EXHIBIT 99.1
[PRICEWATERHOUSECOOPERS LETTERHEAD]
Report of Independent Auditors
To the Board of Directors and Stockholders of
D&N Financial Corporation:
In our opinion, the accompanying Consolidated Statements of Condition and the
related Consolidated Statements of Operations, Stockholders' Equity and of Cash
Flows present fairly, in all material respects, the financial position of D&N
Financial Corporation and its Subsidiary at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
January 21, 1999
1
CONSOLIDATED STATEMENTS OF CONDITION
D&N FINANCIAL CORPORATION
December 31
-------------------------
1998 1997
----------- ------------
(Dollars in thousands)
ASSETS
Cash and due from banks $ 15,945 $ 16,239
Federal funds sold -- 300
Interest-bearing deposits in other banks 34 3,958
---------- ----------
Total cash and cash equivalents 15,979 20,497
Investment securities
(market value of $28,678,000 in 1998 and $56,594,000 in 1997) 28,678 56,524
Investment securities available for sale (at market value) 101,394 46,112
Mortgage-backed securities
(market value of $42,025,000 in 1998 and $199,525,000 in 1997) 41,446 198,050
Mortgage-backed securities available for sale (at market value) 452,766 160,246
Loans receivable (including loans held for sale of $8,801,000 in 1998
and $5,275,000 in 1997) 1,340,143 1,311,508
Allowance for loan losses (10,995) (10,549)
---------- ----------
Net loans receivable 1,329,148 1,300,959
Other real estate owned, net 857 1,474
Federal income taxes 2,721 1,129
Office properties and equipment, net 19,005 16,621
Other assets 26,160 13,703
---------- ----------
$2,018,154 $1,815,315
========== ==========
LIABILITIES
Checking and NOW accounts $ 166,802 $ 119,412
Money market accounts 103,878 92,314
Savings deposits 237,600 163,119
Time deposits 754,317 667,204
Accrued interest 1,543 1,118
---------- ----------
Total deposits 1,264,140 1,043,167
Securities sold under agreements to repurchase 18,153 149,092
FHLB advances and other borrowed money 559,982 470,431
Advance payments by borrowers and investors held in escrow 25,416 17,585
Other liabilities 6,284 8,239
---------- ----------
Total liabilities 1,873,975 1,688,514
PREFERRED STOCK OF SUBSIDIARY 28,719 28,719
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value per share (1,000,000 shares authorized;
none issued) -- --
Common stock, $.01 par value per share (shares authorized - 25,000,000;
shares outstanding - 9,318,089 in 1998 and 9,197,224 in 1997) 93 92
Additional paid-in capital 78,375 77,025
---------- ----------
Total paid-in capital 78,468 77,117
Retained earnings - substantially restricted 35,265 21,042
Less: Cost of treasury stock (none in 1998 and 98,129 in 1997) -- (1,581)
Accumulated other comprehensive income 1,727 1,504
---------- ----------
Total stockholders' equity 115,460 98,082
---------- ----------
$2,018,154 $1,815,315
========== ==========
See Notes to Consolidated Financial Statements.
2
CONSOLIDATED STATEMENTS OF INCOME
D&N Financial Corporation
Year Ended December 31
1998 1997 1996
-------------------------------------------------
(Dollars in thousands, except earnings per share)
INTEREST INCOME
Loans $ 105,777 $ 98,560 $ 86,151
Mortgage-backed securities 27,568 19,085 10,930
Investments and deposits 6,629 8,048 7,228
-------- -------- --------
Total interest income 139,974 125,693 104,309
INTEREST EXPENSE
Deposits 51,206 47,961 43,859
Securities sold under agreements to repurchase 4,521 5,571 2,193
FHLB advances and other borrowed money 31,558 23,222 15,494
-------- -------- --------
Total interest expense 87,285 76,754 61,546
-------- -------- --------
Net interest income 52,689 48,939 42,763
Provision for loan losses 2,500 1,350 1,100
-------- -------- --------
Net interest income after provision for loan
losses 50,189 47,589 41,663
NONINTEREST INCOME
Loan administrative fees 1,850 1,916 1,914
Deposit related fees 4,389 4,080 3,621
Gain on sale of loans held for sale 3,521 1,728 1,031
Gain on sale of securities available for sale 2,830 539 188
Other income 1,230 657 470
-------- -------- --------
Total noninterest income 13,820 8,920 7,224
NONINTEREST EXPENSE
Compensation and benefits 19,643 17,881 16,881
Occupancy 3,362 3,110 2,834
Other expense 13,357 11,655 11,863
-------- -------- --------
General and administrative expense 36,362 32,646 31,578
Other real estate owned, net 167 (81) 71
FDIC insurance 794 658 7,894
-------- -------- --------
Total noninterest expense 37,323 33,223 39,543
-------- -------- --------
Income before income tax expense 26,686 23,286 9,344
Federal income tax expense 7,901 7,743 349
-------- -------- --------
Income before preferred stock dividends 18,785 15,543 8,995
Preferred stock dividend of subsidiary 2,723 1,218 --
-------- -------- --------
NET INCOME $ 16,062 $ 14,325 $ 8,995
======== ======== ========
Earnings per share:
Basic $ 1.75 $ 1.58 $ 1.08
======== ======== ========
Diluted $ 1.69 $ 1.53 $ 1.01
======== ======== ========
See Notes to Consolidated Financial Statements.
3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
D&N Financial Corporation
Treasury Accumulated
Additional Stock & Leveraged Other Total
Common Paid-in Retained Treasury ESOP Comprehensive Stockholders'
Stock Capital Earnings Warrants Debt Income Equity
---------- --------- ---------- --------- -------- -------------- --------------
(Dollars in thousands)
Balance December 31, 1995 $ 75 $ 49,936 $ 20,573 $ (257) $ (63) $ 1,715 $ 71,979
Comprehensive Income:
Net income -- -- 8,995 -- -- -- 8,995
Change in value of securities
available for sale -- -- -- -- -- (472) (472)
------
Total comprehensive income 8,523
Issuance of common stock
upon exercise of stock options
and warrants - 960,508 shares 9 9,046 -- -- -- -- 9,055
Purchase of treasury stock
and warrants -- -- -- (3,499) -- -- (3,499)
Reissuance of 256,251 treasury shares -- (3,530) -- 3,350 -- -- --
Reduction of leveraged ESOP debt -- -- -- -- 63 -- 63
---------- ------- --------- -------- ----- ------------- --------
Balance December 31, 1996 $ 84 $ 55,452 $ 29,568 $ (226) $ -- $ 1,243 $ 86,121
Comprehensive Income:
Net income -- -- 14,325 -- -- -- 14,325
Change in value of securities
available for sale -- -- -- -- -- 261 261
--------
Total comprehensive income 14,586
Cash dividends, common stock
($0.10 per share) -- -- (826) -- -- -- (826)
10% common stock dividend, at
fair market value 8 22,017 (22,025) -- -- -- --
Issuance of common stock upon
exercise of stock options -
98,681 shares -- 1,196 -- -- -- -- 1,196
Purchase of treasury stock -- -- -- (2,995) -- -- (2,995)
Reissuance of 96,681 treasury shares -- (1,640) -- 1,640 -- -- --
---------- ------- --------- -------- ----- ------------- --------
Balance December 31, 1997 $ 92 $ 77,025 $ 21,042 $ (1,581) $ -- $ 1,504 $ 98,082
Comprehensive Income:
Net income -- -- 16,062 -- -- -- 16,062
SFAS 133 transition adjustment -- -- -- -- -- 2,432 2,432
Change in value of securities
available for sale -- -- -- -- -- (2,209) (2,209)
--------
Total comprehensive income 16,285
Cash dividends, common stock
($0.20 per share) -- -- (1,839) -- -- -- (1,839)
Issuance of common stock upon
exercise of stock options -
235,224 shares 1 3,314 -- -- -- -- 3,315
Purchase of treasury stock -- -- -- (383) -- -- (383)
Reissuance of 114,359 treasury shares -- (1,964) -- 1,964 -- -- --
---------- ------- --------- -------- ----- ------------- ------------
Balance December 31, 1998 $ 93 $ 78,375 $ 35,265 $ -- $ -- $ 1,727 $115,460
========== ========= ========= ======== ===== ============= ============
See Notes to Consolidated Financial Statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
D&N FINANCIAL CORPORATION
Year Ended December 31
1998 1997 1996
---------- ---------- ----------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 16,062 $ 14,325 $ 8,995
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 2,500 1,350 1,100
Depreciation and amortization of office properties and equipment 2,323 1,987 1,954
Amortization of net premiums (discounts) on purchased
loans and securities (520) (925) (73)
Originations and purchases of loans held for sale (106,167) (47,928) (56,132)
Proceeds from sales of loans held for sale 231,097 89,889 73,658
Gain on securities available for sale (2,830) (539) (188)
Gain on sale of loan servicing rights (207) -- --
Amortization and writedowns of mortgage servicing rights 1,866 543 300
Increase in originated mortgage servicing rights (4,554) (1,236) (543)
(Increase) decrease in income taxes deferred (1,367) 5,357 (662)
Increase in prepaid dealer reserves (2,635) (3,223) (1,918)
(Increase) decrease in core deposit intangible (6,791) 113 113
Other (1,026) (37) 635
--------- --------- ---------
Net cash provided by operating activities 127,751 59,676 27,239
INVESTING ACTIVITIES
Proceeds from sales of investment securities available for sale -- 20 298
Proceeds from maturities of investment securities 231,353 202,066 83,970
Purchases of investment securities to be held to maturity (259,044) (184,903) (107,012)
