SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarter Ended June 30, 1999 Commission File Number 0-15734
REPUBLIC BANCORP INC.
(Exact name of registrant as specified in its charter)
Michigan 38-2604669
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1070 East Main Street, Owosso, Michigan 48867
(Address of principal executive offices)
(517) 725-7337
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
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.
Common Stock Outstanding as of July 31, 1999:
Common Stock, $5 Par Value .......................... 41,104,906 Shares
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998 ..................................... 3
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 1999 and 1998........................ 4
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1999 and 1998........................ 5
Notes to Consolidated Financial Statements................. 6 - 8
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition.............. 9 - 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................... 24
Item 2. Changes in Securities...................................... 24
Item 6. Exhibits and Reports on Form 8-K........................... 24
SIGNATURE.................................................................... 25
EXHIBITS.....................................................................26 - 27
2
PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements
REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
June 30, December 31,
(Dollars in thousands) 1999 1998
- --------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents ............................... $ 53,503 $ 47,712
Mortgage loans held for sale ............................ 420,413 770,028
Securities held to maturity (market value of $70,703) ... -- 70,124
Securities available for sale (amortized cost of
$287,285 and $601,793, respectively) ................. 284,307 601,429
Securities sold not yet delivered ....................... 164,310 --
Loans ................................................... 2,882,177 2,543,772
Less allowance for loan losses ....................... (24,489) (21,446)
----------- -----------
Net loans ............................................... 2,857,688 2,522,326
----------- -----------
Premises and equipment .................................. 33,823 37,185
Mortgage servicing rights ............................... 62,121 64,267
Other assets ............................................ 101,396 100,695
----------- -----------
Total assets ........................................ $ 3,977,561 $ 4,213,766
=========== ===========
LIABILITIES
Noninterest-bearing deposits ............................ $ 222,584 $ 213,562
Interest-bearing deposits ............................... 2,334,778 2,429,269
----------- -----------
Total deposits ..................................... 2,557,362 2,642,831
Federal funds purchased, securities sold under agreements
to repurchase and other short-term borrowings ...... 23,450 96,938
Short-term FHLB advances ................................ 275,000 208,000
Long-term FHLB advances ................................. 641,911 778,571
Accrued expenses and other liabilities .................. 147,798 139,709
Long-term debt .......................................... 51,669 52,194
----------- -----------
Total liabilities .................................. 3,697,190 3,918,243
Minority interest ....................................... 1,062 927
Preferred stock of subsidiary ........................... 28,719 28,719
SHAREHOLDERS' EQUITY
Preferred stock, $25 stated value: $2.25 cumulative
and convertible; 5,000,000 shares authorized,
none issued and outstanding .......................... -- --
Common stock, $5 par value, 75,000,000 shares
authorized; 41,091,210 and 40,712,087 shares
issued and outstanding, respectively ................. 205,456 203,560
Capital surplus ......................................... 23,038 22,130
Retained earnings ....................................... 24,033 38,697
Accumulated other comprehensive income (loss) ........... (1,937) 1,490
----------- -----------
Total shareholders' equity ......................... 250,590 265,877
----------- -----------
Total liabilities and shareholders' equity ......... $ 3,977,561 $ 4,213,766
=========== ===========
See notes to consolidated financial statements and management's discussion and
analysis.
3
REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share data) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------
Interest Income:
Loans, including fees ............................. $ 61,276 $ 62,268 $ 121,907 $ 121,256
Investment securities ............................. 9,758 8,577 20,144 18,011
--------- --------- --------- ---------
Total interest income ...................... 71,034 70,845 142,051 139,267
--------- --------- --------- ---------
Interest Expense:
Deposits .......................................... 26,635 26,553 54,088 52,392
Short-term borrowings ............................. 627 2,022 1,894 4,829
FHLB advances ..................................... 12,216 13,101 24,652 25,459
Long-term debt .................................... 947 1,004 1,924 2,015
--------- --------- --------- ---------
Total interest expense ..................... 40,425 42,680 82,558 84,695
--------- --------- --------- ---------
Net interest income ............................... 30,609 28,165 59,493 54,572
Provision for loan losses ......................... 6,575 2,050 8,100 3,800
--------- --------- --------- ---------
Net interest income after provision for loan losses 24,034 26,115 51,393 50,772
--------- --------- --------- ---------
Non-interest Income:
Service charges ................................... 1,805 1,445 3,509 2,851
Mortgage banking .................................. 37,118 33,558 74,255 62,678
Loss on sales of securities ....................... (7,237) (46) (6,588) (144)
Gain on sales of SBA loans ........................ 111 477 348 1,096
Other non-interest income ......................... 1,045 854 1,904 2,135
--------- --------- --------- ---------
Total non-interest income .................. 32,842 36,288 73,428 68,616
--------- --------- --------- ---------
Non-interest Expense:
Salaries and employee benefits .................... 20,779 16,361 41,520 32,411
Mortgage loan commissions and incentives .......... 13,097 13,190 24,982 24,431
Occupancy expense of premises ..................... 3,456 2,765 6,792 5,439
Equipment expense ................................. 1,662 1,545 3,445 3,037
Merger integration and restructuring .............. 31,521 -- 31,521 --
Other non-interest expense ........................ 11,653 13,042 25,488 23,423
--------- --------- --------- ---------
Total non-interest expense ................. 82,168 46,903 133,748 88,741
--------- --------- --------- ---------
Income (loss) before income taxes ................. (25,292) 15,500 (8,927) 30,647
Provision (credit) for income taxes ............... (7,464) 4,938 (1,935) 10,098
--------- --------- --------- ---------
Income (loss) before preferred stock dividends .... (17,828) 10,562 (6,992) 20,549
Dividends on preferred stock ...................... 680 680 1,361 1,361
--------- --------- --------- ---------
Net income (loss) ................................. $ (18,508) $ 9,882 $ (8,353) $ 19,188
========= ========= ========= =========
Basic earnings (loss) per share ................... $ (.45) $ .25 $ (.20) $ .48
========= ========= ========= =========
Diluted earnings (loss) per share ................. $ (.45) $ . 24 $ (.20) $ .47
========= ========= ========= =========
Average common shares outstanding - diluted ....... 41,550 41,230 41,504 41,119
========= ========= ========= =========
Cash dividends declared per common share .......... $ .09 $ .08 $ .18 $ .16
========= ========= ========= =========
See notes to consolidated financial statements and management's discussion and
analysis.
