ============= ============= ==============
Net Income (Loss) Per Share
Basic $ (.10) $ .27 $ .49 $ .78
Diluted (.10) .26 .49 .76
Dividends Per Common Share
Declared $ .133 $ .081 $ .400 $ .242
Paid .133 .081 .400 .242
See notes to interim consolidated financial statements.
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INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine months ended
September 30,
1999 1998
--------------- ---------------
(unaudited)
-------------------------------
Net Income $ 5,593,000 $ 8,728,000
--------------- --------------
Adjustments to Reconcile Net Income
to Net Cash from Operating Activities
Proceeds from sales of loans held for sale 240,105,000 340,301,000
Disbursements for loans held for sale (206,653,000) (356,197,000)
Provision for loan losses 1,966,000 2,568,000
Deferred loan fees (8,000) 145,000
Depreciation and amortization of premiums and accretion of
discounts on securities and loans 4,666,000 3,840,000
Net gains on sales of real estate mortgage loans (3,662,000) (4,699,000)
Net (gains) losses on sales of securities 93,000 (145,000)
Increase in accrued income and other assets (4,113,000) (3,831,000)
Increase (decrease) in accrued expenses and other liabilities 5,944,000 (2,293,000)
---------------- --------------
Total Adjustments 38,338,000 (20,311,000)
---------------- --------------
Net Cash from Operating Activities 43,931,000 (11,583,000)
---------------- --------------
Cash Flow from Investing Activities
Proceeds from the sale of securities available for sale 15,928,000 4,882,000
Proceeds from the maturity of securities available for sale 35,281,000 19,304,000
Proceeds from the maturity of securities held to maturity 533,550,000 754,906,000
Principal payments received on securities available for sale 11,183,000 15,761,000
Principal payments received on securities held to maturity 463,000 1,223,000
Purchases of securities available for sale (104,065,000) (18,328,000)
Purchases of securities held to maturity (480,164,000) (700,859,000)
Principal payments on portfolio loans purchased 2,073,000 12,264,000
Portfolio loans made to customers, net of principal payments received (84,566,000) (58,945,000)
Acquisition of business, less cash received 1,459,000
Acquisition of branches, less cash received 16,168,000
Capital expenditures (5,209,000) (5,667,000)
---------------- --------------
Net Cash from Investing Activities (75,526,000) 42,168,000
---------------- --------------
Cash Flow from Financing Activities
Net increase in total deposits 41,636,000 66,084,000
Net increase (decrease) in short-term borrowings 14,422,000 (51,134,000)
Proceeds from Federal Home Loan Bank advances 56,831,000 78,968,000
Payments of Federal Home Loan Bank advances (88,584,000) (118,000,000)
Retirement of long-term debt (1,500,000) (1,500,000)
Dividends paid (3,047,000) (2,674,000)
Proceeds from issuance of common stock 883,000 801,000
---------------- --------------
Net Cash from Financing Activities 20,641,000 (27,455,000)
---------------- --------------
Net Increase (Decrease) in Cash and Cash Equivalents (10,954,000) 3,130,000
Cash and Cash Equivalents at Beginning of Period 53,943,000 39,273,000
---------------- --------------
Cash and Cash Equivalents at End of Period $ 42,989,000 $ 42,403,000
================ ==============
Cash paid during the period for
Interest $ 43,708,000 $ 48,333,000
Income taxes 2,600,000 4,000,000
Transfer of loans to other real estate 1,635,000 699,000
See notes to interim consolidated financial statements
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INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
-----------------------------------------------
Nine months ended
September 30,
1999 1998
-------------- ---------------
(unaudited)
-------------------------------
Balance at beginning of period $ 117,042,000 $ 104,625,000
Net income 5,593,000 8,728,000
Cash dividends declared (3,610,000) (2,727,000)
Issuance of common stock 1,686,000 3,326,000
ESOP valuation adjustment (48,000) (67,000)
Net change in unrealized gain (loss) on securities
available for sale, net of related tax effect (note 4) (3,247,000) 966,000
=============== ==============
Balance at end of period $ 117,416,000 $ 114,851,000
=============== ==============
See notes to interim consolidated financial statements.
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------
(unaudited)
1. In the opinion of management of the Registrant, the accompanying unaudited
consolidated financial statements contain all the adjustments (consisting only
of normal recurring accruals) necessary to present fairly the consolidated
financial condition of the Registrant as of September 30, 1999 and December 31,
1998, and the results of operations for the nine-month periods ended September
30, 1999 and 1998.
2. Management's assessment of the allowance for loan losses is based on an
evaluation of the loan portfolio, recent loss experience, current economic
conditions and other pertinent factors. Loans on non-accrual status, past due
more than 90 days, or restructured amounted to $5,126,000 at September 30, 1999,
and $6,837,000 at December 31, 1998. (See Management's Discussion and Analysis
of Financial Condition and Results of Operations).
3. The provision for income taxes represents federal income tax expense
calculated using annualized rates on taxable income generated during the
respective periods.