Proceeds from sales of mortgage-backed securities available for sale 112,168 24,094 --
Principal collected on mortgage-backed securities 175,549 64,150 54,951
Purchases of mortgage-backed securities (337,029) (107,400) (58,661)
Loans purchased (193,778) (234,886) (148,405)
Net change in loans receivable (45,029) (137,882) (94,006)
(Increase) decrease in other real estate owned 617 (4) (151)
Sales of loan servicing rights 207 -- --
Purchases of office properties and equipment (5,229) (3,279) (3,128)
--------- --------- ---------
Net cash used by investing activities (320,215) (378,024) (272,144)
FINANCING ACTIVITIES
Increase in time deposits 87,113 50,102 23,058
Increase in other deposits 133,435 28,748 18,666
Proceeds from notes payable, securities sold under agreements
to repurchase and other borrowed money 340,285 513,052 309,040
Payments on maturity of notes payable, securities sold under
agreements to repurchase and other borrowed money (381,811) (297,717) (121,482)
Net change in advance payments by borrowers and investors
held in escrow 7,831 5,777 479
Common stock cash dividend (1,839) (826) --
Net proceeds from issuance of stock 3,315 1,196 9,055
Purchases of treasury stock/warrants (383) (2,995) (3,499)
Proceeds from issuance of subsidiary preferred stock -- 28,719 --
Reduction of leveraged ESOP debt -- -- (63)
--------- --------- ---------
Net cash used by investing activities 187,946 326,056 235,254
Increase (Decrease) in cash and cash equivalents (4,518) 7,708 (9,651)
Cash and cash equivalents at beginning of year 20,497 12,789 22,440
--------- --------- ---------
Cash and cash equivalents at end of year $ 15,979 $ 20,497 $ 12,789
========= ========= =========
Supplemental disclosures of cash flow information:
Interest paid $ 87,487 $ 75,416 $ 61,689
Income taxes paid $ 8,740 $ 2,027 $ 299
Noncash investing activities:
Transfer of loans to other real estate owned $ 359 $ 961 $ 3,373
Securitization of loans into mortgage-backed securities $ 82,856 $ 86,066 $ 119,717
See Notes to Consolidated Financial Statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
D&N FINANCIAL CORPORATION, DECEMBER 31, 1998
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
D&N Financial Corporation ("the Company") is a financial services holding
company whose sole subsidiary is D&N Bank ("the Bank"), a federally-chartered
stock savings bank. D&N Financial Corporation's primary business is the
delivery of financial services to consumers and businesses through its network
of 53 community banking and financial services offices in Michigan.
Principles of Consolidation: The consolidated financial statements include
the accounts and transactions of the Company and the Bank and the Bank's
wholly-owned subsidiaries. Significant intercompany accounts and transactions
have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements: The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and assumptions.
Cash and Cash Equivalents: Cash and cash equivalents represent short-term
highly liquid investments with original maturities of three months or less and
include cash, demand deposits in other banks and interest-bearing deposits in
other banks.
Investment Classifications: Securities are classified as either held to
maturity (amortized cost), trading (fair value, with unrealized gains and losses
reported in income), or available for sale (fair value, with unrealized gains
and losses reported directly in equity, net of taxes).
Investment and Mortgage-Backed Securities: Investment and mortgage-backed
securities which the Company has the ability and the intent to hold until
maturity are stated at amortized cost. Investment and mortgage-backed
securities available for sale are carried at fair value. Fair value adjustments
are included in stockholders' equity, net of tax. Gains or losses realized on
the sale of investment and mortgage-backed securities are determined by the
specific identification method and are included in securities gains (losses).
Interest income is adjusted using the level-yield method for amortization of
premiums and accretion of discounts.
Allowance for Loan Losses: The allowance for loan losses represents the
Company's estimate of probable credit losses related to specifically identified
loans as well as probable credit losses inherent in the remainder of the
Company's loan portfolio that have been incurred as of the balance sheet date.
The allowance for loan loss is maintained at an adequate level through additions
to the provision for loan losses. An appropriate level of the general allowance
is determined based on the application of projected risk percentages to graded
loans by categories. In addition, specific reserves are established for
individual loans when deemed necessary by management. Management also considers
other factors when determining the unallocated allowance, including loan
quality, changes in the size and character of the loan portfolio, consultation
with regulatory authorities, amount of nonperforming loans, delinquency trends,
economic conditions and industry trends.
SFAS No. 114, Accounting By Creditors for Impairment of a Loan, as
amended by SFAS No. 118, considers a loan impaired when it is probable that
payment of principal and interest will not be collected in accordance with the
contractual terms of the original loan agreement. Consistent with this
definition, all non-accrual and restructured loans (with the exception of
residential mortgage and consumer installment loans) are impaired. An impaired
loan for which it is deemed necessary to record a specific allowance is,
typically, written down to the fair value of the underlying collateral at the
time it is placed on non-accrual status via a direct charge-off against the
allowance for loan losses. Consequently, those impaired loans not requiring a
specific allowance represent loans for which the fair value of the underlying
collateral equaled or exceeded the recorded investment in the loan. All impaired
loans were evaluated using the fair value of the underlying collateral as the
measurement method.
It must be understood, however, that inherent risks and uncertainties
related to the operation of a financial institution require management to depend
on estimates, appraisals and evaluations of loans to prepare the Company's
financial statements. Changes in economic conditions and the financial
prospects of borrowers may result in abrupt changes to the estimates, appraisals
or evaluations used. In addition, if actual circumstances and losses differ
substantially from management's assumptions and estimates, the allowance for
loan losses may not be sufficient to absorb all future losses, and net income
could be significantly impacted.
Each element of the general allowance for December 31, 1998 was determined
as adequate by applying the following risk percentages to each grade: Pass -
residential: 0%, commercial: 0%, consumer: 0.80%; Special mention - residential:
0%, commercial:
6
0%, consumer: 0.83%; Substandard - residential: 0%, commercial: 0%, consumer:
1.66%; Doubtful - 50%; and Loss - 100%. The risk percentages are developed by
the Company in consultation with regulatory authorities, actual loss experience
and peer group loss experience, and are adjusted for current economic
conditions. The risk percentages are considered a prudent measurement of the
risk of the Company's loan portfolio. The general allowances for December 31,
1997 and December 31, 1996 were determined as adequate based on this same rating
system, using different risk percentages.
The Company periodically reviews each commercial loan and assigns a grade
based on loan type, collateral value, financial condition of the borrower and
payment history. Delinquent residential mortgage and installment loans are
reviewed and assigned a rating based on their payment history, financial
condition of the borrower and collateral values. Specific mortgage and
installment loans are also reviewed in conjunction with the previously described
review of any related commercial loan.
Based upon these reviews, the Company determines the grades for its loan
portfolio on a quarterly basis and computes the allowance for loan losses.
Management believes this periodic review provides a mechanism that results in
loans being graded in the proper category and accordingly, assigned the proper
risk loss percentage in computing the general or specific reserve.
Mortgage Loans Held for Sale: The Bank enters into commitments to
originate and does originate mortgage loans for sale to investors and in the
secondary market.
Loans held for sale are carried at the lower of cost or market value,
determined on an aggregate basis. Commitment fees are amortized either over the
commitment period or the combined commitment and loan period depending upon the
probability of performance under the commitment.
Interest on Loans: Interest on loans is credited to income when earned.