4
REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30 (In thousands) 1999 1998
- ------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net income (loss) ................................................ $ (8,353) $ 19,188
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................... 5,761 6,697
Amortization of mortgage servicing rights ................... 7,943 7,515
Net losses on sale of securities available for sale ......... 6,588 144
Net gains on sale of mortgage servicing rights .............. (21,843) (15,749)
Net gains on sale of loans .................................. (682) (2,182)
Origination of mortgage loans held for sale ................. (2,675,140) (2,746,632)
Proceeds from sales of mortgage loans held for sale ......... 3,024,755 2,606,649
Net increase in other assets ................................ (6,595) (13,894)
Net increase in other liabilities ........................... 8,089 34,098
Other, net .................................................. 2,598 (1,163)
----------- -----------
Total adjustments ......................................... 351,474 (124,517)
----------- -----------
Net cash provided by (used in) operating activities ... 343,121 (105,329)
----------- -----------
Cash Flows From Investing Activities:
Proceeds from sale of securities available for sale .............. 192,791 57,195
Proceeds from maturities/payments of securities available for sale 299,318 100,793
Purchases of securities available for sale ....................... (165,590) (110,440)
Proceeds from maturities/payments of securities held to maturity . 11,149 28,972
Purchases of securities held to maturity ......................... (121,561) (22,651)
Proceeds from sale of loans ...................................... 51,371 105,801
Net increase in loans made to customers .......................... (387,325) (293,692)
Proceeds from sale of fixed assets ............................... 82 205
Proceeds from sale of mortgage servicing rights .................. 42,224 15,143
Additions to mortgage servicing rights ........................... (28,723) (15,879)
----------- -----------
Net cash used in investing activities ................. (106,264) (134,553)
----------- -----------
Cash Flows From Financing Activities:
Net (decrease) increase in deposits .............................. (85,469) 146,972
Net (decrease) increase in short-term borrowings ................. (73,488) 5,015
Net increase (decrease) in short-term FHLB advances .............. 67,000 (102,500)
Proceeds from long-term FHLB advances ............................ 35,000 254,936
Payments on long-term FHLB advances .............................. (171,660) (61,000)
Payments on long-term debt ....................................... (525) (837)
Net proceeds from issuance of common shares ...................... 4,184 3,774
Repurchase of common shares ...................................... (1,598) (288)
Dividends paid ................................................... (4,510) (4,649)
----------- -----------
Net cash (used in) provided by financing activities ... (231,066) 241,423
----------- -----------
Net increase in cash and cash equivalents ........................ 5,791 1,541
Cash and cash equivalents at beginning of period ................. 47,712 50,165
----------- -----------
Cash and cash equivalents at end of period ....................... $ 53,503 $ 51,706
=========== ===========
See notes to consolidated financial statements and management's discussion and
analysis.
5
REPUBLIC BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Republic Bancorp
Inc. and Subsidiaries (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes necessary
for a comprehensive presentation of financial position, results of operations
and cash flow activity required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all normal
recurring adjustments necessary for a fair presentation of results have been
included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K and D&N Financial Corporation's Annual Report of Form 10-K for the year
ended December 31, 1998.
Note 2 - Principles of Consolidation
The consolidated financial statements include the accounts of the parent
company, Republic Bancorp Inc., and its wholly-owned banking subsidiaries,
Republic Bank and D&N Bank. Republic Bank has two mortgage company subsidiaries:
Republic Bancorp Mortgage Inc., including its three divisions, Home Funding,
Inc., Unlimited Mortgage Services, Inc., and Exchange Mortgage Corporation; and
Market Street Mortgage Corporation, including its division, Leader Financial.
Republic Bank has an 80%-majority ownership interest in Market Street Mortgage,
while Republic Bancorp Mortgage is wholly-owned. D&N Bank has two subsidiaries:
D&N Capital Corporation and Quincy Insurance, Inc. All significant intercompany
accounts and transactions have been eliminated in consolidation.
In May 1999, the Company merged with D&N Financial Corporation. Under terms of
the merger, D&N Financial Corporation shareholders received 1.82 shares of
Republic Bancorp Inc. common stock for each D&N Financial Corporation share
owned. The merger was accounted for as a pooling of interests, therefore, all
prior period data presented have been restated to include the results of
operations and financial position of D&N Financial Corporation.
Note 3 - Consolidated Statements of Cash Flows
Supplemental disclosures of cash flow information for the six months ended June
30, include:
(In thousands) 1999 1998
---- ----
Cash paid during the period for:
Interest .................. $82,689 $85,429
Income taxes .............. $ 4,098 5,743
Non-cash investing activities:
Loan charge-offs .......... $ 5,335 $ 975
6
Note 4 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands, except per share data) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings (loss) per share:
Net income (loss) ................................... $ (18,508) $ 9,882 $ (8,353) $ 19,188
Denominator:
Denominator for basic earnings per share--
weighted-average shares ........................... 41,020,276 40,176,625 40,918,719 40,068,814
Effect of dilutive securities:
Employee stock options ........................ 484,140 930,024 540,000 922,503
Warrants ...................................... 45,584 123,654 45,765 127,920
------------ ------------ ------------ ------------
Dilutive potential common shares ......... 529,724 1,053,678 585,765 1,050,423
------------ ------------ ------------ ------------
Denominator for diluted earnings per share--
adjusted weighted-average shares for
assumed conversions ............................... 41,550,000 41,230,303 41,504,484 41,119,237
============ ============ ============ ============
Basic earnings (loss) per share ..................... $ (.45) $ .25 $ (.20) $ .48
============ ============ ============ ============
Diluted earnings (loss) per share ................... $ (.45) $ .24 $ (.20) $ .47
============ ============ ============ ============
Note 5 - Segment Information
The Company's operations are managed as two major business segments: (1)
commercial and retail banking and (2) mortgage banking. The Commercial and
Retail Banking segment consists of commercial lending to small- and medium-sized
companies; mortgage portfolio lending; home equity lending; the origination of
consumer installment loans through automobile and other durable goods dealers;
and the deposit-gathering function. The Mortgage Banking segment is comprised of
mortgage loan production and mortgage loan servicing.
7
Note 5 - Segment Information (continued)
The following table presents the financial results of each business segment for
the three months ended June 30, 1999 and 1998.
Commercial and
Retail Banking(2) Mortgage Banking(1)(2) Consolidated
- ----------------------------------------------------------------------------------------------------
Three Months Ended, Three Months Ended, Three Months Ended,
June 30, June 30, June 30, June 30, June 30, June 30,
(In thousands) 1999 1998 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------
Interest income $61,860 $59,555 $ 9,174 $11,290 $71,034 $70,845
Interest expense 32,620 32,922 7,805 9,758 40,425 42,680
------- ------- ------- ------- ------- -------
Net interest income 29,240 26,633 1,369 1,532 30,609 28,165
Provision for loan losses 1,575 2,050 -- -- 1,575 2,050
Noninterest income 3,276 2,730 37,118 33,558 40,394 36,288
Noninterest expense 15,180 16,419 35,466 30,484 50,646 46,903
------- ------- ------- ------- ------- -------
Income before taxes $15,761 $10,894 $ 3,021 $ 4,606 $18,782 $15,500
======= ======= ======= ======= ======= =======
Preferred stock dividend $ 680 $ 680 $ -- $ -- $ 680 $ 680
Income taxes $ 5,334 $ 3,488 $ 1,077 $ 1,450 $ 6,411 $ 4,938
Depreciation and amortization $ 1,954 $ 2,378 $ 4,203 $ 5,388 $ 6,157 $ 7,766
Capital expenditures $ 532 $ 1,313 $ 1,449 $ 1,770 $ 1,981 $ 3,083
Identifiable assets (in millions) $ 3,430 $ 3,127 $ 548 $ 856 $ 3,978 $ 3,983
Efficiency ratio 46.68% 55.83% 92.15% 86.87% 71.33% 72.72%
- ---------------------------------------------------------------------------------------------------
The following table presents the financial results of each business segment for
the six months ended June 30, 1999 and 1998.