4. The Registrant adopted Statement of Financial Accounting Standards, No. 130,
"Reporting Comprehensive Income", (SFAS #130) effective January 1, 1998. SFAS
#130 establishes standards for reporting and displaying comprehensive income and
its components, including but not limited to unrealized gains and losses on
securities available for sale.
Comprehensive income (loss) for the three-month and the nine-month periods
ending September 30 follows:
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
------------- ------------- -------------- -------------
Net income (loss) $ (1,179,000) $ 3,019,000 $ 5,593,000 $ 8,728,000
Net change in unrealized gain
on securities available for sale,
net of related tax effect (1,560,000) 984,000 (3,247,000) 966,000
============= ============= ============== =============
Comprehensive income (loss) $ (2,739,000) $ 4,003,000 $ 2,346,000 $ 9,694,000
============= ============= ============== =============
5. The Registrant adopted Statement of Financial Accounting Standards, No. 131,
"Disclosures about Segments of an Enterprise and Related Information", (SFAS
#131) on January 1, 1998. SFAS #131 establishes standards for the way that
public entities report information about operating segments in financial
statements.
The Registrant's reportable segments are based upon legal entities. The
Registrant has five reportable segments: Independent Bank ("IB"), Independent
Bank West Michigan ("IBWM"), Independent Bank South Michigan ("IBSM"),
Independent Bank East Michigan ("IBEM") and Independent Bank MSB ("IBMSB"). The
Registrant evaluates performance based principally on net income of the
respective reportable segments.
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
--------------------------------------------------------------
(unaudited)
A summary of selected financial information for the Registrant's reportable
segments for the three and nine-month periods ended September 30, follows:
Three months ended September 30,
IB IBWM IBSM IBEM IBMSB OTHER(1) TOTAL
--------------------------------------------------------------------------------------------
(in thousands)
1999
Total assets $ 374,673 $ 302,139 $ 171,441 $ 285,633 $ 545,035 $ 9,506 $ 1,688,427
Interest income 7,187 6,652 3,339 5,233 9,348 5 31,764
Net interest income 4,424 4,172 2,014 3,170 3,890 (531) 17,139
Provision for loan losses 150 135 60 150 150 645
Income (loss) before
Income tax 1,605 1,607 611 1,055 (5,560) (882) (1,564)
Net income (loss) 1,145 1,104 493 812 (4,128) (605) (1,179)
1998
Total assets $ 353,141 $ 270,012 $ 167,940 $ 247,333 $ 585,875 $ 4,993 $ 1,629,294
Interest income 7,272 6,403 3,492 4,793 9,668 7 31,635
Net interest income 4,334 3,825 2,009 2,831 3,059 (582) 15,476
Provision for loan losses 295 425 90 105 120 1,035
Income (loss) before
Income tax 1,551 1,375 697 872 672 (892) 4,275
Net income (loss) 1,068 961 513 648 437 (608) 3,019
Nine months ended September 30,
IB IBWM IBSM IBEM IBMSB OTHER(1) TOTAL
--------------------------------------------------------------------------------------------
(in thousands)
1999
Total assets $ 374,673 $ 302,139 $ 171,441 $ 285,633 $ 545,035 $ 9,506 $ 1,688,427
Interest income 21,371 19,235 9,908 15,011 27,894 18 93,437
Net interest income 13,198 12,156 6,072 9,291 10,766 (1,616) 49,867
Provision for loan losses 450 405 220 450 441 1,966
Income (loss) before
Income tax 4,855 4,584 2,072 2,946 (3,769) (2,607) 8,081
Net income (loss) 3,395 3,156 1,581 2,236 (2,964) (1,811) 5,593
1998
Total assets $ 353,141 $ 270,012 $ 167,940 $ 247,333 $ 585,875 $ 4,993 $ 1,629,294
Interest income 21,223 18,341 10,183 14,224 30,509 24 94,504
Net interest income 12,680 11,171 5,838 8,502 8,931 (1,770) 45,352
Provision for loan losses 745 815 250 408 350 2,568
Income (loss) before
Income tax 4,730 4,012 2,162 2,563 1,806 (2,864) 12,409
Net income (loss) 3,276 2,809 1,582 1,853 1,174 (1,966) 8,728
(1) Includes items relating to the Registrant and certain insignificant operations.
7
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
--------------------------------------------------------------
(unaudited)
6. A reconciliation of basic and diluted earnings per share for the three-month
and the nine-month periods ending September 30 follows:
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
-------------- -------------- ------------- -------------
Net income (loss) $ (1,179,000) $ 3,019,000 $ 5,593,000 $ 8,728,000
============== ============== ============ =============
Shares outstanding (Basic) (1) 11,428,000 11,305,000 11,392,000 11,255,000
Effect of dilutive securities - stock options 131,000 150,000 132,000 171,000
-------------- -------------- ------------ -------------
Shares outstanding (Diluted) 11,559,000 11,455,000 11,524,000 11,426,000
============== ============== ============ =============
Net income (loss) per share
Basic $ (.10) $ .27 $ .49 $ .78
Diluted (.10) .26 .49 .76
(1) Shares outstanding have been adjusted for a 5% stock dividend in 1999.