An allowance for interest on loans is provided when management considers the
collection of these loans doubtful and the accrual of interest is usually
suspended when a loan becomes more than 90 days past due.
Loan Fees: Loan origination and commitment fees and certain direct loan
origination costs are deferred and recognized over the lives of the related
loans as an adjustment of the yields using the level-yield method.
Other Real Estate Owned: Real estate acquired through foreclosure and
similar proceedings is recorded at estimated fair value of the property, less
cost to dispose of, at the acquisition date. Operating expenses of such
properties, net of any income, are charged to expense.
Depreciation: Provisions for depreciation are computed using the straight-
line method over the estimated useful lives of office properties and equipment,
as follows: buildings - 40 years; leasehold improvements - life of lease;
furniture and fixtures - 15 years; and computers - 3 years.
Securities Sold Under Agreements to Repurchase: The Company enters into
sales of investment and mortgage-backed securities under agreements to
repurchase the same or essentially identical securities. The agreements are
short-term and are accounted for as secured borrowings. The obligations to
repurchase securities sold are reflected as a liability and the securities which
collateralize the agreements are reflected as an asset in the Consolidated
Statements of Condition.
Capitalized Mortgage Servicing Rights: The Company services mortgage loans
for investors. Fees earned for and in connection with this activity are
recognized as income when the related mortgage payments are received. Mortgage
servicing costs are charged to expense as incurred.
As the Company acquires mortgage servicing rights through either the
purchase or origination of mortgage loans and sells or securitizes those loans
with servicing rights retained, it must allocate the total cost of the mortgage
loans to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based on their relative fair values. Capitalized mortgage
servicing rights are reported in Other Assets. The capitalized cost of mortgage
servicing rights is amortized in proportion to, and over the period of,
estimated net servicing income (servicing revenue in excess of servicing costs),
into noninterest income.
Capitalized mortgage servicing rights are periodically assessed for
impairment based on the fair value of those rights on a disaggregate basis,
stratified by mortgage type, term and rate. Identified impairments are
recognized through a valuation allowance.
7
Income Taxes: The Company uses the liability method in accounting for
income taxes. Under this method, deferred income taxes result from temporary
differences between the tax bases of assets and liabilities and the bases
reported in the consolidated financial statements. The deferred taxes are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Per Share Data: The Company adopted SFAS 128 "Earnings per Share", for the
year ended December 31, 1997. The earnings per share for the year 1996 has been
restated to comply with this standard.
Basic earnings per share is calculated by dividing net income by the
average number of shares outstanding during the applicable period.
The Company has issued stock options and warrants which are considered to
be potentially dilutive to common stock. Diluted earnings per share is
calculated by dividing net income by the average number of shares outstanding
during the applicable period adjusted for these potentially dilutive options and
warrants.
The following table sets forth the computation of per share earnings as
provided in SFAS 128, and illustrates the dilutive effect of options and
warrants outstanding:
Year Ending December 31
---------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------
Earnings Earnings Earnings
Shares per share Shares per share Shares per share
-------- ---------- -------- ----------- ------ ----------
(In thousands, except per share earnings)
Basic EPS: 9,158 $ 1.75 9,094 $ 1.58 8,337 $ 1.08
Net dilutive effect of:
Stock options outstanding 349 (0.06) 271 (0.05) 167 (0.02)
Warrants outstanding -- -- -- -- 402 (0.05)
----- ------ ----- ------ ----- ------
Diluted EPS: 9,507 $ 1.69 9,365 $ 1.53 8,906 $ 1.01
===== ====== ===== ====== ===== ======
Options to purchase 170,234 shares of common stock at $24.38 to $25.50 per
share were outstanding at December 31, 1998. Options to purchase 107,800
shares of common stock at $19.26 to $24.37 per share were outstanding at
December 31, 1997. These options were not included in the computation of
diluted earnings per share because the exercise prices were greater than the
average annual market price of the common stock in 1998 and 1997, respectively.
Reclassifications: Certain amounts in previously issued consolidated
financial statements have been reclassified to conform with the current year
presentation.
Comprehensive Income: The Bank adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, Reporting Comprehensive Income, as of January 1,
1998. SFAS No. 130 established standards for reporting and display of
comprehensive income and its components. The Company displays comprehensive
income in the statement of stockholders' equity and has reclassified all prior
periods as required.
Segment Reporting: In 1998, the Company adopted SFAS 131, Disclosure about
Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS 14,
Financial Reporting for Segments of a Business Enterprise, replacing the
"industry segment" approach with the "management" approach which designates the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.
SFAS 131 also requires disclosure about products and services, geographic areas,
and major customers. The adoption of SFAS 131 did not affect results of
operations or financial position but did affect the disclosure of segment
information (see "Segment Information" Note W).
Accounting for Derivative Instruments and Hedging Activities: The Company
elected to adopt Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities, on July 1, 1998, which
constituted early adoption. In accordance with the transition provision of SFAS
133, the Company reclassified $163.4 million of "held-to-maturity" securities as
"available-for-sale". This reclassification resulted in a net-of-tax cumulative-
effect-type adjustment of approximately $2.4 million in other comprehensive
income. Under the provision of SFAS 133, such reclassification does not call
into question the Company's intent to hold current or future debt securities to
their maturity.
8
NOTE B: BUSINESS COMBINATION
On April 10, 1996, Macomb Federal Savings Bank ("Macomb") was merged into
the Company. The Company issued 716,497 shares of common stock and cash in lieu
of fractional shares for all of the outstanding shares of Macomb. At the time
of the merger, Macomb had assets and stockholders' equity (unaudited) of
$41,932,000 and $6,268,000, respectively. The merger was accounted for as a
pooling-of-interests and accordingly, the financial statements have been
restated to include the results of Macomb.
A reconciliation of previously reported net interest income and net income
is as follows:
Three Months Ended
March 31, 1996
-----------------------
(Dollars in thousands)
Net interest income (as previously reported) $9,465
Macomb Federal Savings Bank - net interest income 217
------
Total net interest income $9,682
======
Net income (as previously reported) $3,497
Macomb Federal Savings Bank - net income (9)
------
Total net income $3,488
======
A reconciliation of per share income is as follows:
Three Months Ended
March 31, 1996
----------------------
Basic earnings per share
Net income (as previously reported) $ 0.47
Macomb Federal Savings Bank (0.05)
------
Basic earnings per share $ 0.42
======
Diluted earnings per share
Net income (as previously reported) $ 0.44
Macomb Federal Savings Bank (0.04)
------
Diluted earnings per share $ 0.40
======
NOTE C: REAL ESTATE INVESTMENT TRUST
D&N Capital Corporation ("D&N Capital") is a Delaware corporation
incorporated on March 18, 1997 for the purpose of acquiring and holding real
estate assets and is a Real Estate Investment Trust ("REIT"). All shares of
common stock of D&N Capital are owned by D&N Bank.
On July 17, 1997, D&N Capital sold 1.21 million shares of its 9.0%
noncumulative preferred stock, Series A with a liquidation preference of $25.00
per share (totaling $30,250,000). As part of this transaction, D&N Capital
received $28,719,000 in net proceeds, after offering costs of $1,531,000. The
Series A Preferred Shares are generally not redeemable prior to July 21, 2002.
On or after July 21, 2002, the Series A Preferred Shares may be redeemed for
cash at the option of the Bank, in whole or in part, at a redemption price of
$25.00 per share.
The preferred shares are treated as Tier-1 Capital by the Bank, and are
traded on Nasdaq as DNFCP. During 1998 and 1997, D&N Capital declared and paid
preferred dividends totaling $2,722,500 and $1,217,563, respectively.
NOTE D: RESTRICTIONS ON CASH AND NONINTEREST-BEARING BALANCES
The Company is required to maintain reserve balances with the Federal
Reserve Bank. The average amounts of those reserve balances for the years ended
December 31, 1998 and December 31, 1997 were $1,235,000 and $452,000,
respectively.