Commercial and
Retail Banking(2) Mortgage Banking(1)(2) Consolidated
- ----------------------------------------------------------------------------------------------------------
Six Months Ended, Six Months Ended, Six Months Ended,
June 30, June 30, June 30, June 30, June 30, June 30,
(In thousands) 1999 1998 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------
Interest income $122,519 $119,495 $ 19,532 $ 19,772 $142,051 $139,267
Interest expense 65,763 67,010 16,795 17,685 82,558 84,695
-------- -------- -------- -------- -------- --------
Net interest income 56,756 52,485 2,737 2,087 59,493 54,572
Provision for loan losses 3,100 3,800 -- -- 3,100 3,800
Noninterest income 6,725 5,938 74,255 62,678 80,980 68,616
Noninterest expense 32,881 31,723 69,345 57,018 102,226 88,741
-------- -------- -------- -------- -------- --------
Income before taxes $ 27,500 $ 22,900 $ 7,647 $ 7,747 $ 35,147 $ 30,647
======== ======== ======== ======== ======== ========
Preferred stock dividend $ 1,361 $ 1,361 $ -- $ -- $ 1,361 $ 1,361
Income taxes $ 9,371 $ 7,670 $ 2,569 $ 2,428 $ 11,940 $ 10,098
Depreciation and amortization $ 4,019 $ 4,687 $ 9,685 $ 9,525 $ 13,704 $ 14,212
Capital expenditures $ 2,708 $ 2,744 $ 2,399 $ 2,528 $ 5,107 $ 5,272
Identifiable assets (in millions) $ 3,430 $ 3,127 $ 548 $ 856 $ 3,978 $ 3,983
Efficiency ratio 51.27% 54.17% 90.07% 88.04% 69.51% 71.95%
- --------------------------------------------------------------------------------
(1)Net interest income for the mortgage banking segment is generated from the
interest earned on mortgage loans held for sale, less the interest expense
incurred on short-term borrowings used to fund loan production and servicing
acquisitions.
(2)Amounts exclude $31.5 million of pre-tax merger integration and
restructuring charges related to the merger with D&N Financial Corporation
in the second quarter of 1999, a $7.6 million pre-tax loss on the sale of
low-yielding fixed rate securities, and an additional $5 million pre-tax
provision for loan losses.
- --------------------------------------------------------------------------------
8
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
ACQUISITIONS
On May 17, 1999, the Company merged with D&N Financial Corporation whereby each
share of D&N Financial Corporation common stock was converted into 1.82 shares
of the Company's common stock. The merger constitutes a tax-free reorganization
and has been accounted for as a pooling of interests. In connection with the
merger, the Company recorded $22.0 million in after tax merger integration and
restructuring charges in the second quarter. The merger integration and
restructuring costs include appropriate accruals, reserves and charges for
severance and employee benefit accruals, professional fees, branch closings and
real estate transactions, systems and other charges.
The following table provides details of the merger integration and restructuring
charge by type of cost recorded in the quarter ended June 30, 1999:
Pre-tax After-tax
(In thousands) Cost Cost
- ----------------------------------------------------------------------------
Type of Costs:
Severance and employee benefit accruals............. $10,446 $ 6,790
Professional fees................................... 5,133 4,886
Branch closings and real estate transactions........ 8,652 5,624
Systems............................................. 2,201 1,431
Other............................................... 5,089 3,308
------- -------
Total merger integration and restructuring costs.. $31,521 $22,039
======= =======
EARNINGS PERFORMANCE
To better understand underlying trends and performance, net operating earnings
exclude the after tax impact of the merger integration and restructuring charges
related to the Company's merger with D&N Financial Corporation in the second
quarter of 1999, the $4.9 million loss on the sale of low yielding fixed rate
securities, and an additional $3.3 million provision for loan losses for the
quarter ended June 30, 1999.
The Company reported record net operating for the second quarter of $11.7
million, or $0.28 per diluted share, up 17% from $0.24 earned for the second
quarter of 1998. Net operating income for the quarter generated annualized
returns of 1.18% on average assets and 17.56% on average equity. These compare
with returns of 1.04% on average assets and 16.29% on average equity for the
second quarter of 1998.
Net operating income for the six months ended June 30, 1999 was $21.8 million, a
14% increase over the $19.2 million earned for the six months ended June 30,
1998. For the six months period ended June 30, 1999, diluted earnings per share
were $0.53, an increase of 13% over the $0.47 earned in 1998. Net operating
income for the first six months of 1999 generated annualized return on average
assets and return on average shareholders' equity of 1.08% and 16.29%,
respectively.
Including these charges described above, the Company reported a net loss for the
second quarter of $18.5 million and a net loss of $8.4 million for the six
months ended June 30, 1999.
9
RESULTS OF OPERATIONS
Mortgage Banking
The following discussion provides information that relates specifically to the
Company's mortgage banking line of business, which generates revenue from
mortgage loan production and mortgage loan servicing activities. Mortgage
banking revenue represents the largest component of the Company's total
noninterest income.
The Company closed $1.5 billion in single-family residential mortgage loans in
the second quarter of 1999, compared to $1.6 billion closed in the same period
last year. During the first half of 1999, mortgage loan closings were $2.9
billion, compared to $3.1 billion for the comparable period in 1998. Retail
mortgage loan volumes during the first half of 1999 decreased slightly due to a
rising interest rate environment which has resulted in a lower level of
refinance activity. Refinancings for the second quarter of 1999 represented
approximately 28% of total closings compared to 31% in the second quarter of
1998. During the first half of 1999, refinancings represented approximately 36%
of total closings compared to 42% for the first half of 1998.
The following table summarizes the Company's income from mortgage banking
activities:
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------
Mortgage loan production income (1)..... $36,346 $33,512 $73,107 $61,643
Net mortgage loan servicing income (2).. 772 46 1,148 1,035
------- ------- ------- -------
Total mortgage banking income..... $37,118 $33,558 $74,255 $62,678
======= ======= ======= =======
(1) Includes fee revenue derived from the loan origination process (i.e.,
points collected), gains on the sale of mortgage loans and gains on the
sale of mortgage servicing rights released concurrently with the underlying
loans sold.
(2) Includes servicing fees, late fees and other ancillary charges, net of
amortization and charges for impairment of mortgage servicing rights, if
any.
For the three months ended June 30, 1999, mortgage banking income increased $3.6
million, or 11%, to $37.1 million from $33.6 million a year earlier, as mortgage
loan production revenue and net mortgage servicing revenue increased. Mortgage
loan production revenue grew primarily as a result of improvement in execution
on the sale of mortgages and the related mortgage servicing rights sold
concurrently with the underlying loans. The Company sold $1.5 billion of
single-family residential mortgage loans in the second quarters of 1999 and
1998. The ratio of mortgage loan production revenue to mortgage loans sold
increased to 2.45% for the second quarter of 1999, compared to 2.20% in 1998.
Net mortgage loan servicing income was $772,000 for the quarter ended June 30,
1999 compared to $46,000 for the second quarter of 1998. The increase was
primarily the result of a decrease in amortization expense, which was offset by
a decrease in the average loans serviced. Loans serviced for others averaged
$3.6 billion for the second quarter of 1999, a 10% decrease from $4.0 billion
during the second quarter of 1998. Amortization of mortgage servicing rights
totaled $3.2 million for the second quarter of 1999 compared to $4.1 million for
the second quarter of 1998. The decrease in amortization was a result of the
decline in residential mortgage loan refinance activity in the second quarter of
1999 compared to the second quarter of 1998.
For the six months ended June 30, 1999, mortgage banking income increased $11.6
million, or 18%, compared to the same period a year ago, reflecting increased
gains on the sale of mortgages with servicing rights released and increased net
mortgage servicing revenue. The increase in mortgage loan production income was
a result of an increase in mortgage loan sales which totaled $3.0 billion for
the first half of 1999, compared to $2.9 billion in 1998 and an improvement in
execution. The ratio of mortgage loan production revenue to mortgage loans sold
increased to 2.43% for the six months ended June 30, 1999, compared to 2.14% for
the same period in
10
1998. The increase in net mortgage loan servicing income is primarily the result
of a 64% increase in the principal balance of loans serviced under subservicing
agreements during the first half of 1999 compared to 1998.
For the six months ended June 30, 1999 and 1998, amortization of mortgage
servicing rights totaled $7.9 million and $7.5 million, respectively. The
Company evaluates its mortgage servicing rights for impairment on a quarterly
basis and as of June 30, 1999 the balance of the impairment reserve was $3.0
million, an increase of $525,000 from December 31, 1998.