7. The Financial Accounting Standards Board adopted Statement of Financial
Accounting Standards, No. 133, "Accounting for Derivative Instruments and
Hedging Activities", ("SFAS #133") in June 1998.
SFAS #133, which has been subsequently amended by SFAS #137, requires companies
to record derivatives on the balance sheet as assets and liabilities measured at
fair value. The accounting for increases and decreases in the value of those
derivatives will depend upon the use of those derivatives and whether or not
they qualify for hedge accounting.
This statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 2000 with earlier application allowed and is to be applied
prospectively. The adoption of this statement is not expected to have a material
impact on the Registrant's financial statements.
8. Prior period financial information has been restated to reflect the
acquistion of Mutual Savings Bank, f.s.b., ("MSB") completed September 15, 1999,
which has been accounted for as a pooling of interests. Management believes that
the tax benefits associated with MSB's deferred tax assets will more likely than
not be realized, and therefore prior period financial information of MSB has
been adjusted to include the net deferred tax asset as if no valuation allowance
had been recognized.
9. The results of operations for the three- and nine-month period ended
September 30, 1999, are not necessarily indicative of the results to be expected
for the full year.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results of
operations contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results could differ materially
from those projected in such forward-looking statements.
The following section presents additional information that may be necessary to
assess the financial condition and results of operations of the Registrant and
its subsidiary banks (the "Banks"). This section should be read in conjunction
with the consolidated financial statements contained elsewhere in this report as
well as the Registrant's 1998 Annual Report on Form 10-K.
RECENT ACQUISITION
On September 15, 1999, the Registrant completed its acquisition of Mutual
Savings Bank, f.s.b. ("MSB"). On September 30, 1999, MSB's assets and
shareholders' equity totaled $582.0 million and $43.9 million, respectively. The
markets served by MSB's 22 offices are located within the Lower Peninsula of
Michigan and are generally contiguous to markets that are served by the
remaining Banks.
The Registrant's consideration consisted of 3,436,000 shares of its common stock
(3,608,000 shares adjusted for the Registrant's 5% stock dividend declared
September 21, 1999) with an aggregate value of approximately $54.8 million. The
transaction qualified as a "pooling of interests" and the Registrant's results
of operations for the three- and nine-month periods ended September 30, 1999,
include MSB's revenues and expenses since January 1, 1999. The Registrant's
results of operations for the corresponding periods of 1998 as well as its
statement of financial condition at December 31, 1998 have been restated.
Management expects that total restructuring charges and other non-recurring
expenses will range between $7.5 and $8.5 million. Such non-recurring expenses
include costs related to an existing lawsuit against MSB that was settled on
October 1, 1999. Non-recurring charges of $6,743,000 are included in the
Registrant's results of operation for the three- and nine-month periods ended
September 30, 1999. Any remaining charges will be realized during the three
months ending December 31, 1999. (See "Securities.")
NON-RECURRING CHARGES
September 30,
1999
---------------
Litigation settlement $ 2,025,000
Data processing termination and conversion costs 1,210,000
Legal and professional 1,133,000
Severance 683,000
Write-down of fixed assets 950,000
Loss on sale of securities 95,000
Other 647,000
---------------
6,743,000
Tax effect (1,822,000)
---------------
$ 4,921,000
===============
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FINANCIAL CONDITION
SUMMARY Loans, excluding loans held for sale ("Portfolio Loans"), increased by
7.1% to $1.234 billion at September 30, 1999. Real estate mortgage loans grew by
6.0% during the nine-month period to $762.6 million at September 30, 1999, and
account for 53% of the $81.6 million increase in Portfolio Loans. Commercial and
agricultural loans grew by 10.5% to $306.0 million while installment loans
increased by 6.0% to $165.1 million. (See "Portfolio loans and asset quality.")
An increase in deposits as well as a decline in loans held for sale principally
funded the increase in Portfolio Loans. Proceeds from the sale or maturity of
securities also funded a portion of the increase in Portfolio Loans.
(See "Securities.")
Deposits grew by 3.4% to $1.293 billion at September 30, 1999. Savings and NOW
accounts grew by $26.8 million during the nine-month period and account for a
majority of the $42.0 million increase in total deposits. The $17.7 million
increase in time deposits reflects the Banks' use of brokered certificates of
deposits. (See "Deposits and borrowings.")
SECURITIES The Banks maintain diversified securities portfolios that include
obligations of the U.S. Treasury and government-sponsored agencies as well as
securities issued by states and political subdivisions, corporate securities and
mortgage-backed securities. Management continually evaluates the Banks'
asset/liability management needs and attempts to maintain a portfolio structure
that provides sufficient liquidity and cash flow. (See "Asset/liability
management.")