9
NOTE E: INVESTMENT SECURITIES
Investment securities consisted of the following:
1998 1997
-----------------------------------------------
Book Market Book Market
Value Value Value Value
---------- ---------- ---------- -----------
(Dollars in thousands)
U.S. Treasury securities $ -- $ -- $ 33,299 $ 33,369
Investment in Federal Home Loan Bank stock 28,651 28,651 23,200 23,200
Other equity securities 27 27 25 25
-------- -------- -------- --------
Held to maturity 28,678 28,678 56,524 56,594
U.S. Treasury securities 10,237 10,246 44,764 44,860
Commercial paper 89,851 89,851 -- --
Municipal bonds 141 141 148 148
Other securities 1,141 1,156 1,088 1,104
Valuation allowances 24 -- 112 --
-------- -------- -------- --------
Available for sale 101,394 101,394 46,112 46,112
-------- -------- -------- --------
$130,072 $130,072 $102,636 $102,706
======== ======== ======== ========
An analysis of gross unrealized gains and losses is as follows:
1998 1997
-----------------------------------------------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ---------- ---------- ----------
(Dollars in thousands)
Held to maturity $ -- $ -- $ 70 $ --
-------- -------- -------- --------
U.S. Treasury securities -- -- 70 --
Available for sale 9 -- 97 (1)
U.S. Treasury securities 15 -- 16 --
-------- -------- -------- --------
Other securities 24 -- 113 (1)
-------- -------- -------- --------
$ 24 $ -- $ 183 $ (1)
======== ======== ======== ========
There were no sales of investment securities during 1998 or 1997. Proceeds
from sales of investment securities available for sale during 1996 were
$298,000. Gross gains of $188,000 were realized on those sales.
The book value, market value and average yield of U. S. Treasury securities
available for sale with contractual maturities under one year available for sale
at December 31, 1998 were $10,237,000, $10,246,000 and 6.03% respectively.
10
NOTE F: MORTGAGE-BACKED SECURITIES
Mortgage-backed securities consisted of the following:
December 31
--------------------------------------------
1998 1997
--------------------- ---------------------
Book Market Book Market
Value Value Value Value
---------- --------- ---------- ---------
(Dollars in thousands)
Government agency securities $ 5,528 $ 5,694 $112,156 $113,253
Collateralized mortgage obligations 35,824 35,992 84,788 84,987
Accrued interest receivable 339 339 1,285 1,285
Net discounts (245) -- (179) --
-------- -------- -------- --------
Held to maturity 41,446 42,025 198,050 199,525
Government agency securities 95,590 96,652 86,658 88,145
Collateralized mortgage obligations 350,213 353,055 69,104 69,715
Interest-only certificates 153 620 378 1,422
Accrued interest receivable 2,439 2,439 964 964
Net premiums 1,738 -- 940 --
Valuation allowances 2,633 -- 2,202 --
-------- -------- -------- --------
Available for sale 452,766 452,766 160,246 160,246
-------- -------- -------- --------
$494,212 $494,791 $358,296 $359,771
======== ======== ======== ========
Mortgage-backed securities with a carrying value of $109,125,000 are
specifically pledged as collateral for advances from the Federal Home Loan Bank
of Indianapolis and other borrowings.
An analysis of gross unrealized gains and losses is as follows:
December 31
------------------------------------------------
1998 1997
---------- ----------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ----------- ---------- -----------
(Dollars in thousands)
Government agency securities $ 167 $ -- $1,238 $(368)
Collateralized mortgage obligations 422 (8) 675 (70)
------ ----- ------ -----
Held to maturity 589 (8) 1,913 (438)
Government agency securities 1,027 -- 743 (1)
Collateralized mortgage obligations 1,342 (203) 424 (8)
Interest only certificates 467 -- 1,044 --
------ ----- ------
Available for sale 2,836 (203) 2,211 (9)
------ ----- ------ -----
$3,425 $(211) $4,124 $(447)
====== ===== ====== =====
Proceeds from sales of mortgage-backed securities available for sale
during 1998 were $112,557,000. Gross gains of $2,830,000 were realized on
those sales. Proceeds from sales of mortgage-backed securities available for
sale during 1997 were $30,154,000. Gross gains of $543,000 and gross losses of
$4,000 were realized on those sales. There were no sales of mortgage-backed
securities during 1996.
11
The book value and market value of mortgage-backed securities at December 31,
1998, by contractual maturity, were as follows:
Held to Maturity Available for Sale
------------------ -----------------------------
Book Market Average Book Market Average
Value Value Yield Value Value Yield
-------- -------- -------- -------- -------- ---------
(Dollars in thousands)
Government agency securities
Less than one year $ -- $ -- --% $ -- $ -- --%
One to five years 835 843 6.76 -- -- --
Five to ten years 679 695 7.55 -- -- --
After ten years 4,014 4,156 7.54 95,625 96,652 6.40
------- ------- ----- -------- -------- --------
5,528 5,694 7.42 95,625 96,652 6.40
Collateralized mortgage obligations
Less than one year -- -- -- -- -- --
One to five years -- -- -- -- -- --
Five to ten years 3,996 4,039 6.82 -- -- --
After ten years 31,583 31,953 7.00 351,916 353,055 6.33
------- ------- ----- -------- -------- --------
35,579 35,992 6.98 351,916 353,055 6.33
Interest-only certificates
Less than one year -- -- -- -- -- --
One to five years -- -- -- -- -- --
Five to ten years -- -- -- 2 10 1411.67
After ten years -- -- -- 151 610 143.30
------- ------- ----- -------- -------- --------
-- -- -- 153 620 168.18
------- ------- ----- -------- -------- --------
$41,107 $41,686 7.04% $447,694 $450,327 6.40%
======= ======= ===== ======== ======== ========
Mortgage-backed securities will mature according to the repayment
characteristics of the underlying mortgage loans which collateralize the
securities. Expected maturities for mortgage-backed securities will differ from
contractual maturities because borrowers have the right to prepay.
The aggregate book value and aggregate market value of the securities of
any one issuer, other than U.S. Government agencies, did not exceed 10% of
stockholders' equity at December 31, 1998 or 1997.
NOTE G: LOANS RECEIVABLE
The carrying amounts and fair values of loans receivable consisted of the
following:
December 31
------------------------------------------------
1998 1997
---------- ----------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ---------- ----------- ----------
(Dollars in thousands)
Residential mortgages $ 638,725 $ 643,103 $ 694,902 $ 706,459
Residential mortgages held for sale 8,801 8,804 5,275 5,275
Mortgages on income producing property 94,009 93,869 81,304 79,007
Construction loans 55,122 54,986 56,176 55,901
Consumer loans 501,062 501,208 446,710 449,276
Commercial loans 51,022 50,819 38,164 37,706
Accrued interest receivable 7,023 7,023 7,311 7,311
---------- ---------- ---------- ----------
1,355,764 1,359,812 1,329,842 1,340,935
Less:
Discounts on purchased loans (2,312) -- (2,356) --
Allowance for loan losses 10,995 -- 10,549 --
Undisbursed portion of loan proceeds 17,679 -- 20,315 --
Deferred income 254 -- 375 --
---------- ---------- ---------- ----------
$1,329,148 $1,359,812 $1,300,959 $1,340,935
========== ========== ========== ==========
12
Credit is extended based on evaluation of the borrower's financial
condition, the value of the collateral and, in the case of income producing
property, the sufficiency of net cash flows from the property's operation to
service the debt. When loans are made to businesses, personal guarantees may
also be required of owners or partners.
Loans collateralized by income producing property are categorized as
follows:
December 31
-------------------------------
1998 1997
------------------------------
(Dollars in thousands)
Shopping centers $24,020 $22,185
Offices 18,355 6,905
Multi-family apartments 12,238 19,913
Motels/hotels 11,270 11,491
Nursing Homes 9,498 5,291
Condominium Development 6,945 4,240
Industrial 6,830 4,774
Mobile home parks 4,262 2,118
Other 591 4,387
----------------------------
$94,009 $81,304
============================
Loans collateralized by income producing property categorized by state are
as follows:
December 31
------------------------
1998 1997
-------------------------
(Dollars in thousands)
Michigan $85,017 $65,697
California 6,261 11,008
New York -- 805
Pennsylvania 241 405
Other 2,490 3,389
-------------------------
$94,009 $81,304
=========================
Changes in the allowance for loan losses are summarized as follows:
1998 1997 1996
-----------------------------
(Dollars in thousands)
Balance at beginning of year $10,549 $11,042 $10,081
Provisions for loan losses 2,500 1,350 1,100
Net charge-offs (2,054) (1,843) (139)
-----------------------------
Balance at end of year $10,995 $10,549 $11,042
=============================
At December 31, 1998 and 1997, the total recorded investment in impaired
loans, as defined by SFAS 114 "Accounting by Creditors for Impairment of a
Loan", was $9,667,000 and $4,779,000, respectively. In 1998 and 1997 the amount
of the recorded investment for which there is a related allowance for loan
losses is $1,145,000 and $145,000, respectively, and the amount of the recorded
investment for which there is no related allowance for loan losses is $8,522,000
and $4,634,000, respectively. Interest income on impaired loans is recognized
primarily on a cash basis. During 1998 and 1997, the amount of interest income
recognized on impaired loans was insignificant.