Commercial and Retail Banking
The remaining disclosures and analyses within Management's Discussion and
Analysis regarding the Company's results of operations and financial condition
relate principally to the commercial and retail banking line of business.
Net Interest Income
The following discussion should be read in conjunction with Tables I and II on
the following pages, which provide detailed analyses of the components impacting
net interest income for the three and six months ended June 30, 1999 and 1998.
Net interest income, on a fully taxable equivalent (FTE) basis, was $30.6
million for the second quarter of 1999, an increase of $2.4 million, or 8%, over
the second quarter of 1998. This increase was primarily the result of a $153.1
million, or 29%, increase in average commercial loans and a $66.1 million, or
11% increase in installment loans during the second quarter of 1999 compared to
1998. Funding the growth in commercial and installment loans was a reduction in
the average balance of mortgage loans held for sale and an increase in average
deposits. Net interest income growth was partially offset by the interest
expense associated with a $257.5 million, or 12% increase in average
interest-bearing deposits.
The net interest margin (FTE) was 3.25% for the quarter ended June 30, 1999, an
increase of 11 basis points from 3.14% in 1998. The increase in the margin was
due to an improved mix of earning assets toward higher-yielding commercial and
installment loans, a reduction in the Company's cost of funds, and a $13.6
million increase in the average balance of noninterest-bearing deposits over the
second quarter of 1998.
For the six months ended June 30, 1999, net interest income (FTE) was $59.5
million, an increase of $4.9 million, or 9%, over the first half of 1998. The
net interest margin (FTE) for the six months ended June 30, 1999, rose 3 basis
points to 3.13% from 3.10% for the comparable period in 1998. The increase in
the net interest margin was due to the improved mix of earning assets, a
reduction in the Company's cost of funds, and an increase in the average balance
of noninterest-bearing deposits.
11
Table I - Quarterly Net Interest Income and Rate/Volume Analysis (FTE)
Three Months Ended Three Months Ended
June 30, 1999 June 30, 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(Dollar amounts in thousands) Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------------
Average Assets:
Short-term investments............................ $ 31,447 $ 433 5.52% $ 5,891 $ 81 5.52%
Mortgage loans held for sale...................... 508,324 9,126 7.20 597,638 11,271 7.56
Investment securities ............................ 570,569 9,344 6.55 503,143 8,514 6.69
Portfolio loans(1):
Commercial loans............................... 690,350 14,750 8.57 537,234 12,394 9.25
Real estate mortgage loans..................... 1,320,515 23,520 7.12 1,372,462 25,643 7.47
Installment loans.............................. 646,426 13,879 8.61 580,287 12,960 8.96
------------ ---------- ----- ----------- ------- -----
Total loans, net of unearned income...... 2,657,291 52,149 7.86 2,489,983 50,997 8.20
------------ ---------- ----- ----------- ------- -----
Total interest-earning assets................ 3,767,631 71,052 7.55 3,596,655 70,863 7.88
Allowance for loan losses......................... (22,480) (19,662)
Cash and due from banks........................... 44,622 36,563
Other assets...................................... 167,721 177,723
------------ -----------
Total assets................................. $ 3,957,494 $ 3,791,279
============ ===========
Average Liabilities and Shareholders' Equity:
Interest-bearing demand deposits.................. $ 95,539 398 1.67 $ 94,584 409 1.73
Savings deposits ................................. 795,055 5,730 2.89 704,425 6,268 3.57
Time deposits..................................... 1,532,098 20,507 5.37 1,366,233 19,876 5.81
------------ ---------- ---- ----------- ------- ----
Total interest-bearing deposits................ 2,422,692 26,635 4.41 2,165,242 26,553 4.91
Short-term borrowings............................. 44,404 627 5.66 143,676 2,022 5.67
FHLB advances.................................... 862,387 12,216 5.68 901,620 13,101 5.77
Long-term debt.................................... 53,583 947 7.07 54,262 1,004 7.50
------------ ---------- ----- ----------- -------- -----
Total interest-bearing liabilities........... 3,383,066 40,425 4.79 3,264,800 42,680 5.24
---------- ----- ------- -----
Noninterest-bearing deposits...................... 163,524 149,968
Other liabilities................................. 115,881 105,170
------------ -----------
Total liabilities............................ 3,662,471 3,519,938
Preferred stock of subsidiary..................... 28,719 28,719
Shareholders' equity.............................. 266,304 242,622
------------ -----------
Total liabilities and shareholders' equity... $ 3,957,494 $ 3,791,279
============ ===========
Net interest income/rate spread (FTE)............. $ 30,627 2.76% $ 28,183 2.64%
========== ==== ======== ====
Net interest margin (FTE)......................... 3.25% 3.14%
==== ====
Increase (decrease) due to change in: Volume(2) Rate(2) Net Change
--------------------------------------------------------------------------------------------------------
Short-term investments................... $ 352 $ - $ 352
Mortgage loans held for sale............. (1,627) (518) (2,145)
Investment securities.................... 1,022 (192) 830
Portfolio loans(1):
Commercial loans...................... 3,325 (969) 2,356
Real estate mortgage loans............ (949) (1,174) (2,123)
Installment loans..................... 1,441 (522) 919
---------- -------- --------
Total loans, net of unearned income. 3,817 (2,665) 1,152
---------- -------- --------
Total interest income............... 3,565 (3,376) 189
Interest-bearing demand deposits......... 4 (15) (11)
Savings deposits......................... 749 (1,287) (538)
Time deposits............................ 2,240 (1,609) 631
---------- -------- --------
Total interest-bearing deposits........ 2,992 (2,910) 82
Short-term borrowings.................... (1,393) (2) (1,395)
FHLB advances............................ (651) (234) (885)
Long-term debt........................... (10) (47) (57)
---------- -------- --------
Total interest expense............. 938 (3,193) (2,255)
---------- -------- --------
Net interest income................. $ 2,628 $ (184) $2,444
========== ======== ========
(1) Non-accrual loans and overdrafts are included in average balances.
(2) Rate/volume variances are proportionately allocated to rate and volume
based on the absolute value of the change in each.