SECURITIES
Unrealized
----------------------------
Amortized Fair
Cost Gains Losses Value
-------------- -------------- ------------- -------------
(in thousands)
Securities available for sale
September 30, 1999 $192,915 $ 613 $2,531 $190,997
December 31, 1998 152,622 3,132 130 155,624
Securities held to maturity
September 30, 1999 $ 108,686 $ 301 $ 840 $ 108,147
December 31, 1998 161,301 762 119 161,944
The purchase or sale of securities is dependent upon Management's assessment of
reinvestment opportunities as well as the Banks' asset/liability management
needs. The Banks sold securities designated as available for sale with an
aggregate market value of $15.9 million during the nine months ended September
30, 1999, compared to $4.9 million during the corresponding period of 1998. The
increase in the sale of securities designated as available for sale principally
relates to Management's efforts to restructure MSB's securities portfolios.
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SALES OF SECURITIES AVAILABLE FOR SALE
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
---------------- --------------- ---------------- ----------------
Proceeds $15,661,000 -- $15,928,000 $4,882,000
=============== ================ ================ ================
Gross gains $14,000 $145,000
Gross losses (108,000) -- (107,000)
--------------- ---------------- ---------------- ----------------
Net Gains $(108,000) -- $(93,000) $145,000
=============== ================ ================ ================
Mortgage pass-thru securities issued by government-sponsored agencies that had
been designated as available for sale comprise the majority of the securities
sold during 1999. Such securities had a weighted-average life of approximately
2.7 years and have been sold to yield approximately 6.15%. Proceeds have been
utilized to fund increases in Portfolio Loans or invested in higher-yielding
securities, including securities issued by states and political subdivisions and
corporate securities.
Management also continues to evaluate opportunities to restructure MSB's
security portfolios. Based upon its ongoing evaluations, Management believes
that MSB may sell securities with an aggregate market value of as much as $50
million. Management further believes that MSB may incur additional losses, which
have been included in its estimate of non-recurring charges. (See "Recent
Acquisition.")
PORTFOLIO LOANS AND ASSET QUALITY Management believes that the Registrant's
decentralized structure provides important advantages in serving the credit
needs of the Banks' principal lending markets. In addition to the communities
served by the Banks' branch networks, principal lending markets include nearby
communities and metropolitan areas. Subject to established underwriting
criteria, the Banks also participate in commercial lending transactions with
certain non-affiliated banks and may also purchase real estate mortgage loans
from third-party originators.
Although the Management and Board of Directors of each Bank retain authority and
responsibility for credit decisions, each of the Banks has adopted uniform
underwriting standards. Further, the Registrant's loan committee as well as the
centralization of commercial loan credit services and loan review functions
promote compliance with such established underwriting standards. The
centralization of retail loan services also provides for consistent service
quality and facilitates compliance with consumer protection laws and
regulations.
Management has determined that the retention of certain real estate mortgage
loans, generally 15- and 30-year fixed rate obligations, is inconsistent with
its goal to maintain profitable leverage or the Banks' interest-rate risk
profiles. Accordingly, the majority of such loans are sold to mitigate exposure
to changes in interest rates. Adjustable-rate and balloon real estate mortgage
loans may often be profitably funded within established risk parameters. The
retention of such loans, together with commercial and agricultural loans, has
been a principal focus of the Banks' balance sheet management strategies. (See
"Asset/liability management.")
Real estate mortgages comprise a substantial portion of the Banks' lending
activities. The $43.2 million increase in real estate mortgage loans reflects an
increase in the relative demand for
11
13
adjustable rate and balloon loans that accompanied the increase in interest
rates. A decline in prepayment rates [refinancing activity] also contributed to
the increase in real estate mortgage loans. (See "Non-interest income.")
NON-PERFORMING ASSETS
September 30, December 31,
1999 1998
----------------- -----------------
Non-accrual loans $2,994,000 $4,302,000
Loans 90 days or more past due and
still accruing interest 1,858,000 2,240,000
Restructured loans 274,000 295,000
----------------- -----------------
Total non-performing loans 5,126,000 6,837,000
Other real estate 985,000 1,265,000
================= =================
Total non-performing assets $6,111,000 $8,102,000
================= =================
As a percent of Portfolio Loans
Non-performing loans 0.42 % 0.59 %
Non-performing assets 0.50 0.70
Allowance for loan losses 1.02 1.00
Allowance for loan losses as a percent of
non-performing loans 246 169
Impaired loans totaled approximately $3,400,000 at September 30, 1999. At that
same date, certain impaired loans with a balance of approximately $1,000,000,
had specific allocations of the allowance for loan losses calculated in
accordance with Statement of Financial Accounting Standards #114 totaling
approximately $200,000. The Banks' average investment in impaired loans was
approximately $3,300,000, for the nine-month period ended September 30, 1999.
Cash receipts on impaired loans on non-accrual status are generally applied to
the principal balance. Interest recognized on impaired loans during that
nine-month period was approximately $120,000.
