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 September 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 October 31, 1999:
Common Stock, $5 Par Value 41,250,716 Shares
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 1999
and December 31, 1998..................................... 3
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 1999 and 1998.................. 4
Consolidated Statements of Cash Flows for the Nine
Months Ended September 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 - 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................... 25
Item 2. Changes in Securities..................................... 25
Item 6. Exhibits and Reports on Form 8-K.......................... 25
SIGNATURE............................................................. 26
EXHIBITS.............................................................. 27 - 28
2
PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements
REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
September 30, December 31,
(Dollars in thousands) 1999 1998
- ------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents......................... $ 53,914 $ 47,712
Mortgage loans held for sale...................... 440,461 770,028
Securities held to maturity (market value of
$70,703)......................................... - 70,124
Securities available for sale (amortized cost of
$281,986 and $601,793, respectively)............. 278,554 601,429
Loans............................................. 3,288,088 2,543,772
Less allowance for loan losses................... (25,868) (21,446)
---------- ----------
Net loans......................................... 3,262,220 2,522,326
---------- ----------
Premises and equipment............................ 40,129 37,185
Mortgage servicing rights......................... 61,053 64,267
Other assets...................................... 98,482 100,695
---------- ----------
Total assets $4,234,813 $4,213,766
========== ==========
LIABILITIES
Noninterest-bearing deposits...................... $ 217,853 $ 213,562
Interest-bearing deposits......................... 2,304,625 2,429,269
---------- ----------
Total deposits................................. 2,522,478 2,642,831
Federal funds purchased, securities sold under
agreements to repurchase and other short-term
borrowings....................................... 45,625 96,938
Short-term FHLB advances.......................... 635,000 208,000
Long-term FHLB advances........................... 583,911 778,571
Accrued expenses and other liabilities............ 106,071 139,709
Long-term debt.................................... 51,291 52,194
---------- ----------
Total liabilities.............................. 3,944,376 3,918,243
Minority interest................................. 1,135 927
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; 41,230,698 and 40,712,087 shares
issued and outstanding, respectively............. 206,153 203,560
Capital surplus................................... 23,884 22,130
Retained earnings................................. 32,778 38,697
Accumulated other comprehensive income (loss)..... (2,232) 1,490
---------- ----------
Total shareholders' equity..................... 260,583 265,877
---------- ----------
Total liabilities and shareholders' equity..... $4,234,813 $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 Nine Months Ended
September 30, September 30,
(In thousands, except per share data) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------
Interest Income:
Loans, including fees............................. $ 70,017 $ 62,305 $191,924 $ 183,561
Investment securities............................. 6,325 10,151 26,469 28,162
---------- ---------- -------- ----------
Total interest income.......................... 76,342 72,456 218,393 211,723
---------- ---------- -------- ----------
Interest Expense:
Deposits.......................................... 25,357 28,679 79,445 81,070
Short-term borrowings............................. 744 1,634 2,638 6,465
FHLB advances..................................... 15,506 13,104 40,158 38,564
Long-term debt.................................... 930 995 2,854 3,008
---------- ---------- -------- ----------
Total interest expense......................... 42,537 44,412 125,095 129,107
---------- ---------- -------- ----------
Net interest income............................... 33,805 28,044 93,298 82,616
Provision for loan losses......................... 1,575 1,400 9,675 5,200
---------- ---------- -------- ----------
Net interest income after provision for loan
losses........................................... 32,230 26,644 83,623 77,416
---------- ---------- -------- ----------
Non-interest Income:
Service charges................................... 1,922 1,534 5,431 4,385
Mortgage banking.................................. 30,054 36,524 104,309 99,202
Gain (loss) on sales of securities................ 10 1,283 (6,578) 1,139
Other non-interest income......................... 1,364 1,594 3,616 4,804
---------- ---------- -------- ----------
Total non-interest income...................... 33,350 40,935 106,778 109,530