Changes in capitalized mortgage servicing rights, included in other assets
in the Consolidated Statements of Condition, are summarized as follows:
1998 1997 1996
----------------------------
(Dollars in thousands)
Balance at beginning of year $ 2,136 $1,443 $1,113
Originations and acquisitions 4,552 1,236 630
Amortizations, sales, and writedowns (1,866) (543) (300)
---------------------------
Balance at end of year $ 4,822 $2,136 $1,443
===========================
13
Changes in the valuation allowance for mortgage servicing rights are
summarized as follows:
1998 1997 1996
---------------------------
(Dollars in thousands)
Balance at beginning of year $ 321 $ 221 $ 291
Additions:
Purchased mortgage servicing right -- 38 151
Originated mortgage servicing rights 464 154 55
---------------------------
Total additions 464 192 206
Reductions:
Purchased mortgage servicing rights 177 69 158
Originated mortgage servicing rights 99 23 118
---------------------------
Total reductions 276 92 276
---------------------------
Balance at end of year $ 509 $ 321 $ 221
===========================
At December 31, 1998 and 1997, the fair value of capitalized mortgage
servicing rights was $4,897,000 and $2,389,000, respectively.
Loans serviced for others amounted to $575,818,000, $518,877,000, and
$415,156,000 at December 31, 1998, 1997 and 1996, respectively.
NOTE H: OTHER REAL ESTATE OWNED
Other real estate owned ("OREO") consisted of the following:
December 31
--------------------
1998 1997
--------------------
(Dollars in thousands)
Real estate acquired through foreclosure $ 680 $ 742
Real estate in judgment 177 732
---------------
$ 857 $1,474
===============
Changes in the allowance for possible losses on OREO are summarized as
follows:
1998 1997 1996
-------------------------
(Dollars in thousands)
Balance at beginning of year $ -- $ -- $ 133
Provision for losses -- -- --
Net charge-offs -- -- (133)
-------------------------
Balance at end of year $ -- $ -- $ 0
=========================
The Company recorded writedowns of other real estate owned amounting to
$61,000 during 1998 and $75,000 during 1996. The Company did not record any
writedowns of other real estate owned in 1997.
The Company recognized net gains on sale of OREO amounting to $68,000,
$132,000 and $164,000 during 1998, 1997 and 1996, respectively.
14
NOTE I: OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows:
December 31
----------------------
1998 1997
----------------------
(Dollars in thousands)
Cost:
Land $ 2,651 $ 2,565
Buildings and improvements 19,348 17,653
Furniture and equipment 17,214 18,749
-------------------
39,213 38,967
Less accumulated depreciation 20,208 22,346
-------------------
$19,005 $16,621
===================
Depreciation and amortization expense was $2,323,000, $1,987,000 and
$1,954,000 in 1998, 1997 and 1996, respectively.
Rental expense for leased properties and equipment was $1,424,000,
$1,150,000 and $938,000 in 1998, 1997 and 1996, respectively. The aggregate
minimum annual rental commitments under these leases are approximately
$1,323,000 in 1999, $1,208,000 in 2000, $1,082,000 in 2001, $837,000 in 2002,
$539,000 in 2003 and $2,422,000 thereafter.
NOTE J: DEPOSITS
The carrying amounts and fair values of deposits and the nominal rates of
interest paid were as follows:
December 31
--------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------
Weighted Weighted
Carrying Fair Average Carrying Fair Average
Amount Value Rate Amount Value Rate
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands)
Checking accounts $ 79,415 $ 79,415 --% $ 56,473 $ 56,473 --
NOW accounts 87,387 87,387 1.66 62,939 62,939 1.51
Money market accounts 103,878 103,878 3.27 92,314 92,314 4.02
Savings deposits 237,600 237,600 3.14 163,119 163,119 3.16
Certificates of deposit 754,317 764,584 5.55 667,204 673,314 5.93
Accrued interest 1,543 1,543 -- 1,118 1,118 --
---------------------------------------------------------------------
$1,264,140 $1,274,407 4.29% $1,043,167 $1,049,277 4.74%
=====================================================================
Included in deposits are $228,468,000 and $144,426,000 of deposit accounts
with balances in excess of $100,000 as of December 31, 1998 and 1997,
respectively.
Certificates of deposit had the following maturities at December 31, 1998:
Weighted
Amount Average Rate
---------------------------
(Dollars in thousands)
1999 $605,344 5.52%
2000 91,464 5.63
2001 24,801 5.68
2002 9,737 6.06
2003 and beyond 22,971 5.76
----------------------
$754,317 5.55%
======================
15
The average balance, interest expense and average rate on deposits were as
follows:
1998 1997 1996
---------------------------------------------------------------------------------------------------------
Average Interest Average Average Interest Average Average Interest Average
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Checking accounts $ 62,935 $ -- -- % $ 47,680 $ -- -- % $ 40,349 $ -- $ --
NOW and money
market accounts 168,545 4,841 2.87 152,615 4,547 2.98 146,863 4,490 3.06
Savings deposits 196,502 6,581 3.35 154,541 4,623 2.99 153,701 4,446 2.89
Certificates of deposit 686,017 39,784 5.80 657,401 38,791 5.90 597,571 34,923 5.84
------------------------------------------------------------------------------------------------------
$1,113,999 $ 51,206 4.60% $1,012,237 $ 47,961 4.74% $ 938,484 $ 43,859 4.67%
======================================================================================================
NOTE K: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase, in which the Company
will repurchase identical securities, consisted of the following:
December 31
-------------------------------------
1998 1997
-------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------------------------------
(Dollars in thousands)
Collateral pledged:
Mortgage-backed securities and Treasury
notes with a book value including accrued
interest of $18,715,000 and a market value
of $18,997,000 in 1998, and a book value
including accrued interest of $151,761,000
and a market value of $152,766,000 in 1997. $18,153 $18,153 $149,092 $149,092
=====================================
Securities sold under agreements to repurchase averaged $80,106,000 and
$98,471,000 during 1998 and 1997, respectively, and the maximum amounts
outstanding at any month-end during 1998 and 1997 were $148,639,000 and
$181,055,000, respectively.
The securities underlying the agreements were delivered to the dealers who
arranged the transactions. The dealers may have sold, loaned or otherwise
disposed of such securities to other parties in the normal course of their
operations, and have agreed to resell to the Company essentially identical
securities at the maturities of the agreements.
As of December 31, 1998, the only agreement to repurchase was with Bear
Stearns in the amount of $18,153,000 at an interest rate of 5.50%, with a
maturity date of January 8, 1999.
16
NOTE L: FHLB ADVANCES AND OTHER BORROWED MONEY
The carrying amounts and fair values of Federal Home Loan Bank of
Indianapolis ("FHLB") advances and other borrowed money consisted of the
following:
December 31
--------------------------------------------------------------------
1998 1997 1998 1997
---- ---- ----------------- -------------------
Year of Weighted Carrying Fair Carrying Fair
Maturity Average Rate Amount Value Amount Value
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Advances from FHLB:
Variable rate of interest:
5.69 - 5.88% 1998 --% 5.76% $ -- $ -- $ 61,000 $ 61,001
Fixed rate of interest:
5.47 - 5.98% 1998 -- 5.88 -- -- 153,000 153,190
5.81 - 6.20 1999 5.99 5.99 179,000 179,801 179,000 179,927
5.35 - 5.97 2000 5.78 5.92 145,000 146,608 70,000 70,509
5.21 - 5.94 2001 5.64 -- 205,000 207,831 -- --
4.00 2005 4.00 4.00 1,003 925 1,003 888
-------------------------------------------------------------------
530,003 535,165 464,003 465,515
Other borrowed money:
Overnight funds 5.36 -- 25,285 25,285 -- --
Collateralized mortgage obligation. 10.60 10.04 4,694 5,207 6,428 6,974
--------------------------------------------------------
$559,982 $565,657 $470,431 $472,489
======================================
The Company is required to maintain qualifying loans, investments and
mortgage-backed securities as collateral for the FHLB advances.
The collateralized mortgage obligation ("CMO") was issued through a special
purpose finance subsidiary established in 1986. The CMO is secured by mortgage-
backed securities with unpaid principal balances of $5,241,000 and $7,154,000 at
December 31, 1998 and December 31, 1997, respectively. The note underlying the
obligations bears interest, payable quarterly, at a rate of 7.27%, with a
contractual maturity date of 2010.