ALLOWANCE FOR LOAN LOSSES
Nine months ended
September 30,
1999 1998
---------------- --------------
Balance at beginning of period $11,557,000 $9,639,000
Additions (deduction)
Provision charged to operating expense 1,966,000 2,568,000
Recoveries credited to allowance 620,000 509,000
Loans charged against the allowance (1,536,000) (1,684,000)
================ ==============
Balance at end of period $12,607,000 $11,032,000
================ ==============
Net loans charged against the allowance to
average Portfolio Loans (annualized) 0.11% 0.15%
Management's assessment of the allowance for loan losses is based on the
composition of the loan portfolio, an evaluation of specific credits, historical
loss experience as well as the level of non-performing and impaired loans. Loans
charged against the allowance for loan losses, net of
12
14
recoveries, were equal to .11% of average loans during the nine months ended
September 30, 1999, compared to .15% during the comparable period of 1998. (See
"Provision for loan losses.")
DEPOSITS AND BORROWINGS The Banks' competitive position within many of the
markets served by the branch networks limits the ability to materially increase
deposits without adversely impacting the weighted-average cost of core deposits.
Accordingly, Management employs pricing tactics that are intended to enhance the
value of core deposits and the Banks' have implemented funding strategies that
incorporate other borrowings and Brokered CDs to finance a portion of the
Portfolio Loans. The use of such alternate sources of funds is also an integral
part of the Banks' asset/liability management efforts.
September 30, 1999 December 31, 1998
------------------------------- ---------------------------------
Average Average
Amount Maturity Rate Amount Maturity Rate
------ -------- ---- ------ -------- ----
(dollars in thousands)
Brokered CDs $79,317 7.2 years 6.22% $54,885 4.4 years 5.64%
Fixed rate FHLB advances 89,551 4.9 years 5.79 103,855 4.3 years 6.04
Variable rate FHLB advances 51,056 0.3 years 5.41 68,500 0.5 years 5.21
Other borrowed funds, principally advances from the Federal Home Loan Bank (the
"FHLB"), decreased to $195.4 million at September 30, 1999, from $229.2 million
at December 31, 1998. The decline in other borrowed funds reflects the
competitive cost of Brokered CDs as well as Management's efforts to diversify
the Banks' funding sources. Brokered CDs totaled $79.3 million and $54.9 million
at September 30, 1999 and December 31, 1998, respectively.
INTEREST-RATE DERIVATIVE FINANCIAL INSTRUMENTS
SWAPS
----------------------------------
CAPS FLOORS COLLARS PAY FIXED PAY VARIABLE
- ----------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Notional amount $24,500 $3,000 $10,000 $61,500 $73,000
Weighted-average
maturity 3.0 years 1.6 years 0.9 years 2.4 years 7.7 years
Cap strike 6.47% 6.42%
Floor strike 4.63% 5.71
Rate paying 5.39% 5.30%
Rate receiving 5.40 6.32
Premium paid $ 564 $ 5
Annual cost
.43% .09%
Amortized cost $ 430 $ 4
Fair value 405 1 $ (36) $ 825 $(2,160)
Derivative financial instruments are employed to reduce the cost of alternate
funding sources and to manage the Banks' exposure to changes in interest rates.
Certain derivative financial instruments may also mitigate the interest-rate
risk associated with prepayments on fixed-rate loans. (See "Asset/liability
management.") At September 30, 1999, the Company employed interest-rate caps and
collars with a notional amount of $24.5 million and $10.0 million, respectively.
The Banks also employed interest-rate swaps with an aggregate notional amount of
$134.5 million.
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LIQUIDITY AND CAPITAL RESOURCES Effective management of the Registrant's capital
resources is critical to Management's mission to create value for the
Registrant's shareholders. The cost of capital is an important factor in
creating shareholder value and, accordingly, the Registrant's capital structure
includes unsecured debt and Preferred Securities.
To profitably deploy capital within existing markets, the Banks have implemented
balance sheet management strategies that combine efforts to originate Portfolio
Loans with disciplined funding strategies. Acquisitions as well as the open
market purchase of the Registrant's common stock are also integral components of
Management capital management strategies. (See "Stock repurchase plan.")
CAPITALIZATION
September 30, December 31,
1999 1998
--------------- -------------
Unsecured debt $ 8,500,000 $ 10,000,000
Preferred Securities 17,250,000 17,250,000
Shareholders' Equity
Preferred stock, no par value
Common Stock, par value $1.00 per share 11,477,000 10,815,000
Capital surplus 75,576,000 66,406,000
Retained earnings 32,428,000 38,639,000
Accumulated other comprehensive income (loss) (1,266,000) 1,981,000
Unearned employee stock ownership plan shares (799,000) (799,000)
------------ ------------
Total shareholders' equity 117,416,000 117,042,000
------------ ------------
Total capitalization $143,166,000 $144,292,000
============ ============
Shareholders' equity totaled $117.4 million at September 30, 1999, largely
unchanged from $117.0 million at December 31, 1998, as an increase in unrealized
losses on securities available for sale offset the retention of earnings and the
issuance of common stock pursuant to various equity-based incentive compensation
plans. Shareholders' equity was equal to 6.95% of total assets at September 30,
1999, compared to 7.05% at December 31, 1998.