---------- ---------- -------- ----------
Non-interest Expense:
Salaries and employee benefits.................... 16,269 18,996 57,789 51,537
Mortgage loan commissions and other incentives.... 13,081 14,950 38,063 39,249
Occupancy expense of premises..................... 3,492 2,990 10,284 8,429
Equipment expense................................. 2,195 1,474 5,640 4,511
Merger integration and restructuring.............. - - 31,521 -
Other non-interest expense........................ 10,657 12,464 36,145 35,868
---------- ---------- -------- ----------
Total non-interest expense..................... 45,694 50,874 179,442 139,594
---------- ---------- -------- ----------
Income before income taxes........................ 19,886 16,705 10,959 47,352
Provision for income taxes........................ 6,750 5,710 4,815 15,808
---------- ---------- -------- ----------
Income before preferred stock dividends........... 13,136 10,995 6,144 31,544
Dividends on preferred stock...................... 681 681 2,042 2,042
---------- ---------- -------- ----------
Net income........................................ $ 12,455 $ 10,314 $ 4,102 $ 29,502
========== ========== ======== ==========
Basic earnings per share.......................... $ .30 $ .26 $ .10 $ .73
========== ========== ======== ==========
Diluted earnings per share........................ $ .30 $ . 25 $ .10 $ .72
========== ========== ======== ==========
Average common shares outstanding - diluted....... 41,689 41,219 41,567 41,140
========== ========== ======== ==========
Cash dividends declared per common share.......... $ .09 $ .08 $ .27 $ .24
========== ========== ======== ==========
See notes to consolidated financial statements and management's discussion and
analysis.
4
REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30 (In thousands) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net income............................................................................... $ 4,102 $ 29,502
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.......................................................... 7,190 10,833
Amortization of mortgage servicing rights.............................................. 10,096 11,551
Net losses (gains) on sale of securities available for sale............................ 6,578 (1,139)
Net gains on sale of mortgage servicing rights......................................... (29,263) (25,552)
Net gains on sale ofloans.............................................................. (2,627) (5,774)
Origination of mortgage loans held for sale............................................ (3,330,280) (4,163,363)
Proceeds from sales of mortgage loans held for sale.................................... 3,659,847 3,982,033
Net decrease (increase) in other assets................................................ 4,238 (35,550)
Net (decrease) increase in other liabilities........................................... (33,638) 44,709
Other, net............................................................................. (3,837) (5,336)
----------- -----------
Total adjustments..................................................................... 288,304 (187,588)
----------- -----------
Net cash provided by (used in) operating activities................................ 292,406 (158,086)
----------- -----------
Cash Flows From Investing Activities:
Proceeds from sale of securities available for sale...................................... 423,499 118,791
Proceeds from maturities/payments of securities available for sale....................... 308,765 165,478
Purchases of securities available for sale............................................... (243,561) (229,090)
Proceeds from maturities/payments of securities held to maturity......................... 11,149 43,458
Purchases of securities held to maturity................................................. (121,561) (65,338)
Proceeds from sale of loans.............................................................. 54,025 177,450
Net increase in loans made to customers.................................................. (792,331) (320,492)
Proceeds from sale of fixed assets....................................................... 82 208
Proceeds from sale of mortgage servicing rights.......................................... 57,482 36,677
Additions to mortgage servicing rights................................................... (38,767) (27,205)
----------- -----------
Net cash used in investing activities.............................................. (341,218) (100,063)
----------- -----------
Cash Flows From Financing Activities:
Net (decrease) increase in deposits...................................................... (120,353) 348,545
Purchase of bank branch deposits......................................................... - 71,888
Net decrease in short-term borrowings.................................................... (51,313) (152,546)
Net increase (decrease) in short-term FHLB advances...................................... 427,000 (101,000)
Proceeds from long-term FHLB advances.................................................... 35,000 324,936