NOTE M: FEDERAL INCOME TAXES
Federal income tax expense (credit) consisted of the following:
1998 1997 1996
------------------------
(Dollars in thousands)
Current $7,138 $4,634 $ --
Deferred 763 3,109 3,228
Change in valuation allowance
for deferred tax assets -- -- (2,879)
------------------------
$7,901 $7,743 $ 349
========================
Deferred income tax expense (credit) included in stockholders' equity
related to the change in unrealized holding gains (losses) on securities
available for sale for 1998, 1997 and 1996 amounted to $262,000, $141,000, and
$(181,000), respectively.
17
A reconciliation of the statutory federal income tax rate to the effective
income tax rate follows:
1998 1997 1996
--------------------
Statutory tax rate 35.0% 35.0% 35.0%
Effect of:
Change in valuation allowance
for deferred tax assets -- -- (30.8)
Other, net (2.0) 0.1 (0.5)
--------------------
Effective tax rate 33.0% 35.1% 3.7%
====================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred and other tax assets and liabilities are as follows:
December 31
----------------------
1998 1997
----------------------
(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses $3,031 $3,086
Net deferral required by SFAS 91 17 79
Pension and other benefit obligations 676 700
Other, net 281 398
------------------
Total deferred tax assets 4,005 4,263
Deferred tax liabilities:
Securities marked to market for tax purposes* 147 (13)
Fixed assets 644 588
FHLB stock 1,075 1,075
Valuation adjustment on CMO residuals 1,459 1,431
Other, net 52 53
------------------
Total deferred tax liabilities 3,377 3,134
------------------
Total net deferred tax assets 628 1,129
Current income tax receivable due to overpayments 2,093 --
------------------
Total net federal income tax assets $2,721 $1,129
==================
* The amount shown is net of the $930,000 and $810,000 tax effect of SFAS 115
unrealized holding gains at December 31, 1998 and December 31, 1997,
respectively.
NOTE N: STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
OTS regulations governing the payment of dividends by savings institutions
provide that an institution may only pay dividends with regulatory approval.
Unlike the Bank, the Company is not subject to these regulatory restrictions on
the payment of dividends to its stockholders. However, the source of future
dividends may depend upon the payment of dividends from the Bank to the Company.
In December 1993, the Company issued 1,003,219 units in a shareholder
rights offering. Each unit consisted of three shares of common stock and one
warrant. Each warrant entitled the holder thereof to purchase one share of
common stock at an exercise price of $8.25 at any time no later than December
31, 1996. During 1996, 1995 and 1994, 996,369, 2,553 and 390 warrants were
exercised, respectively. The warrant period ended with 3,907 warrants
unexercised.
During 1996, the Company paid a one-time charge of $5.5 million pretax,
($3.6 million after tax) as the mandated contribution of D&N Bank, to replenish
the Federal Deposit Insurance Corporation's depleted Savings Association
Insurance Fund ("SAIF"). This charge is the result of federal legislation
passed and signed into law on September 30, 1996, which required all thrifts to
pay a one-time assessment to restore the SAIF fund to its statutory reserve
level. The assessment was 65.7 basis points (b.p.) of the institution's
deposits as of March 31, 1995.
18
Macomb had a leveraged Employee Stock Ownership Plan ("ESOP") which was
terminated subsequent to the merger with the Company. The related ESOP debt was
paid in full in 1996.
In December, 1996, D&N Financial Corporation's Board of Directors
authorized a program to acquire up to 440,000 shares of D&N Financial
Corporation common stock for the Company's treasury. In 1996, 257,222 shares
were acquired and 256,251 were reissued as holders of D&N Financial Corporation
warrants (issued in 1993) presented their maturing warrants for conversion to
common stock. In 1997, the authorized program was completed when an additional
182,050 shares were acquired for general corporate purposes, including the
satisfaction of its obligation to issue shares upon the exercise of employees'
and directors' stock options. By December 31, 1998, 100% of these shares had
been reissued upon the exercise of stock options.
On December 10, 1997, the Company declared a $.05 per share cash dividend
and a 10% stock dividend. Both were paid on January 13, 1998, to holders of
record on December 23, 1997. The liability for the cash dividend is shown in
Other Liabilities on the accompanying financial statements. All per share data
have been adjusted to include the effect of the stock dividend.
During 1998, the Company declared and paid a $0.05 per share cash dividend,
quarterly. The fourth quarter's dividend was paid on January 12, 1999, to
holders of record December 23, 1998. The liability for the cash dividend is
shown in Other Liabilities on the accompanying financial statements.
Regulatory standards, as dictated by the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA") impose the following capital
requirements: a risk-based capital standard expressed as a percent of risk-
adjusted assets, a leverage ratio of core capital to total adjusted assets, and
a tangible capital ratio expressed as a percent of total adjusted assets. As of
December 31, 1998, the Bank exceeded all regulatory capital standards.
The table below summarizes as of December 31, 1998, the Bank's capital
requirements under FIRREA and its actual capital ratios at that date:
Regulatory Bank Actual
Requirements Capital
---------------------------------------------
Amount Percent Amount Percent
---------------------------------------------
(Dollars in thousands)
Risk-based capital $101,933 8.00% $139,380 10.94%
Tier 1 risk-based capital 76,450 6.00 129,530 10.17
Core capital 60,720 3.00 129,530 6.40
Tangible capital 30,360 1.50 129,530 6.40
The FDIC Improvement Act of 1992 ("FDICIA") requires each federal banking
agency to implement prompt corrective actions for institutions that it
regulates. The OTS has adopted rules, based upon FDICIA's five capital tiers:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Under FDICIA, the OTS is
required to take supervisory action against institutions that are not deemed
either well capitalized or adequately capitalized.
The rules generally provide that a savings institution is well capitalized
if its risk-based capital ratio is 10% or greater, its ratio of core capital to
risk-based assets ("tier 1 risk-based capital") is 6% or greater, its core
capital ("leverage") ratio is 5% or greater, and the institution is not subject
to a capital directive. At December 31, 1998, the Bank was considered well
capitalized.
NOTE O: EMPLOYEE BENEFIT PLANS
The Company sponsors an employee savings and investment plan in which all
employees may participate after completing a minimum of 1,000 hours in an
eligibility period. The plan allows participants to make contributions by
salary deductions equal to 19% or less of their salary pursuant to Section
401(k) of the Internal Revenue Code. Employee contributions are matched by the
Company at the rate of 100 cents per dollar, up to 6% of the employee's salary.
Employees vest immediately in their own contributions and over a five-year
period in the Company's contributions. Employee contributions may be invested
in a variety of instruments, including the
19
Company's common stock and preferred stock of D&N Capital Corporation. The
Company's matching contribution is invested at the direction of the participant.
The Company's contributions to the plan were $688,000, $653,000 and $621,000 in
1998, 1997, and 1996, respectively.
The Company terminated its noncontributory defined benefit retirement plan
during 1996, with all assets being distributed to participants. No gain or loss
was recorded on this transaction.
NOTE P: POSTRETIREMENT BENEFITS
The Company has a contributory unfunded benefit plan which provides
postretirement medical benefits to certain employees who have retired prior to
September 30, 1995. The Company is recognizing its accumulated postretirement
benefit obligation over a prospective 20-year period.
The following table sets forth the change in accumulated postretirement
benefit obligation for the years ended 1998 and 1997.
1998 1997
-----------------------
(Dollars in thousands)
Accumulated postretirement benefit obligation,
beginning of year $1,187 $1,241
Interest cost 95 84
Employee contribution 27 20
Benefits paid (183) (180)
Actuarial loss 303 22
-------------------
Accumulated postretirement benefit obligation,
end of year $1,429 $1,187
===================
The following table sets forth the plan's status and amounts recognized in
the Company's Consolidated Statements of Condition:
December 31
1998 1997
------------------------
(Dollars in thousands)
Accumulated postretirement benefit obligation $1,429 $1,187
Unrecognized net loss (418) (141)
Unrecognized transition obligation (732) (780)
-----------------------
Accrued postretirement benefit cost $ 279 $ 266
=======================
Postretirement benefit expense included the following components:
1998 1997 1996
-------------------
(Dollars in thousands)
Service cost $ -- $ -- $ --
Interest cost 95 84 97
Amortization of transition obligation 48 48 48
-------------------
$ 143 $ 132 $ 145
===================
A weighted average discount rate of 6.50% in 1998 and 7.25% in 1997 was
used in determining the accumulated post retirement benefit obligation. The
1998 health care trend rate was projected to be 8.5% for participants under the
age of 65, and this rate is assumed to trend downward until it reaches 5.5% and
remains at that level thereafter. This trend rate assumption does not have a
significant effect on the plan; therefore, a one percent change in the trend
rate is not material in the determination of the accumulated postretirement
benefit obligation or the ongoing expense.