12
Table II - Year-to-Date Net Interest Income and Rate/Volume Analysis (FTE)
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
- -------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(Dollar amounts in thousands) Balance Interest Rate Balance Interest Rate
- -------------------------------------------------------------------------------------------------------------------------------
Average Assets:
Short-term investments............................ $ 28,483 $ 604 4.28% $ 4,795 $ 130 5.47%
Mortgage loans held for sale...................... 555,858 19,553 7.09 536,033 19,696 7.35
Investment securities............................. 612,235 19,576 6.39 532,977 17,918 6.78
Portfolio loans(1):
Commercial loans............................... 669,071 28,593 8.62 515,462 23,909 9.35
Real estate mortgage loans..................... 1,300,162 46,791 7.20 1,399,877 52,295 7.47
Installment loans.............................. 633,180 26,970 8.59 570,333 25,356 8.97
---------- --------- ------ ----------- -------- ------
Total loans, net of unearned income.......... 2,602,413 102,354 7.90 2,485,672 101,560 8.20
---------- --------- ------ ----------- -------- ------
Total interest-earning assets................ 3,798,989 142,087 7.51 3,559,477 139,304 7.86
Allowance for loan losses......................... (22,152) (18,931)
Cash and due from banks........................... 37,618 36,017
Other assets...................................... 244,538 184,872
---------- -----------
Total assets................................. $4,058,993 $ 3,761,435
========== ===========
Average Liabilities and Shareholders' Equity:
Interest-bearing demand deposits.................. $ 99,578 887 1.80 $ 91,717 772 1.70
Savings deposits.................................. 790,948 11,471 2.92 685,460 11,978 3.52
Time deposits..................................... 1,545,400 41,730 5.45 1,363,337 39,642 5.87
---------- --------- ---- ----------- -------- ------
Total interest-bearing deposits................ 2,435,926 54,088 4.48 2,140,514 52,392 4.94
Short-term borrowings............................. 71,030 1,894 5.37 170,413 4,829 5.71
FHLB advances.................................... 873,688 24,652 5.69 881,557 25,459 5.78
Long-term debt.................................... 55,302 1,924 6.96 54,698 2,015 7.43
---------- --------- ---- ----------- -------- ------
Total interest-bearing liabilities........... 3,435,946 82,558 4.84 3,247,182 84,695 5.25
--------- ---- -------- ------
Noninterest-bearing deposits...................... 176,034 146,966
Other liabilities................................. 150,060 100,425
---------- -----------
Total liabilities............................ 3,762,040 3,494,573
Preferred stock of subsidiary..................... 28,719 28,719
Shareholders' equity.............................. 268,234 238,143
---------- -----------
Total liabilities and shareholders' equity... $4,058,993 $ 3,761,435
========== ===========
Net interest income/Rate spread (FTE)............. $ 59,529 2.67% $54,609 2.61%
========= ==== ======= ======
Net interest margin............................... 3.13% 3.10%
==== ======
Increase (decrease) due to change in: Volume(2) Rate(2) Net Change
---------------------------------------------------------------------------------------------------------
Short-term investments................... $ 509 $ (35) $ 474
Mortgage loans held for sale............. 640 (783) (143)
Investment securities.................... 2,694 (1,036) 1,658
Portfolio loans(1):
Commercial loans...................... 6,693 (2,009) 4,684
Real estate mortgage loans............ (3,651) (1,853) (5,504)
Installment loans..................... 2,732 (1,118) 1,614
-------- -------- --------
Total loans, net of unearned income. 5,773 (4,979) 794
-------- -------- --------
Total interest income............... 9,616 (6,833) 2,783
Interest-bearing demand deposits......... 68 47 115
Savings deposits......................... 1,711 (2,218) (507)
Time deposits............................ 5,088 (3,000) 2,088
-------- -------- --------
Total interest-bearing deposits........ 6,867 (5,171) 1,696
Short-term borrowings.................... (2,663) (272) (2,935)
FHLB advances............................ (294) (513) (807)
Long-term debt........................... 24 (115) (91)
-------- -------- --------
Total interest expense............. 3,935 (6,072) (2,137)
-------- -------- --------
Net interest income................. $ 5,681 $ (761) $ 4,920
======== ======== ========
(1) Non-accrual loans and overdrafts are included in average balances.
(2) Rate/volume variances are proportionately allocated to rate and volume
based on the absolute value of the change in each.
13
Noninterest Expense
Noninterest expense for the three and six months ended June 30, 1999 includes a
one-time merger integration and restructuring charge of $31.5 million related to
the merger with D&N Financial Corporation on May 17, 1999. Excluding this
charge, noninterest expense for the quarter ended June 30, 1999 increased $3.7
million, or 8%, to $50.6 million from $46.9 million a year earlier. Also, on a
year-to-date basis excluding the charge, total noninterest expense was $102.2
million, up $13.5 million, or 15%, over the first six months of 1998. The rise
in noninterest expense, in part, reflects an increase in salaries and employee
benefits expense attributed to a 16% increase in the number of employees at June
30, 1999 compared to June 30, 1998. The opening of 27 additional retail bank and
loan production offices during the past twelve months also contributed to the
increase in noninterest expense.
BALANCE SHEET ANALYSIS
ASSETS
At June 30, 1999, the Company had $4.0 billion in total assets, a decrease of
$236.2 million, or 6%, from $4.2 billion at December 31, 1998. The decrease is
primarily the result of the decrease in investment securities and mortgage loans
held for sale described below.
Securities
During the second quarter of 1999, all investment securities at D&N Bank were
reclassified as available for sale in conjunction with the merger and to provide
additional liquidity to the consolidated organization. Total investment
securities declined $387.2 million, or 58%, to $284.3 million, and represented
7.1% of total assets at June 30, 1999. In order to reduce interest rate risk and
improve future net interest income, in June 1999, the Company sold $304.5
million of low-yielding fixed rate investment securities, of which $164.3
million were sold not yet delivered at June 30, 1999. The proceeds from the sale
were redeployed into higher yielding residential mortgage loans. Gross realized
gains and losses on sales of available-for-sale securities were $422,000 and
$7,659,000, respectively, for the quarter ended June 30, 1999. For the first six
months of 1999, gross realized gains and losses totaled $1,159,000 and
$7,747,000, respectively.
The Company's securities portfolio serves as a source of liquidity and earnings,
carries relatively minimal principal risk and contributes to the management of
interest rate risk. The debt securities portfolio is comprised primarily of U.S.
Government agency securities, obligations collateralized by U.S. Government
agencies, mainly in the form of mortgage-backed securities and collateralized
mortgage obligations, and municipal obligations. With the exception of municipal
obligations, the maturity structure of the debt securities portfolio is
generally short-term in nature or indexed to variable rates. The Company's
equity securities portfolio consists primarily of Federal Home Loan Bank stock.
During the second quarter, in order to mitigate interest rate risk associated
with fixed rate investment securities, the Company purchased $140 million
notional amount of interest rate caps indexed to the three month LIBOR with a
strike rate of 6.5%, with various expiration dates from June 2001 to June 2002.
In addition, the Company purchased $75 million notional amount of options to
enter into interest rate swap agreements indexed to the three month LIBOR
expiring in June 2002.
14
The following table details the composition, amortized cost and fair value of
the Company's investment securities portfolio at June 30, 1999:
Securities Available for Sale
------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------
Debt Securities:
U.S. Government agency securities ........ $ 15,242 $ -- $ 95 $ 15,147
Collateralized mortgage obligations ...... 190,101 19 3,119 187,001
Mortgage-backed securities ............... 21,912 534 456 21,990
Municipal and other securities ........... 3,103 139 -- 3,242
-------- -------- -------- --------
Total Debt Securities .................. 230,358 692 3,670 227,380
Equity securities ........................... 56,927 -- -- 56,927
-------- -------- -------- --------
Total Securities Available for Sale..... $287,285 $ 692 $ 3,670 $284,307
======== ======== ======== ========
Certain securities having a carrying value of approximately $59.1 million and
$117.9 million at June 30, 1999 and December 31, 1998, respectively, were
pledged to secure certain securities sold under agreements to repurchase and
public deposits as required by law.
Mortgage Loans Held for Sale
Mortgage loans held for sale were $420.4 million at June 30, 1999 compared to
$770 million at December 31, 1998. This decrease was caused by the $367 million
decrease in residential mortgage loan closings during the second quarter of 1999
over the fourth quarter of 1998 (loans closed generally remain in loans held for
sale for 30 to 60 days after closing) and due to the Company maintaining a
higher percentage of residential mortgage loan closings in its loan portfolio.
Portfolio Loans
Total portfolio loans were $2.88 billion at June 30, 1999, an increase of $338.4
million, or 13.3%, from $2.54 billion at December 31, 1998. This increase
resulted from increases in the commercial, residential real estate mortgage and
installment loan portfolios. The residential mortgage portfolio loan balance
increased $179.5 million, or 14%, since year-end 1998 to $1.47 billion at June
30, 1999. The installment loan portfolio increased $56.7 million, or 9%, since
year-end 1998 to $672.3 million at June 30, 1999.