Payments on long-term FHLB advances...................................................... (229,660) (183,000)
Payments on long-term debt............................................................... (903) (1,413)
Net proceeds from issuance of common shares.............................................. 5,177 4,549
Repurchase of common shares.............................................................. (1,729) (1,040)
Dividends paid........................................................................... (8,205) (7,031)
----------- -----------
Net cash provided by financing activities 55,014 303,888
----------- -----------
Net increase in cash and cash equivalents................................................ 6,202 45,739
Cash and cash equivalents at beginning of period......................................... 47,712 50,165
----------- -----------
Cash and cash equivalents at end of period............................................... $ 53,914 $ 95,904
=========== ===========
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 nine months ended
September 30, include:
(In thousands) 1999 1998
---- ----
Cash paid during the period for:
Interest........................................ $123,917 $127,860
Income taxes.................................... $ 7,991 8,843
Non-cash investing activities:
Loan charge-offs................................ $ 6,420 $ 2,475
6
Note 4 - Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands, except per share data) 1999 1998 1999 1998
- ---------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted
earnings per share:
Net income................................... $ 12,455 $ 10,314 $ 4,102 $ 29,502
Denominator:
Denominator for basic earnings per share--
weighted-average shares.................... 41,144,693 40,372,559 40,994,871 40,170,037
Effect of dilutive securities:
Employee stock options................. 503,681 761,630 527,761 855,543
Warrants............................... 40,462 85,422 43,978 113,598
----------- ----------- ----------- -----------
Dilutive potential common shares.. 544,143 847,052 571,739 969,141
----------- ----------- ----------- -----------
Denominator for diluted earnings per share--
adjusted weighted-average shares for
assumed conversions........................... 41,688,836 41,219,611 41,566,610 41,139,178
=========== =========== =========== ===========
Basic earnings per share......................... $ .30 $ .26 $ .10 $ .73
=========== =========== =========== ===========
Diluted earnings per share....................... $ .30 $ .25 $ .10 $ .72
=========== =========== =========== ===========
Note 5 - Comprehensive Income
The following table sets forth the computation of comprehensive income:
Three Months Ended Nine Months Ended
(In thousands) September 30, 1999 September 30, 1999
- ------------------------------------------------------------------------------------------------
Net income ........................................ $ 12,455 $ 4,102
Unrealized holding losses on securities, net of tax $ (289) $ (7,576)
Less reclassification adjustment for gains/(losses)
included in net income, net of tax ........... 7 (3,854)
-------- --------
Net unrealized losses on securities, net of tax ... (296) (3,722)
-------- --------
Comprehensive income ......................... $ 12,159 $ 380
======== ========
7
Note 6 - 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.
The following table presents the financial results of each business segment for
the three months ended September 30, 1999 and 1998.
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial and
Retail Banking Mortgage Banking(1)(3) Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended, Three Months Ended, Three Months Ended,
Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
(In thousands) 1999 1998 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income $ 67,495 $ 61,307 $ 8,847 $11,149 $ 76,342 $ 72,456
Interest expense 35,304 34,274 7,233 10,138 42,537 44,412
-------- -------- -------- ------- -------- --------
Net interest income 32,191 27,033 1,614 1,011 33,805 28,044
Provision for loan losses 1,575 1,400 - - 1,575 1,400
Noninterest income 1,991 4,411 31,359 36,524 33,350 40,935
Noninterest expense 15,760 19,237 29,934 31,637 45,694 50,874
-------- -------- -------- ------- -------- --------
Income before taxes $ 16,847 $ 10,807 $ 3,039 $ 5,898 $ 19,886 $ 16,705
======== ======== ======== ======= ======== ========
Preferred stock dividend $ 681 $ 681 $ - $ - $ 681 $ 681
Income taxes $ 5,680 $ 3,608 $ 1,070 $ 2,102 $ 6,750 $ 5,710
Depreciation and amortization $ 775 $ 4,051 $ 2,807 $ 4,121 $ 3,582 $ 8,172
Capital expenditures $ 1,387 $ 4,554 $ 1,708 $ 679 $ 3,095 $ 5,233
Identifiable assets (in millions) $ 3,676 $ 3,243 $ 559 $ 827 $ 4,235 $ 4,070
Efficiency ratio 46.12% 63.78% 90.78% 84.29% 68.05% 75.15%
- -----------------------------------------------------------------------------------------------------------------------------------
The following table presents the financial results of each business segment for
the nine months ended September 30, 1999 and 1998.