20
NOTE Q: STOCK OPTION PLAN
The Company has stock option plans in which 1,214,000 shares of common
stock have been reserved for issuance as of December 31, 1998. Under the plans,
the exercise price of any option will not be less than the fair market value of
the common stock on the date of grant. The dates on which the options are first
exercisable is determined by the Stock Option Committee of the Board of
Directors and have generally vested over a two year period from the date of
grant. The term on any option may not exceed ten years from the date of grant.
The Company has elected to continue to measure compensation cost using the
intrinsic value method, in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, since
all options are granted at a fixed price not less than the fair market value of
the Company's common stock on the date of grant, no compensation cost has been
recognized for its stock option plans. Had stock option costs of these plans
been determined based on the fair value at the 1998, 1997 and 1996 grant dates
for awards under those plans consistent with the methodology of Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based
Compensation", the pro forma effects on the Company's net income and earnings
per share would be as follows:
1998 1997 1996
--------------------------------------------------
(Dollars in thousands, except earnings per share)
Net income (as reported) $16,062 $14,325 $8,995
Stock option compensation cost (994) (761) (396)
------------------------------------------
Pro forma net income $15,068 $13,564 $8,599
==========================================
Basic earnings per share (as reported) $ 1.75 $ 1.58 $ 1.08
Stock option compensation cost (0.10) (0.08) (0.05)
------------------------------------------
Pro forma basic earnings per share $ 1.65 $ 1.50 $ 1.03
==========================================
Diluted earnings per share (as reported) $ 1.69 $ 1.53 $ 1.01
Stock option compensation cost (0.10) (0.08) (0.04)
------------------------------------------
Pro forma diluted earnings per share $ 1.59 $ 1.45 $ 0.97
==========================================
The fair value of each option grant in 1998, 1997 and 1996 was estimated
using the Black-Scholes option pricing model with the following assumptions
used:
1998 1997 1996
------------------------------
Estimated weighted average fair value
per share of options granted $11.19 $ 7.63 $ 4.61
Assumptions:
Annualized dividend yield .9% .8% --
Common-stock price volatility 37.4% 32.5% 25.1%
Weighted average risk
free rate of return 5.7% 6.5% 5.9%
Weighted average
expected option term (in years) 7 5 5
The following table sets forth changes in options outstanding:
1998 1997 1996
-----------------------------------------------------------------------------
Weighted Weighted Weighted
Amount Avg. Price Amount Avg. Price Amount Avg. Price
-----------------------------------------------------------------------------
Shares under option:
Outstanding at beginning
of year 949,346 $12.07 820,943 $ 9.31 653,956 $ 7.56
Granted 77,834 25.41 261,087 19.55 315,929 12.26
Forfeited (8,253) 21.90 (34,003) 12.27 (21,836) 9.45
Canceled -- -- -- -- (6,353) 14.60
Exercised (227,852) 9.15 (98,681) 9.05 (120,753) 7.22
----------------------------------------------------------------------------
Outstanding at end of
year 791,075 14.14 949,346 12.07 820,943 9.31
----------------------------------------------------------------------------
Exercisable at end of
year 661,620 $12.61 738,092 $11.25 590,858 $ 8.40
----------------------------------------------------------------------------
21
The following table sets forth details of options outstanding at December 31, 1998:
Options Outstanding Options Exercisable
- -----------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------
$ 5.45 - 7.62 226,212 4.9 Years $ 6.98 226,212 $ 6.98
10.17 - 12.05 199,147 6.4 Years 11.47 199,147 11.47
12.95 - 14.04 55,186 7.9 Years 14.03 55,186 14.03
16.36 - 25.50 310,530 8.7 Years 21.08 181,075 20.46
- -----------------------------------------------------------------------------------------------------
$ 5.45 - 25.50 791,075 7.0 Years $14.14 661,620 $12.61
======================================================================================================
NOTE R: LITIGATION
The Company is a defendant in a number of matters of litigation,
substantially all of which have arisen in the ordinary course of business. It
is the opinion of management that the resulting liabilities, if any, from these
actions will not materially affect the Consolidated Financial Statements.
D&N Bank is a plaintiff, like approximately 120 other institutions, in a
currently pending claim in the United States Court of Federal Claims seeking
substantial damages as a result of the 1989 Financial Institutions Reform,
Recovery and Enforcement Act's mandatory phase-out of the regulatory capital
treatment of supervisory goodwill. The ultimate outcome of this matter as it
relates to D&N, cannot be determined at this time.
NOTE S: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk
(in the normal course of its business) to meet the financial needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments may include commitments to originate or purchase
loans, standby letters of credit, recourse arrangements on sold assets, and
forward commitments. The instruments involve, to varying degrees, elements of
credit and interest rate risk in addition to the amounts recognized in the
Consolidated Statements of Condition. The contract amounts of those instruments
reflect the extent of the Company's involvement in particular classes of
financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters of
credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as for on-balance sheet instruments.
For forward commitments, the contract amounts do not represent exposure to
credit loss. The Company controls the credit risk of those instruments through
credit approvals, limits and monitoring procedures.
22
The following table sets forth financial instruments with off-balance sheet
risk and their contract amounts and fair values:
December 31
---------------------------------------
1998 1997
---------------------------------------
Contract Fair Contract Fair
Amount Value Amount Value
---------------------------------------
(Dollars in thousands)
Financial instruments whose contract amounts
represent credit risk:
Commitments to originate and purchase loans $ 82,029 $ (820) $78,710 $(787)
Unused lines of credit 107,087 (1,071) 93,709 (937)
Standby letters of credit 4,922 (49) 3,907 (39)
Loans sold with recourse 921 (46) 2,155 (108)
Financial instruments whose contract amounts
exceed the amount of credit risk:
Forward commitments to sell loans 14,200 (71) 6,400 (64)
Commitments to originate loans are agreements to lend to a customer
provided there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected to
expire without being drawn on, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's evaluation of the borrower's creditworthiness.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Additionally, the Company has
retained credit risk on certain residential and commercial mortgage loans sold
with recourse with outstanding balances at December 31, 1998 of $921,000 and
none, respectively. These balances as of December 31, 1997 were $1,310,000 and
$845,000, respectively. The maximum amount of loss to which the Company is
subject, under the recourse provisions, is $921,000 at December 31, 1998.
Management does not believe the recourse provisions subject the Company to any
material risk of loss. This credit risk is considered to be no more onerous than
that existing on similar loans in the Company's loan portfolio.
Forward commitments to sell loans are contracts the Company negotiates for
the purpose of reducing the market risk associated with rate lock agreements
with customers for new loan applications that have not yet been closed. In order
to fulfill a forward commitment, the Company typically exchanges through FNMA,
FHLMC or GNMA, its current production of loans for mortgage-backed securities
which are then delivered to a national securities firm at a future date at
prices or yields specified by the contracts. Risks may arise from the possible
inability of the Company to originate loans to fulfill the contracts, in which
case the Company would normally purchase securities in the open market to
deliver against the contracts.
NOTE T: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of
financial instruments at the dates indicated. SFAS 107, "Disclosures about Fair
Value of Financial Instruments", defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale.
23
December 31
------------------------------------------------------
1998 1997
------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------
(Dollars in thousands)
Cash and cash equivalents $ 15,979 $ 15,979 $ 20,497 $ 20,497
Investment securities (Note E) 130,072 130,072 102,636 102,706
Mortgage-backed securities (Note F) 494,212 494,791 358,296 359,771
Loans receivable (Note G) 1,329,148 1,359,812 1,300,959 1,340,935
Deposits (Note J) (1,264,140) (1,274,407) (1,043,167) (1,049,277)
Securities sold under agreement
to repurchase (Note K) (18,153) (18,153) (149,092) (149,092)
Debt (Note L) (559,982) (565,657) (470,431) (472,489)
Commitments to originate and
purchase loans (Note S) -- (820) -- (787)
Unused lines of credit (Note S) -- (1,071) -- (937)
Standby letters of credit (Note S) -- (49) -- (39)
Loans sold with recourse (Note S) -- (46) -- (108)
Forward commitments to sell loans (Note S) -- (71) -- (64)
Estimation of Fair Values
SFAS 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the Statement of Condition, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. SFAS 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
The carrying amounts reported in the Statement of Condition for cash and
cash equivalents approximate those assets' fair value. Fair values for
investment securities and mortgage-backed securities are based on quoted market
prices, where available. If quoted market prices are not available, fair values
are based on quoted market prices of comparable instruments. Fair values for the
Company's loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. The carrying amount of accrued interest approximates
its fair value.