The commercial loan balance increased $102.3 million during the first half of
1999, for an annualized growth rate of 32%, reflecting continued strong demand
for real estate-secured lending in markets served by the Company. During the
second quarter of 1999, the Company closed $12.9 million in Small Business
Administration (SBA) loans, a 52% increase from the $8.5 million closed in the
second quarter of 1998. For the first six months of 1999 and 1998, SBA loan
closings were $18.8 million and $15.0 million, respectively. The Company sold
$4.6 million and $14.9 million of the guaranteed portion of SBA loans in the
first six months of 1999 and 1998, respectively, resulting in corresponding
gains of $348,000 and $1,096,000, respectively.
15
The following table provides further information regarding the Company's loan
portfolio:
June 30, 1999 December 31, 1998
--------------------------- ---------------------------
(Dollars in thousands) Amount Percent Amount Percent
- -----------------------------------------------------------------------------------------------------------
Commercial loans:
Commercial and industrial ........... $ 95,469 3.3% $ 83,105 3.3%
Commercial real estate mortgage...... 639,505 22.2 549,586 21.6
---------- ----- ---------- -----
Total commercial loans ......... 734,974 25.5 632,691 24.9
Residential real estate mortgages....... 1,474,948 51.2 1,295,484 50.9
Installment loans ...................... 672,255 23.3 615,597 24.2
---------- ----- ---------- -----
Total portfolio loans ........... $2,882,177 100.0% $2,543,772 100.0%
========== ===== ========== =====
Credit Quality
The Company attempts to minimize credit risk in the loan portfolio by focusing
primarily on real estate-secured lending (i.e., residential real estate
construction loans, residential real estate mortgage loans, commercial real
estate construction loans, commercial real estate mortgage loans, and home
equity loans). As of June 30, 1999, such loans comprised approximately 82% of
total portfolio loans. The Company's general policy is to originate conventional
residential real estate mortgages with loan-to-value ratios of 80% or less and
SBA-secured loans or real estate-secured commercial loans with loan-to-value
ratios of 75% or less.
The substantial majority of the Company's residential mortgage loan production
is underwritten in compliance with the requirements for sale to or conversion to
mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation
(FHLMC), the Federal National Mortgage Association (FNMA), or the Government
National Mortgage Association (GNMA). The majority of the Company's commercial
loans is secured by real estate and is generally made to small and medium-size
businesses. These loans are made at rates based on the prevailing prime interest
rates of Republic Bank and D&N Bank, as well as fixed rates for terms generally
ranging from three to five years. Management's emphasis on real estate-secured
lending and adherence to conservative underwriting standards is reflected in the
Company's historically low net charge-offs.
Non-Performing Assets
Non-performing assets consist of non-accrual loans and other real estate owned
(OREO). OREO represents real estate properties acquired through foreclosure or
by deed in lieu of foreclosure and is classified as other assets on the balance
sheet until such time as the property is sold. Commercial loans, residential
real estate loans and installment loans are generally placed on non-accrual
status when principal or interest is 90 days or more past due, unless the loans
are well-secured and in the process of collection. Loans may be placed on
non-accrual status earlier when, in the opinion of management, reasonable doubt
exists as to the full, timely collection of interest or principal.
16
The following table summarizes the Company's non-performing assets and 90-day
past due loans:
June 30, December 31,
(Dollars in thousands) 1999 1998
- -------------------------------------------------------------------------------------------------
Non-Performing Assets:
Non-accrual loans:
Commercial ........................................... $ 4,989 $ 6,141
Residential real estate mortgages .................... 8,259 12,011
Installment .......................................... 1,775 1,826
------- -------
Total non-accrual loans ............................ 15,023 19,978
Restructured loans ........................................ -- --
------- -------
Total non-performing loans ......................... 15,023 19,978
Other real estate owned ................................ 4,575 5,648
------- -------
Total non-performing assets ........................ $19,598 $25,626
======= =======
Non-performing assets as a percentage of:
Portfolio loans and OREO ............................. .68% 1.01%
Portfolio loans, mortgage loans held for
sale and OREO .................................. .59% .77%
Total assets ......................................... .49% .61%
Loans past due 90 days or more and still accruing interest:
Commercial ............................................. $ 245 $ 112
Residential real estate ................................ -- --
Installment ............................................ -- --
------- -------
Total loans past due 90 days or more ............... $ 245 $ 112
======= =======
At June 30, 1999, approximately $24.0 million, or .83% of total portfolio loans
were 30-89 days delinquent, compared to $23.4 million, or .92%, at December 31,
1998.
Provision and 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 loan portfolio that have been
incurred as of the balance sheet date. The allowance for loan losses 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 considers certain factors when determining
the unallocated allowance, including but not limited to, loan quality, changes
in the size and character of the loan portfolio, consultation with regulatory
authorities, amount of nonperforming loans, delinquency trends and 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 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 in 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
17
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.
Gross loan charge-offs increased $3.9 million to $5.3 million for the six months
ended June 30, 1999 compared to $1.4 million for the same period of 1998. The
increase is related primarily to charge-offs of certain commercial loans during
the second quarter of 1999. Reflecting this increase in charge-offs, the Company
recorded provision for loan losses of $6.6 million for the second quarter of
1999 compared to $2.1 million in 1998.
The following table provides an analysis of the allowance for loan losses:
Six Months Ended
June 30,
------------------------------
(Dollars in thousands) 1999 1998
--------- ----------
Allowance for loan losses:
Balance at January 1 ................................................ $ 21,446 $ 17,883
Loans charged off ................................................ (5,335) (1,443)
Recoveries of loans previously charged off ....................... 278 309
-------- --------
Net charge-offs ................................................ (5,057) (1,134)
Provision charged to expense ..................................... 8,100 3,800
-------- --------
Balance at June 30 .................................................. $ 24,489 $ 20,549
======== ========
Annualized net charge-offs as a percentage of average portfolio loans
(including loans held for sale) ................................ .32% .07%
Allowance for loan losses as a percentage of total portfolio loans
outstanding at period-end ...................................... .85 .84
Allowance for loan losses as a percentage of non-performing
loans .......................................................... 163.01 107.35
Off-Balance Sheet Instruments
Unused commitments to extend credit totaled $920.3 million for residential real
estate loans and $222.4 million for commercial real estate loans at June 30,
1999.
At June 30, 1999, the Company had outstanding $579.5 million of commitments to
fund residential real estate loan applications with agreed-upon rates, including
$238.2 million of residential portfolio loans. Committing to fund residential
real estate loan applications at specified rates and holding residential
mortgage loans for sale to the secondary market exposes the Company to interest
rate risk during the period from application to when the loan is sold to the
investors. To minimize this exposure to interest rate risk, the Company enters
into firm commitments to sell such mortgage loans at specified future dates to
various third parties.
At June 30, 1999, the Company had outstanding mandatory forward commitments to
sell $604.4 million of residential mortgage loans, of which $338.6 million
covered mortgage loans held for sale and $265.8 million covered commitments to
fund residential real estate loan applications with agreed-upon rates. These
outstanding
18
forward commitments to sell mortgage loans are expected to settle in the third
quarter of 1999 without producing any material gains or losses. At June 30,
1999, the mortgage loans held for sale balance included $81.8 million of loan
products for which the Company did not enter into mandatory forward commitments.
The Company's exposure to market risk was not significantly increased, however,
since $53.2 million, or 65%, of these loans were loans that had been committed
for bulk sale to third parties prior to June 30, 1999 or were floating rate
residential loans.
LIABILITIES.
Total liabilities were $3.7 billion, a 6% decrease from $3.9 billion at December
31, 1998. This decrease was primarily due to decreases in deposits, short-term
borrowings and FHLB advances.