CAPITAL RATIOS
September 30, 1999 December 31, 1998
---------------------- ----------------------
Equity capital 6.95% 7.05%
Average shareholders equity to average assets(1) 7.27 6.73
Tier 1 leverage (tangible equity capital) 7.06 6.92
Tier 1 risk-based capital 10.09 11.16
Total risk-based capital 11.19 11.22
(1) Based on year to date average balances for the respective periods
ASSET/LIABILITY MANAGEMENT Interest-rate risk is created by differences in the
pricing characteristics of the Banks' assets and liabilities. Options embedded
in certain financial instruments, including caps on adjustable-rate loans as
well as borrowers' rights to prepay fixed-rate loans also create interest-rate
risk.
14
16
The asset/liability management efforts of the Registrant and the Banks are
intended to identify sources of interest-rate risk and to evaluate opportunities
to structure the balance sheet in a manner that is consistent with Management's
mission to maintain profitable financial leverage. The marginal cost of funds is
a principal consideration in the implementation of the Bank's balance sheet
management strategies, but such evaluations further consider interest-rate and
liquidity risk as well as other pertinent factors.
Management employs simulation analyses to monitor the Banks' interest-rate risk
profiles and evaluate potential changes in the Bank's net interest income and
market value of portfolio equity that result from changes in interest rates.
RESULTS OF OPERATIONS
SUMMARY The Registrant's earnings for the three- and nine-month periods in 1999
reflect certain one-time, merger-related charges. These charges, which include
costs to settle a shareholder suit against the former Mutual Savings Bank,
f.s.b., totaled $4,921,000, net of federal income taxes. As a result of these
non-recurring charges, the Registrant reported a net loss of $1,179,000 for the
three months ended September 30, 1999. Net income for the nine-month periods
totaled $5,593,000 in 1999. The company expects to recognize additional
merger-related charges during the fourth quarter of 1999. (See "non-interest
expense.")
Excluding consideration of these non-recurring charges, the Registrant's
earnings for the three months ended September 30, 1999, totaled $3,742,000.
Earnings for the comparable quarter of 1998 totaled $3,019,000. Earnings
(excluding consideration of the non-recurring charges) for the nine months ended
September 30, 1999, totaled $10,514,000, compared to $8,728,000 during the
corresponding period of 1998.
The increase in earnings during both the three- and nine-month periods
(excluding consideration of the non-recurring charges) principally reflects
increases in net interest income and a decline in the provision for loan losses.
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17
KEY PERFORMANCE RATIOS
Three months Nine months
ended September 30, ended September 30,
1999 1998 1999 1998
---------------------------- ----------------------------
Net income (loss) to
Average assets (0.28)% .73% .45% .71%
Average equity (3.83) 10.60 6.19 10.61
Net income (loss) per common share
Basic $(0.10) $.27 $.49 $.78
Diluted (0.10) .26 .49 .76
Cash basis income (loss) to(A)
Average tangible assets (0.20)% .83% .54% .80%
Average tangible equity (3.12) 14.32 8.66 14.19
Cash basis income (loss) per share(A)
Basic $(0.07) $.30 $.58 $.87
Diluted (0.07) .30 .58 .85
(A) Cash basis financial data exclude intangible assets and the related amortization expense
NET INTEREST INCOME Tax equivalent net interest income totaled $17,750,000
during the three months ended September 30, 1999, compared to $15,882,000 during
the comparable period of 1998. Tax equivalent net interest income totaled
$51,427,000 and $45,459,000 during the nine months ended September 30, 1999 and
1998, respectively. Tax equivalent net interest income as a percent of average
earning assets ("Net Yield") was equal to 4.56% of average earning assets during
the three months ended September 30, 1999, compared to 4.13% during the
corresponding period of 1998. Net Yield was equal to 4.46% and 4.03% of average
earning assets during the nine-month periods in 1999 and 1998, respectively.
A portion of the increase in tax equivalent net interest income may be
attributed to the scheduled maturity of certain low-yielding assets and
high-cost liabilities at MSB. Increases in tax equivalent net interest income
also reflect increases in deposits, exluding Brokered CD's ("Core Deposits") as
a percentage of average earning assets. Core Deposits were equal to 78.8% and
72.8% of average earning assets for the nine months ended September 30, 1999 and
1998, respectively.
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18
NET INTEREST INCOME AND SELECTED RATIOS
Three months Nine months
ended September 30, ended September 30,
1999 1998 1999 1998
------------- ------------- ------------- --------------
Average earning assets (in thousands) $1,555,476 $1,534,842 $1,537,168 $1,540,657
Tax equivalent net interest income 17,750 15,882 51,427 46,459
As a percent of average earning assets
Tax equivalent interest income 8.29% 8.30% 8.25% 8.29%
Interest expense 3.73 4.17 3.79 4.27
Tax equivalent net interest income 4.56 4.13 4.46 4.03
Average earning assets as a
percent of average assets 92.34% 93.31% 92.53% 93.05%
Free-funds ratio 9.14% 9.51% 8.93% 9.31%
PROVISION FOR LOAN LOSSES The provision for loan losses was $645,000 during the
three months ended September 30, 1999, compared to $1,035,000 during the
three-month period in 1998. During the nine-month periods, the provision was
$1,966,000 and $2,568,000, respectively.