- -----------------------------------------------------------------------------------------------------------------------------------
Commercial and
Retail Banking(2) Mortgage Banking(1)(2)(3) Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended, Nine Months Ended, Nine Months Ended,
Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
(In thousands) 1999 1998 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Interest income $190,014 $180,802 $ 28,379 $30,921 $218,393 $211,723
Interest expense 101,067 101,284 24,028 27,823 125,095 129,107
-------- -------- -------- ------- -------- --------
Net interest income 88,947 79,518 4,351 3,098 93,298 82,616
Provision for loan losses 4,675 5,200 - - 4,675 5,200
Noninterest income 8,716 10,328 105,614 99,202 114,330 109,530
Noninterest expense 48,641 50,939 99,279 88,655 147,920 139,594
-------- -------- -------- ------- -------- --------
Income before taxes $ 44,347 $ 33,707 $ 10,686 $13,645 $ 55,033 $ 47,352
======== ======== ======== ======= ======== ========
Preferred stock dividend $ 2,042 $ 2,042 $ - $ - $ 2,042 $ 2,042
Income taxes $ 15,050 $ 11,048 $ 3,639 $ 4,760 $ 18,689 $ 15,808
Depreciation and amortization $ 4,794 $ 8,738 $ 12,492 $13,646 $ 17,286 $ 22,384
Capital expenditures $ 4,095 $ 7,298 $ 4,107 $ 3,207 $ 8,202 $ 10,505
Identifiable assets (in millions) $ 3,676 $ 3,243 $ 559 $ 827 $ 4,235 $ 4,070
Efficiency ratio 50.31% 57.42% 90.28% 86.66% 71.58% 73.08%
- -----------------------------------------------------------------------------------------------------------------------------------
(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.
(3) In the third quarter of 1999, the mortgage banking segment was allocated $1,305,000 of noninterest income for forgone gains on
sale of mortgages due to the Company maintaining $230 million of its mortgage loan production in its portfolio rather than
selling the loans in the secondary market.
- -----------------------------------------------------------------------------------------------------------------------------------
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 and the
reserve balance remaining at September 30, 1999:
Reserve
Initial Amount Balance
(In thousands) Reserve Utilized at 9/30/99
- -------------------------------------------------------------------------------------
Type of Costs:
Severance and employee benefit accruals............ $10,446 $ 3,682 $ 6,764
Professional fees.................................. 5,133 4,887 246
Branch closings and real estate transactions....... 8,652 1,615 7,037
Systems............................................ 2,201 - 2,201
Other.............................................. 5,089 4,211 878
------- ------- -------
Total merger integration and restructuring costs.. $31,521 $14,395 $17,126
======= ======= =======
EARNINGS PERFORMANCE
The Company reported record net income for the third quarter of $12.5 million,
or $0.30 per diluted share, up 20% from $0.25 earned for the third quarter of
1998. Net income for the quarter generated annualized returns of 1.21% on
average assets and 19.44% on average equity. These compare with returns of
1.06% on average assets and 16.36% on average equity for the third quarter of
1998.
To better understand underlying trends and performance, net operating earnings
exclude the $22.0 million after tax merger integration and restructuring charges
related to the Company's merger with D&N Financial Corporation in the second
quarter of 1999, a $4.9 million after tax loss on the sale of low-yielding fixed
rate securities, and an additional $3.3 million after tax provision for loan
losses for the quarter ended June 30, 1999.
Net operating earnings for the nine months ended September 30, 1999 was $34.3
million, a 16% increase over the $29.5 million earned for the nine months ended
September 30, 1998. For the nine month period ended September 30, 1999, diluted
earnings per share were $0.83, an increase of 15% over the $0.72 earned in 1998.
Net operating earnings for the first nine months of 1999 generated annualized
return on average assets and return on average shareholders' equity of 1.14% and
17.31%, respectively.
Including the charges described above, the Company reported net income for the
nine months ended September 30, 1999 of $4.1 million.
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 $1.3 billion in single-family residential mortgage loans in
the third quarter of 1999, compared to $1.6 billion closed in the same period
last year. During the first nine months of 1999, mortgage loan closings were
$4.1 billion, compared to $4.8 billion for the comparable period in 1998. Retail
mortgage loan volumes during the first nine months of 1999 decreased due to a
rising interest rate environment which has resulted in a lower level of
refinance activity. Refinancings for the third quarter of 1999 represented
approximately 12% of total closings compared to 35% in the third quarter of
1998. During the nine months of 1999, refinancings represented approximately 24%
of total closings compared to 42% for the same period in 1998.