Deposits
Total deposits decreased $85.5 million, or 3%, to $2.56 billion at June 30, 1999
from $2.64 billion at December 31, 1998 as the Company allowed the run-off of
higher yielding certificate of deposits.
Short-Term Borrowings
Short-term borrowings with maturities of less than one year, along with the
related average balances and interest rates for the six months ended June 30,
1999 and the year ended December 31, 1998, were as follows:
June 30, 1999 December 31, 1998
-------------------------------------- --------------------------------------------
Average Average
Ending Average Rate During Ending Average Rate During
(Dollars in thousands) Balance Balance Period Balance Balance Period
- -------------------------------------------------------------------------------------------------------------------------------
Federal funds purchased .............. $ 20,000 $ 32,189 5.34% $ 73,285 $ 35,717 5.59%
Securities sold under agreements
to repurchase ..................... -- 37,255 5.38 18,153 85,499 5.58
Other short-term borrowings .......... 3,450 1,586 6.05 5,500 3,077 5.03
-------- -------- ---- -------- -------- ----
Total short-term borrowings........ $ 23,450 $ 71,030 5.37% $ 96,938 $124,293 5.57%
======== ======== ==== ======== ======== ====
At June 30, 1999 and December 31, 1998, other short-term borrowings consisted of
treasury, tax and loan (TT&L) demand notes.
FHLB Advances
Republic Bank and D&N Bank routinely borrow short- and long-term advances from
the Federal Home Loan Bank (FHLB) to fund mortgage loan originations, purchases
of investment securities and to minimize the interest rate risk associated with
certain fixed rate commercial and residential mortgage portfolio loans. These
advances are generally secured under a blanket security agreement by first
mortgage loans with an aggregate book value equal to at least 150% of the
advances.
FHLB advances outstanding at June 30, 1999 and December 31, 1998, were as
follows:
June 30, 1999 December 31, 1998
-------------------------- ----------------------------
Average Average
Ending Rate At Ending Rate At
(Dollars in thousands) Balance Period-End Balance Period-End
- --------------------------------------------------------------------------------------------------
Short-term FHLB advances $275,000 5.59% $208,000 5.74%
Long-term FHLB advances . 641,911 5.81 778,571 6.09
-------- -------- -------- -------
Total .............. $916,911 5.66% $986,571 5.83%
======== ======== ======== =======
The long-term FHLB advances have original maturities ranging from August 1999 to
July 2008.
19
Long-Term Debt
Obligations with original maturities of more than one year consisted of the
following:
June 30, December 31,
(Dollars in thousands) 1999 1998
- --------------------------------------------------------------------------------------
7.17% Senior Debentures due 2001 .................... $25,000 $25,000
6.75% Senior Debentures due 2001 .................... 9,000 9,000
6.95% Senior Debentures due 2003 .................... 13,500 13,500
7.27% Collateralized Mortgage Obligation due 2010.... 4,169 4,694
------- -------
Total long-term debt ......................... $51,669 $52,194
======= =======
CAPITAL
Shareholders' equity was $250.6 million at June 30, 1999, a $15.3 million, or
5.7%, decrease from $265.9 million at December 31, 1998. This decrease primarily
resulted from the reduction of retained earnings by the net loss for the six
months ended June 30, 1999 due to the $3l.5 million pretax merger integration
and restructuring charge incurred in connection with the D&N merger and the
declaration of $6.3 million in dividends during the six months ended June 30,
1999.
The Company is subject to regulatory capital requirements administered by
federal banking agencies. Failure to meet minimum capital requirements can
initiate actions by regulators that, if undertaken, could have an effect on the
Company's financial statements. Capital adequacy guidelines require minimum
capital ratios of 8.00% for Total risk-based capital, 4.00% for Tier 1
risk-based capital and 3.00% for Tier 1 leverage. To be considered
well-capitalized under the regulatory framework for prompt corrective action,
minimum capital ratios of 10.00% for Total risk-based capital, 6.00% for Tier 1
risk-based capital and 5.00% for Tier 1 leverage must be maintained.
As of June 30, 1999, the Company met all capital adequacy requirements to which
it is subject and management does not anticipate any difficulty in meeting these
requirements on an ongoing basis. The Company's capital ratios were as follows:
June 30, December 31,
1999 1998
---- ----
Total capital to risk-weighted assets (1)....... 10.58% 10.55%
Tier 1 capital to risk-weighted assets (1)...... 9.68 9.80
Tier 1 capital to average assets (1) ........... 6.71 6.54
(1) As defined by the regulations.
As of June 30, 1999, the Company's total risk-based capital was $288.9 million
and Tier 1 risk-based capital was $264.4 million, an excess of $15.9 million and
$100.6 million, respectively, over the minimum guidelines prescribed by
regulatory agencies for a well-capitalized institution. In addition, Republic
Bank and D&N Bank had regulatory capital ratios in excess of the minimum levels
established for well-capitalized institutions.
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, foreign exchange
rates and equity prices. The Company's market risk exposure is composed entirely
of interest rate risk. Interest rate risk arises in the normal course of
business to the extent that there is a difference between the amount of the
Company's interest-earning assets and interest-bearing liabilities that are
prepaid/withdrawn, reprice or mature in specified periods.
20
The primary objective of asset and liability management is to maintain stability
in the level of net interest income by producing the optimal yield and maturity
mix of assets and liabilities within the interest rate risk limits set by the
Company's Asset and Liability Management Committee (ALCO) and consistent with
projected liquidity needs and capital adequacy requirements.
The Company's ALCO, which meets weekly, is responsible for reviewing the
interest rate sensitivity position of the Company and establishing policies to
monitor and limit exposure to interest rate risk. Senior management at each of
the Company's subsidiaries is responsible for ensuring that the subsidiary asset
and liability management procedures adhere to corporate policies and risk limits
established by its respective board of directors.
The Company utilizes two complementary quantitative tools to measure and monitor
interest rate risk: static gap analysis and earnings simulation modeling. Each
of these interest rate risk measurements has limitations, but when evaluated
together, they provide a reasonably comprehensive view of the exposure the
Company has to interest rate risk.
Static Gap Analysis: Static gap analysis is utilized at the end of each month to
measure the amount of interest rate risk embedded in the balance sheet as of a
point in time. It does this by comparing the differences in the repricing
characteristics of interest-earning assets and interest-bearing liabilities. A
gap is defined as the difference between the principal amount of
interest-earning assets and interest-bearing liabilities that reprice within a
specified time period. This gap provides a general indication of the sensitivity
of the Company's net interest income to interest rate changes. Consequently, if
more assets than liabilities reprice or mature in a given period, resulting in
an asset sensitive position or positive gap, increases in market interest rates
will generally benefit net interest income because earning asset rates will
reflect the changes more quickly. Alternatively, where interest-bearing
liabilities reprice more quickly than interest-earning assets, resulting in a
liability sensitive position or negative gap, increases in market interest rates
will generally have an adverse impact on net interest income. At June 30, 1999,
the Company's cumulative one-year gap was a negative 4.48% of total earning
assets.
The Company's current policy is to maintain a mix of asset and liabilities with
repricing and maturity characteristics that permit a moderate amount of
short-term interest rate risk based on current interest rate projections,
customer credit demands and deposit preferences. The Company generally operates
in a range of plus or minus 10% of total earning assets for the cumulative
one-year gap. Management believes that this range reduces the vulnerability of
net interest income to large shifts in market interest rates while allowing the
Company to take advantage of fluctuations in current short-term rates.