The decrease in the provision during both the three- and nine-month periods
reflects Management's assessment of the allowance for loan losses based upon the
composition of the loan portfolio, an evaluation of specific credits, historical
loss experience as well as the level of non-performing and impaired loans. (See
"Asset quality.")
NON-INTEREST INCOME Non-interest income totaled $4,289,000 during the three
months ended September 30, 1999, compared to $4,933,000 during the comparable
period in 1998. Non-interest income totaled $13,864,000 and $13,544,000 during
the nine months ended September 30, 1999 and 1998, respectively.
The decline in non-interest income during the three-month period principally
reflects decreases in net gains on the sale of real estate mortgage loans. A net
loss on the sale of securities also contributed to the decline in non-interest
income. (See "Securities.") Increases in service charges on deposit accounts and
fees associated with the origination of manufactured home loans partially offset
the decline.
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19
NON-INTEREST INCOME
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
--------------- --------------- --------------- --------------
Service charges on deposit
accounts $1,481,000 $1,211,000 $4,051,000 $3,299,000
Net gains (losses) on asset sales
Real estate mortgage loans 880,000 1,664,000 3,662,000 4,699,000
Securities (108,000) (93,000) 145,000
First Home Financial 613,000 480,000 1,547,000 786,000
Title insurance fees 215,000 206,000 639,000 631,000
Real estate mortgage loan
servicing fees 317,000 316,000 915,000 898,000
Mutual fund and annuity
commissions 365,000 269,000 973,000 676,000
Other 526,000 787,000 2,170,000 2,410,000
=============== =============== ============== ===============
Total non-interest income $4,289,000 $4,933,000 $13,864,000 $13,544,000
=============== =============== ============== ===============
Net gains on the sale of real estate mortgage loans totaled $880,000 during the
three months ended September 30, 1999, compared to $1,664,000 during the
comparable period in 1998. Net gains on the sale of such loans totaled
$3,662,000 and $4,699,000 during the nine months ended September 30, 1999 and
1998, respectively.
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
------------------------------------ ------------------------------------
Real estate mortgage loans
originated $111,120,000 $169,039,000 $414,553,000 $554,116,000
Real estate mortgage loan
sales 55,801,000 109,256,000 236,676,000 337,340,000
Real estate mortgage loan
servicing rights sold 6,090,000 11,313,000 17,053,000 46,803,000
Net gains on the sale of real
estate mortgage loans 880,000 1,664,000 3,662,000 4,699,000
Net gains as a percent of real
estate mortgage loans sold 1.58% 1.52% 1.55% 1.39%
The volume of loans sold is dependent upon the Banks' ability to originate real
estate mortgage loans as well as the demand for fixed-rate obligations and other
loans that the Banks cannot profitably fund within established interest-rate
risk parameters. (See "Portfolio loans and asset quality.") Net gains on real
estate mortgage loans are also dependent upon economic and competitive factors
as well as the Banks' ability to effectively manage exposure to changes in
interest rates. Given a decline in loans held for sale, together with a
substantial decline in refinancing activity, net gains on the sale of real
estate mortgage loans during subsequent periods may not be commensurate with the
amount recorded during the three months ended September 30, 1999.
18
20
The Banks capitalized approximately $1,771,000 and $2,254,000 of related
servicing rights during the nine-month periods ended September 30, 1999 and
1998, respectively. Amortization of capitalized servicing rights for those
periods was $965,000 and $682,000, respectively. The book value of capitalized
mortgage servicing rights was $4,760,000 at September 30, 1999. The fair value
of capitalized servicing rights approximated $7 million at that same date, and
therefore, no valuation allowance was considered necessary. The capitalized
servicing rights relate to approximately $778.0 million of loans sold and
serviced at September 30, 1999.
Service charges on deposit accounts increased by 22% to $1,481,000 during the
three months ended September 30, 1999 and by 23% to $4,051,000 during the
nine-month period. These increases principally reflect the impact of certain
deposit account promotions, including direct mail solicitations, at two of the
Banks.
On April 17, 1998, the Registrant purchased the outstanding capital stock of
First Home Financial, Inc. ("FHF"), an originator of manufactured home loans.
FHF's revenues during the three months ended September 30, 1999, totaled
$613,000 during the three months ended September 30, 1999, compared to $480,000
during the comparable period in 1998. During the nine months ended September 30,
1999 and 1998, FHF's revenues totaled $1,547,000 and $786,000, respectively.
NON-INTEREST EXPENSE Non-recurring charges related to MSB were included in
non-interest expense during the three- and nine-month periods ended September
30, 1999. Such non-recurring expenses totaled $6,648,000 and include the costs
to settle a shareholder suit against the former Mutual Savings Bank, f.s.b.