The following table summarizes the Company's income from mortgage banking
activities:
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------
Mortgage loan production income (1).......... $27,681 $35,652 $100,788 $97,294
Net mortgage loan servicing income (2)....... 2,373 254 3,521 1,290
Gains on bulk sales of servicing............. - 618 - 618
------- ------- -------- -------
Total mortgage banking income............. $30,054 $36,524 $104,309 $99,202
======= ======= ======== =======
(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 September 30, 1999, mortgage banking income decreased
$6.5 million, or 18%, to $30.1 million from $36.5 million a year earlier,
primarily as the result of a decrease in mortgage loan production revenue.
Mortgage loan production income decreased as a result of the 19% decrease in
mortgage loan closings discussed above. The decrease in mortgage loan production
income was partially offset by an increase in net mortgage loan servicing
income.
Net mortgage loan servicing income was $2.4 million for the quarter ended
September 30, 1999 compared to $254,000 for the third quarter of 1998. The
increase was primarily the result of a decrease in amortization expense.
Amortization of mortgage servicing rights totaled $2.2 million for the third
quarter of 1999 compared to $4.4 million for the third quarter of 1998. The
decrease in amortization was a result of the decline in residential mortgage
loan refinance activity in the third quarter of 1999 and a corresponding decline
in mortgage prepayments compared to the third quarter of 1998. Net mortgage
loan servicing income was offset slightly by a decrease in the average loans
serviced. Loans serviced for others averaged $3.5 billion for the third quarter
of 1999, a 12% decrease from $3.9 billion during the third quarter of 1998.
For the nine months ended September 30, 1999, mortgage banking income increased
$5.1 million, or 5%, 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 increased gains on the sale of mortgage loans
during the first nine months of 1999, compared to 1998 due to an improvement in
execution. The ratio of mortgage loan production revenue to mortgage loans sold
10
increased to 2.42% for the nine months ended September 30, 1999, compared to
2.05% for the same period in 1998. The increase in net mortgage loan servicing
income is primarily the result of decreased amortization of mortgage servicing
rights reflecting the increase in interest rates and related reduction of
refinance activity of the mortgage loan servicing portfolio during the nine
months of 1999 compared to 1998.
For the nine months ended September 30, 1999 and 1998, amortization of mortgage
servicing rights totaled $10.1 million and $11.6 million, respectively. The
Company evaluates its mortgage servicing rights for impairment on a quarterly
basis and as of September 30, 1999 the balance of the impairment reserve was
$2.4 million, a decrease of $87,000 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 nine months ended September 30, 1999 and
1998.
Net interest income, on a fully taxable equivalent (FTE) basis, was $33.8
million for the third quarter of 1999, an increase of $5.8 million, or 21%, over
the third quarter of 1998. This increase was primarily the result of a $660.9
million, or 27%, increase in average portfolio loans during the third quarter of
1999 compared to 1998, which reflects a $200.2 million, or 35% increase in
average commercial loans, a $375.3 million, or 29% increase in residential
mortgage loans and a $85.4 million, or 14% increase in installment loans.
Partially funding the growth in portfolio loans was a reduction in the average
balance of investment securities and mortgage loans held for sale. 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. The proceeds from the sale were redeployed into higher yielding
residential mortgage loans. The Company's cost of funds on interest bearing
deposits decreased 57 basis points, contributing to the growth in net interest
income during the third quarter of 1999 compared to 1998.
The net interest margin (FTE) was 3.40% for the quarter ended September 30,
1999, an increase of 37 basis points from 3.03% in 1998. The increase in the
margin was due to an improved mix of earning assets from low-yielding fixed rate
investment securities toward higher-yielding commercial, residential mortgage
and installment loans, and a reduction in the Company's cost of funds.
For the nine months ended September 30, 1999, net interest income (FTE) was
$93.4 million, an increase of $10.7 million, or 13%, over the first nine months
of 1998. The net interest margin (FTE) for the nine months ended September 30,
1999, rose 19 basis points to 3.24% from 3.05% for the comparable period in
1998. The increase in the net interest margin was due to the improved mix of
earning assets and a reduction in the Company's cost of funds.