Earnings Simulation Modeling: On a quarterly basis, the earnings simulation
model is used to quantify the effects of various hypothetical changes in
interest rates on the Company's projected net interest income over the ensuing
twelve-month period. The model permits management to evaluate the effects of
various parallel shifts of the U.S. Treasury yield curve, upward and downward,
on net interest income expected in a stable interest rate environment (i.e.,
base net interest income).
As of June 30, 1999, the earnings simulation model projects net interest income
would decrease by 9.2% of base net interest income, assuming an immediate
parallel shift upward in market interest rates by 300 basis points. If market
interest rates fall by 300 basis points, the model projects net interest income
would increase by 5.0%. These projected levels are well within the Company's
policy limits. These results portray the Company's interest rate risk position
as liability-sensitive for the one-year horizon. The earnings simulation model
assumes that current balance sheet totals remain constant and all maturities and
prepayments of interest-earning assets and interest-bearing liabilities are
reinvested at current market rates.
21
Impact of Year 2000
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
The Company initiated the process of preparing its computer systems and
applications for the year 2000 in June 1997. The Company's computer systems are
typically standard hardware from national computer hardware vendors and the
computer software is typically purchased software from national vendors, and is
installed and operated without major modifications. The Company presently
believes that with modifications or replacements of existing software and
certain hardware, the Year 2000 Issue can be mitigated. However, if such
modifications and replacements are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.
Management of the Company has developed and maintains a Year 2000 Compliance
Plan. The status of the Plan is being reviewed monthly by either the Board of
Directors or its Executive Committee. The Company's Year 2000 Compliance Plan
has been prepared in accordance with the Federal Financial Institutions
Examination Council (FFIEC) guidelines on Year 2000 Compliance and involves the
following five phases: awareness, assessment, renovation, testing, and
implementation. The Company has completed all phases of the Year 2000 Compliance
Plan. As a part of the assessment phase, certain ancillary applications were
identified as not being Year 2000 compliant and have been successfully replaced.
The assessment of hardware compliance has found all mission critical systems
compliant, with the exception of one mortgage banking hardware platform which
has been replaced, and with only minimal personal computer equipment not
compliant. This personal computer equipment will be replaced during the normal
course of business. In addition, due to the Company's business operating needs,
the Company's core banking system was recently converted to a new system,
including complete replacement of hardware and software.
The total Year 2000 project cost for the Company is estimated at $1.0 million
and is being funded through operating cash flows. This estimate does not include
the salaries and wages of Company personnel working on the Company's Year 2000
readiness. To date, the Company has incurred approximately $610,000 ($210,000
expensed and $400,000 capitalized for new systems hardware and software). The
remaining $390,000 relates principally to contingency plan testing, alternative
power supply systems, and communications and is not expected to have a material
effect on the Company's results of operations, liquidity or capital resources.
The impact of the Year 2000 issues on the Company will depend not only on
corrective actions that the Company takes, but also on the way in which Year
2000 issues are addressed by governmental agencies, businesses and other third
parties that provide services or data to, or receive services or data from, the
Company, or whose financial condition or operational capability is important to
the Company. To reduce this exposure, the Company has initiated formal
communications with its significant suppliers and large customers to determine
the extent to which the Company's systems and processes are vulnerable to those
third parties' failures to resolve their own Year 2000 issues. The Company has
received communications from all mission critical third party vendors and the
majority of other third party vendors either confirming that the third parties
software systems are Year 2000 compliant or providing the Company with a time
line of an expected compliance date by mid-1999. All third party vendors with a
direct interface to the Company's computer
22
systems were fully tested during the validation/testing phase. The Company is
continuing to seek assurances that the systems of other companies on which the
Company's systems rely will be timely converted or modified.
The Company's credit risk associated with borrowers may increase to the extent
commercial loan borrowers fail to adequately address Year 2000 issues. As a
result, Republic Bank and D&N Bank have identified their material borrowers and
have assessed their Year 2000 preparedness. The material commercial loan
borrowers' Year 2000 readiness will be monitored periodically, based on the
level of risk that the Year 2000 has been estimated to potentially impact the
business of each borrower. The Company's risk of material loss due to customer
failure to adequately prepare for the Year 2000 is reduced as a result of 87% of
the Company's commercial loan portfolio being secured by real estate.
The Company is preparing general contingency plans to address unforeseen Year
2000 issues in the event mission critical systems still experience difficulties
or other significant third parties fail to adequately address Year 2000 issues.
These plans involve the operation of systems in an off-line "limited
computerized" environment. This would be accomplished by the manual and desktop
computer update of financial records until problems or difficulties are
remedied. The Company has determined that it must rely primarily on its software
vendors to remedy any unforeseen situations of its mission critical systems in a
timely manner.
The Company is also enhancing its existing business resumption plans for both
information and non-information technology areas to reflect Year 2000 issues. It
has developed plans, designed to coordinate the efforts of its personnel and
resources, in addressing any year 2000 difficulties that become evident as a
result of Year 2000 issues. There can be no assurance that any plans will fully
mitigate any such difficulties. Furthermore, there may be certain mission
critical third parties, such as utilities or telecommunication companies, where
alternative arrangements or other sources are limited or unavailable.
The costs of the Year 2000 project were based on management's best estimates.
There can be no guarantee that these estimates will be achieved and actual
results could differ from those anticipated. Specific factors that might cause
differences include, without limitation, the ability of other companies on which
the Company's systems rely to modify or convert their systems to be Year 2000
compliant, the ability to locate and correct all relevant computer codes, the
ability to execute general contingency and business resumption plans, and
similar uncertainties.
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. In the event that Year 2000
program of either the Company or its third party vendors were not completed
effectively, under the most reasonably likely worst case scenario, the Company
could be unable to process customer loan and deposit transactions, perform
interest computations or collect payments. In addition, disruptions in the
economy generally resulting from Year 2000 issues could also materially
adversely affect the Company. The Company could be subject to litigation for
equipment shutdown or failure to properly date customer records. The amount of
potential liability and lost revenue cannot be reasonably estimated at this
time.
Accounting Developments
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which was amended in June 1999 by SFAS No.
137, Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No. 133, and is required to be adopted by
the Company in fiscal years beginning after June 15, 2000. The Statement will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives will either be offset against the
change in fair value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. The Company has not
yet determined what the effect of Statement 133 will be on the earnings and
financial position of the Company.
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of business, the Company and its subsidiaries
are parties to certain routine litigation. In the opinion of
management, the aggregate liabilities, if any, arising from such legal
proceedings would not have a material adverse effect on the Company's
consolidated financial position, results of operations and liquidity.
Item 2. Changes in Securities
On May 17, 1999, the Company merged with D&N Financial Corporation.
Under terms of the merger, D&N Financial Corporation shareholders
received a total of 17,225,457 Republic Bancorp Inc. common shares,
which represented 1.82 shares for each D&N Financial Corporation common
share owned.
On May 20, 1999, the Board of Directors declared a quarterly cash
dividend of $0.09 per share of common stock, payable on July 2, 1999 to
shareholders of record June 4, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(27) Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on May 28, 1999
with respect to the merger of D&N Financial Corporation with and
into Republic Bancorp Inc. effective May 17, 1999.
The Company filed a Current Report on Form 8-K/A on July 16, 1999
as an amendment to the May 28, 1999 Form 8-K filing with respect
to providing pro forma financial information and combined
financial results for 30 days following the merger date.
24
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
REPUBLIC BANCORP INC.
---------------------
(Registrant)
Date: August 16, 1999 BY: /s/ Thomas F. Menacher
---------------------------------------
Thomas F. Menacher
Executive Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
25
EXHIBIT INDEX
Sequential
Exhibit Number Exhibit Page Number
- -------------- ------- -----------
27 Financial Data Schedule 27
26