NON-INTEREST EXPENSE
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
--------------- --------------- --------------- --------------
Salaries $ 6,460,000 $ 5,689,000 $ 18,119,000 $ 16,281,000
Performance-based compensation
and benefits 1,015,000 1,371,000 3,804,000 3,974,000
Other benefits 1,292,000 1,251,000 4,000,000 3,626,000
--------------- --------------- --------------- ---------------
Salaries and benefits 8,767,000 8,311,000 25,923,000 23,881,000
Occupancy, net 1,162,000 1,142,000 3,429,000 3,119,000
Furniture and fixtures 1,108,000 848,000 3,070,000 2,641,000
Computer processing 951,000 761,000 2,635,000 2,138,000
Amortization of intangible assets 433,000 446,000 1,307,000 1,244,000
Communications 564,000 546,000 1,710,000 1,583,000
Advertising 548,000 408,000 1,873,000 1,574,000
Supplies 391,000 363,000 1,127,000 1,058,000
Loan and collection 255,000 334,000 1,159,000 1,067,000
Merger related costs 4,623,000 4,623,000
Litigation settlement 2,025,000 2,025,000
Other 1,520,000 1,940,000 4,803,000 5,614,000
--------------- --------------- --------------- ---------------
Total non-interest expense $22,347,000 $15,099,000 $53,684,000 $43,919,000
=============== =============== =============== ===============
Excluding non-recurring charges, non-interest expense increased by approximately
4% to $15,699,000 during the three-month period and by 7% to $47,036,000 during
the nine months
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21
ended September 30, 1999. Costs associated with FHF and the operation of branch
facilities that were acquired in September of 1998 as well as direct mail
marketing expenses related to deposit account promotions at two of the Banks
contributed to the increase in non-interest expense. Management is considering
the introduction of similar promotions at the remaining Banks.
STOCK REPURCHASE PLAN On October 21, 1999, the Registrant announced that its
board of directors has adopted a share repurchase plan. The plan authorizes the
Registrant to acquire up to 325,000 shares of its common stock in open market
transactions. The Registrant's authority to purchase shares of its common stock
expires on March 15, 2000.
YEAR 2000
The Year 2000 issue refers to computer-based operating systems that were
originally designed to recognize calendar years by their last two digits ("Year
2000"). The Registrant began preparing its computer-based operating systems for
2000 during 1997 and formed a committee to address such issues. A significant
portion of the Registrant's Year 2000 issue relates to its core data processing
applications which are provided by a third-party service provider, M&I Data
Services. The Registrant completed its conversion to M&I Data Services Year 2000
compliant application software in 1998. Testing of all other non-compliant
operating systems was completed during the second quarter of 1999. The
replacement of such systems was completed during the third quarter of 1999.
Costs incurred to date have approximated $1.6 million, which relate primarily to
the replacement of systems and fully depreciated non-compliant personal computer
equipment. Management estimates that total costs will not exceed $1.6 million
and will not have a material impact on the consolidated financial statements. A
substantial portion of these costs represented an acceleration of expenditures
to replace or upgrade systems that will become obsolete or otherwise inadequate
to meet the Registrant's growing technology needs.
While the Registrant is not aware of any Year 2000 problems for which a solution
is not available, other unanticipated issues could arise. These unanticipated
issues may include the ability to identify and correct all relevant computer
code, the availability and cost of trained personnel, the impact of the Year
2000 on our customers and other uncertainties.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No material changes in the market risk faced by the Registrant has occurred
since December 31, 1998.
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22
Item 4. Submission of Matters to a Vote of Security-Holders
A Special Meeting of Shareholders was held on August 26, 1999. As
described in the Registrant's joint proxy statement/prospectus, dated
July 12, 1999, matters considered at that meeting were:
(1) The upon a proposal to approve the Agreement and Plan of
Reorganization, dated March 24, 1999, between the Registrant and
Mutual Savings Bank, f.s.b., ("MSB") the related Consolidation
Agreement, dated April 20, 1999, and the resulting issuance of shares
of common stock of the Registrant in connection with its acquisition
of MSB.
The proposal was approved by the Registrant's shareholders. Tabulation
in the is set forth below.
Broker Non-Votes
----------------
Votes FOR Votes AGAINST and Abstentions
--------- ------------- ---------------
5,182,837 179,079 35,199
Item 6. Exhibits & Reports on Form 8-K
(a) Exhibit Number & Description
11. Computation of Earnings Per Share
27. Financial Data Schedule
(b) Reports on Form 8-K A report on Form 8-K was filed on September 17,
1999, under item 2. The following exhibit was filed under item 2.
Exhibit 2.1 Agreement and Plan of Reorganization dated as of
March 24, 1999, by and between the Registrant and
Mutual Savings Bank, f.s.b., together with the
exhibits thereto, incorporated by reference to
exhibit 2.1 to the Registrant's registration
statement on Form S-4, as amended (file no.
333-79679) filed with the Securities Exchange
Commission on or about May 28, 1999.
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23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date November 11, 1999 By /s/ William R. Kohls
------------------------------ -------------------------------
William R. Kohls, Principal Financial
Officer
Date November 11, 1999 By /s/ James J. Twarozynski
------------------------------- -------------------------------
James J. Twarozynski, Principal
Accounting Officer
22
24
Exhibit Index
-------------
Exhibit No. Description
- ----------- -----------
11 Computation of Earnings per Share
27 Financial Data Schedule