11
Table I - Quarterly Net Interest Income and Rate/Volume Analysis (FTE)
Three Months Ended Three Months Ended
September 30, 1999 September 30, 1998
- ---------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(Dollar amounts in thousands) Balance Interest Rate Balance Interest Rate
- ---------------------------------------------------------------------------------------------------------------------------------
Average Assets:
Short-term investments......................... $ 2,221 $ 28 5.00% $ 28,190 $ 294 4.14%
Mortgage loans held for sale................... 459,526 8,524 7.36 602,833 11,076 7.29
Investment securities.......................... 372,264 6,315 6.79 596,389 9,875 6.62
Portfolio loans(1):
Commercial loans............................ 773,239 16,696 8.57 573,015 13,262 9.18
Real estate mortgage loans.................. 1,679,195 29,784 7.09 1,303,901 24,434 7.50
Installment loans........................... 688,253 15,013 8.65 602,876 13,533 8.91
---------- -------- ----- ---------- ------- -----
Total loans, net of earned income........ 3,140,687 61,493 7.80 2,479,792 51,229 8.23
---------- -------- ----- ---------- ------- -----
Total interest-earning assets............ 3,974,698 76,360 7.65 3,707,204 72,474 7.79
Allowance for loan losses...................... (25,091) (20,759)
Cash and due from banks........................ 45,306 39,286
Other assets................................... 118,642 176,549
---------- ----------
Total assets............................. $4,113,555 $3,902,280
========== ==========
Average Liabilities and Shareholders' Equity:
Interest-bearing demand deposits............... $ 95,188 441 1.84 $ 95,183 438 1.83
Savings deposits............................... 784,145 5,728 2.90 748,813 6,815 3.61
Time deposits.................................. 1,433,856 19,188 5.31 1,467,742 21,426 5.79
---------- -------- ----- ---------- ------- -----
Total interest-bearing deposits............. 2,313,189 25,357 4.35 2,311,738 28,679 4.92
Short-term borrowings.......................... 56,728 744 5.20 113,877 1,634 5.70
FHLB advances.................................. 1,117,085 15,506 5.51 890,172 13,104 5.84
Long-term debt................................. 51,468 930 7.23 53,016 995 7.51
---------- -------- ----- ---------- ------- -----
Total interest-bearing liabilities....... 3,538,470 42,537 4.77 3,368,803 44,412 5.23
-------- ----- ------- -----
Noninterest-bearing deposits................... 183,951 159,044
Other liabilities.............................. 106,244 93,598
---------- ----------
Total liabilities........................ 3,828,665 3,621,445
Preferred stock of subsidiary.................. 28,719 28,719
Shareholders' equity........................... 256,171 252,116
---------- ----------
Total liabilities and
shareholders' equity................... $4,113,555 $3,902,280
========== ==========
Net interest income/rate spread (FTE).......... $33,823 2.88% $28,062 2.56%
======= ===== ======= ====
Net interest margin (FTE)...................... 3.40% 3.03%
===== ====
Increase (decrease) due to change in: Volume(2) Rate(2) Net Change
----------------------------------------------------------------------------------------------------------------
Short-term investments.................. $ (316) $ 50 $ (266)
Mortgage loans held for sale............ (2,655) 103 (2,552)
Investment securities................... (3,806) 246 (3,560)
Portfolio loans(1):
Commercial loans..................... 4,354 (920) 3,434
Real estate mortgage loans........... 6,742 (1,392) 5,350
Installment loans.................... 1,877 (397) 1,480
---------- ------- ----------
Total loans, net of unearned
income......................... 12,973 (2,709) 10,264
---------- ------- ----------
Total interest income............. 6,196 (2,310) 3,886
Interest-bearing demand deposits........ - 3 3
Savings deposits........................ 304 (1,391) (1,087)
Time deposits........................... (487) (1,751) (2,238)
---------- ------- ----------
Total interest-bearing deposits....... (183) (3,139) (3,322)
Short-term borrowings................... (758) (132) (890)
FHLB advances........................... 3,168 (766) 2,402
Long-term debt.......................... (29) (36) (65)
---------- ------- ----------
Total interest expense........... 2,198 (4,073) (1,875)
---------- ------- ----------
Net interest income.............. $ 3,998 $ 1,763 $ 5,761
========== ======= =======
(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)
Nine Months Ended Nine Months Ended
September 30, 1999 September 30, 1998
- --------------------------------------------------------------------------------------------------------------------
Average Average Average Average
(Dollar amounts in thousands) Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------
Average Assets:
Short-term investments......................... $ 19,858 $ 631 4.25% $ 14,745 $ 517 4.69%
Mortgage loans held for sale................... 523,327 28,078 7.17 558,307 30,768 7.37
Investment securities.......................... 532,444 25,892 6.48 551,980 27,700 6.69