The fair values of checking and NOW accounts, money market accounts and
savings deposits are the amounts payable on demand at the reporting date. The
fair value for fixed-maturity time deposits is estimated using a discounted cash
flow analyses using the rates currently offered for deposits with similar
remaining maturities. The fair values of securities sold under agreement to
repurchase and the Company's debt are estimated using discounted cash flow
analyses, based on the Company's current incremental borrowing rates for debt
with similar terms and remaining maturities. Fair values for the Company's off-
balance sheet instruments (guarantees and credit commitments) are based on
current settlement or termination values and on fees currently charged to enter
into similar agreements, given the remaining terms of the agreements and the
counterparties' credit standing.
NOTE U: SEGMENT INFORMATION
D&N Financial Corporation's two reportable segments are Community Banking
and Wholesale Banking. Community Banking includes our network of full service
banking offices and provides a full range of deposit products and residential,
commercial and consumer loans. Wholesale Banking includes residential and
consumer loan servicing and underwriting operations, mortgage lending through
correspondents, and D&N Mortgage Corporation, and the origination of consumer
installment loans through automobile and other durable goods dealers. All
Other includes the Bank's insurance subsidiary, a seasoned portfolio of out-of-
market purchased
24
commercial real estate loans, and the treasury which facilitates inter-segment
funds transfers and manages the corporation's external borrowing and
interest-rate-risk management activities.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. D&N Financial Corporation
evaluates performance based on average balances and net profit or loss including
income taxes. The performance evaluation is completed on a full allocation
basis and therefore corresponds to the Corporation's consolidated net income.
Inter-segment income and expense items are charged at either the current market
rate or an estimate of actual expense incurred to provide a service to other
business lines.
The measurement of the performance of the business segments is based on
the management structure of the Corporation and is not necessarily comparable
with similar information for any other financial institution. The information
presented is also not necessarily indicative of the segments' financial
condition and results of operations if they were independent entities.
The following table sets forth the reportable segments for the years ending
December 31, 1998, 1997 and 1996.
Community Banking Wholesale Banking
1998 1997 1996 1998 1997 1996
----------------------------------------------------------------------------
(Dollars in thousands)
Net interest
income 37,709 34,994 30,675 14,076 10,578 7,893
Provision for
loan losses 994 1,056 1,579 1,506 348 563
Noninterest income:
From external
customers 10,176 6,618 5,377 2,491 1,539 1,272
Inter-segment 5 4 172 0 0 0
Inter-segment
noninterest expense 2,407 2,887 1,877 (1,598) (1,936) (1,878)
Depreciation and
amortization 2,060 1,627 1,590 2,150 914 558
Federal income tax 6,275 4,909 1,642 2,297 2,149 833
Segment profit
(loss) 12,676 8,918 6,627 4,579 3,903 3,358
============================================================================
Segment average
assets 1,182,677 997,991 794,567 665,809 539,307 452,951
============================================================================
Capital
expenditures 4,449 2,279 2,465 701 888 468
============================================================================
All Other Total
1998 1997 1996 1998 1997 1996
----------------------------------------------------------------------------
Net interest
income 904 3,367 4,195 52,689 48,939 42,763
Provision for
loan losses 0 (54) (1,042) 2,500 1,350 1,100
Noninterest income:
From external
customers 1,221 895 787 13,888 9,052 7,436
Inter-segment (5) (4) (172) 0 0 0
Inter-segment
noninterest expense (809) (951) 1 0 0 0
Depreciation and
amortization 96 90 198 4,306 2,631 2,346
Federal income tax (671) 685 (2,126) 7,901 7,743 349
Segment profit
(loss) (1,193) 1,504 (990) 16,062 14,325 8,995
============================================================================
Segment average
assets 57,547 88,924 86,718 1,906,033 1,626,222 1,334,236
============================================================================
Capital
expenditures 79 112 194 5,229 3,279 3,128
============================================================================
25
NOTE V: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Income
Before
Net Provision Income Income
Interest Interest Interest For Loan Gain on Tax Tax Net Earnings Per Share
Income Expense Income Losses Securities Expense Expense Income Basic Diluted
--------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share and stock price)
1st
Quarter
1998 $ 34,547 $ 21,342 $ 13,205 $ 525 $ -- $ 6,786 $ 2,208 $ 3,897 $ 0.43 $ 0.41
1997 28,335 17,000 11,335 300 -- 5,075 1,781 3,294 0.36 0.35
2nd
Quarter
1998 34,368 21,049 13,319 550 -- 6,325 1,663 3,982 0.44 0.42
1997 30,293 18,484 11,809 300 539 5,505 1,926 3,579 0.39 0.38
3rd
Quarter
1998 35,588 22,416 13,172 650 1,360 6,889 2,160 4,048 0.44 0.43
1997 32,142 19,626 12,516 300 -- 6,262 2,003 3,722 0.41 0.40
4th
Quarter
1998 35,471 22,478 12,993 775 1,470 6,686 1,870 4,135 0.45 0.43
1997 34,923 21,644 13,279 450 -- 6,444 2,033 3,730 0.41 0.40
Year
1998 139,974 87,285 52,689 2,500 2,830 26,686 7,901 16,062 1.75 1.69
1997 125,693 76,754 48,939 1,350 539 23,286 7,743 14,325 1.58 1.53
Stock Price
Range
High Low
--------------------
1st
Quarter
1998 28 1/2 23 1/2
1997 16 15/16 14 57/64
2nd
Quarter
1998 29 3/4 25 1/4
1997 17 1/2 15 33/64
3rd
Quarter
1998 27 1/4 15 1/4
1997 19 49/64 16 13/16
4th
Quarter
1998 29 1/2 16
1997 26 3/4 19 13/64
Year
1998 29 3/4 15 1/4
1997 26 3/4 14 57/64
26
NOTE W: D&N FINANCIAL CORPORATION - PARENT COMPANY ONLY
FINANCIAL INFORMATION CONDENSED STATEMENTS OF CONDITION
December 31
------------------------------
1998 1997
------------------------------
(Dollars in thousands)
ASSETS
Cash and cash equivalents $ 2 $ 2
Amounts receivable from subsidiary 3,289 3,523
Investments in subsidiary 112,654 94,994
---------------------------
$115,945 $98,519
===========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Dividends payable $ 466 $ 414
Other liabilities 19 23
Stockholders' equity 115,460 98,082
---------------------------
$115,945 $98,519
===========================
CONDENSED STATEMENTS OF INCOME
Year Ended December 31
-----------------------------------
1998 1997 1996
-----------------------------------
(Dollars in thousands)
Interest income from subsidiary $ 135 $ 228 $ 64
Equity in undistributed net income of subsidiary 16,272 14,388 9,378
Noninterest expense:
Compensation and benefits 12 10 13
Other 333 281 434
-------------------------------
Total noninterest expense 345 291 447
-------------------------------
Income before income tax expense 16,062 14,325 8,995
Federal income tax expense -- -- --
-------------------------------
Net income $ 16,062 $ 14,325 $ 8,995
===============================
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31
-------------------------------
1998 1997 1996
-------------------------------
(Dollars in thousands)
Operating activities
Net income $ 16,062 $ 14,325 $ 8,995
Items not affecting cash:
Equity in undistributed net income of subsidiary (16,272) (14,388) (9,378)
Other 47 438 115
-------------------------------
Net cash provided (used) by operating activities (163) 375 (268)
Investing activities
Change in intercompany receivable 234 2,581 (5,225)
Financing activities
Proceeds from exercise of stock options 2,151 865 9,055
Purchases of treasury stock (383) (2,995) (3,499)
Common stock cash dividends (1,839) (826) --
Payment of ESOP debt -- -- (63)
-------------------------------
Net cash provided (used) by financing activities (71) (2,956) 5,493
-------------------------------
Net change in cash and cash equivalents -- -- --
Cash and cash equivalents at beginning of year 2 2 2
-------------------------------
Cash and cash equivalents at end of year $ 2 $ 2 $ 2
===============================
27