Portfolio loans(1):
Commercial loans............................ 703,793 45,289 8.60 534,900 37,171 9.29
Real estate mortgage loans.................. 1,414,839 76,575 7.22 1,374,205 76,733 7.45
Installment loans........................... 651,537 41,982 8.61 581,188 38,889 8.95
---------- -------- ---- ---------- -------- ----
Total loans, net of unearned income...... 2,770,169 163,846 7.90 2,490,293 152,793 8.19
---------- -------- ---- ---------- -------- ----
Total interest-earning assets............ 3,845,798 218,447 7.58 3,615,325 211,778 7.82
Allowance for loan losses...................... (23,138) (19,543)
Cash and due from banks........................ 40,508 34,557
Other assets................................... 158,134 178,844
---------- ----------
Total assets............................. $4,021,302 $3,809,183
========== ==========
Average Liabilities and Shareholders' Equity:
Interest-bearing demand deposits............... $ 98,115 1,287 1.75 $ 92,861 1,210 1.74
Savings deposits............................... 788,680 17,198 2.92 708,962 18,888 3.56
Time deposits.................................. 1,508,219 60,960 5.40 1,398,303 60,972 5.83
---------- -------- ---- ---------- -------- ----
Total interest-bearing deposits............... 2,395,014 79,445 4.43 2,200,126 81,070 4.93
Short-term borrowings.......................... 66,591 2,638 5.30 151,476 6,465 5.68
FHLB advances.................................. 954,820 40,158 5.62 883,792 38,564 5.83
Long-term debt................................. 52,949 2,854 7.19 54,135 3,008 7.49
---------- -------- ---- ---------- -------- ----
Total interest-bearing liabilities....... 3,469,374 125,095 4.82 3,289,529 129,107 5.25
---------- -------- ---- ---------- -------- ----
Noninterest-bearing deposits................... 178,735 151,077
Other liabilities.............................. 80,261 97,055
---------- ----------
Total liabilities........................ 3,728,370 3,537,661
Preferred stock of subsidiary.................. 28,719 28,719
Shareholders' equity........................... 264,213 242,803
---------- ----------
Total liabilities and
shareholders' equity.................. $4,021,302 $3,809,183
========== ==========
Net interest income/Rate spread (FTE).......... $ 93,352 2.76% $ 82,671 2.57%
======== ==== ======== ====
Net interest margin............................ 3.24% 3.05%
===== ====
Increase (decrease) due to change in: Volume(2) Rate(2) Net Change
----------------------------------------------------------------------------------------------------
Short-term investments.................... $ 167 $ (53) $ 114
Mortgage loans held for sale.............. (1,877) (813) (2,690)
Investment securities..................... (958) (850) (1,808)
Portfolio loans(1):
Commercial loans....................... 11,054 (2,936) 8,118
Real estate mortgage loans............. 2,242 (2,400) (158)
Installment loans...................... 4,610 (1,517) 3,093
------- -------- -------
Total loans, net of
unearned income.................. 17,906 (6,853) 11,053
------- -------- -------
Total interest income............... 15,237 (8,568) 6,669
Interest-bearing demand deposits.......... 70 7 77
Savings deposits.......................... 1,968 (3,658) (1,690)
Time deposits............................. 4,647 (4,659) (12)
------- -------- -------
Total interest-bearing deposits.......... 6,685 (8,310) (1,625)
Short-term borrowings..................... (3,392) (435) (3,827)
FHLB advances............................. 3,023 (1,429) 1,594
Long-term debt............................ (66) (88) (154)
------- -------- -------
Total interest expense.............. 6,251 (10,263) (4,012)
------- -------- -------
Net interest income................. $ 8,986 $ 1,695 $10,681
======= ======== =======
(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 months ended September 30, 1999 decreased $5.2
million, or 10%, compared to the same quarter of 1998, primarily reflecting the
decrease in mortgage loan origination volume. Noninterest expense for the nine
months ended September 30, 1999 includes a one-time merger integration and
restructuring charge of $31.5 million related to the merger with D&N Financial
Corporation recorded in the second quarter of 1999. Excluding this charge,
noninterest expense for the nine months ended September 30, 1999 increased $8.3
million, or 6%, to $147.9 million from $139.6 million a year earlier. The rise
in noninterest expense, in part, reflects an increase in salaries and employee
benefits expense attributed to an 11% increase in the number of employees at
September 30, 1999 compared to September 30, 1998. The opening of 26 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 September 30, 1999, the Company had $4.23 billion in total assets, a slight
increase from $4.21 billion at December 31, 1998. The increase is primarily the
result of the increase in portfolio loans which was partially offset by
decreases in investment securities and mortgage loans held for sale described
below.
Securities
Total investment securities declined $393 million, or 59%, from December 31,
1998 to $278.6 million, and represented 6.6% of total assets at September 30,
1999. During the second quarter of 1999, $33.7 million in 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. In
order to reduce interest rate risk, in June 1999, the Company sold $304.5
million of low-yielding fixed rate investment securities. The proceeds from the
sale were redeployed into higher yielding residential mortgage loans. For the
quarter ended September 30, 1999, gross realized gains and losses on sales of
available-for-sale securities were $1,286,000 and $1,276,000, respectively. For
the first nine months of 1999, gross realized gains and losses totaled
$2,445,000 and $9,023,000, 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.
14
The following table details the composition, amortized cost and fair value of
the Company's investment securities portfolio at September 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....... $ 60,837 $ - $ 524 $ 60,313
Collateralized mortgage obligations..... 105,931 - 2,559 103,372
Mortgage-backed securities 40,043 304 703 39,644
Municipal and other securities.......... 3,103 50 5 3,148
-------- ---- ------ --------
Total Debt Securities.................. 209,914 354 3,791 206,477
Equity securities........................ 72,072 5 - 72,077
-------- ---- ------ --------
Total Securities Available for Sale...... $281,986 $359 $3,791 $278,554
======== ==== ====== ========
Certain securities having a carrying value of approximately $30.6 million and
$117.9 million at September 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 $440.5 million at September 30, 1999 compared
to $770 million at December 31, 1998. This decrease was caused by the $574
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
residential real estate mortgage loan portfolio.
Portfolio Loans
Total portfolio loans were $3.29 billion at September 30, 1999, an increase of
$744.3 million, or 29%, 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 $476.9 million, or 37%, since year-end 1998 to $1.77 billion at
September 30, 1999. The increase in residential mortgage loans reflects the
Company maintaining a higher percentage of residential loan closings in its
portfolio. The installment loan portfolio increased $87.6 million, or 14%,
since year-end 1998 to $703.2 million at September 30, 1999.
The commercial loan balance increased $179.8 million during the nine months of
1999, for an annualized growth rate of 38%, reflecting continued strong demand
for real estate-secured lending in markets served by the Company. During the
third quarter of 1999, the Company closed $16 million in Small Business
Administration (SBA) loans, a 37% increase from the third quarter of 1998. For
the nine months ended September 30, 1999 and 1998, SBA loan closings were $36
million and $27 million, respectively. The Company sold $7.1 million and $24.9
million of the guaranteed portion of SBA loans in the first nine months of 1999
and 1998, respectively, resulting in corresponding gains of $492,000 and
$1,855,000, respectively.
15
The following table provides further information regarding the Company's loan
portfolio:
September 30, 1999 December 31, 1998
--------------------- ---------------------
(Dollars in thousands) Amount Percent Amount Percent
- ----------------------------------- ----------- -------- ----------- --------
Commercial loans:
Commercial and industrial......... $ 89,597 2.7% $ 83,105 3.3%
Commercial real estate mortgage... 722,885 22.0 549,586 21.6
---------- ----- ---------- -----
Total commercial loans.......... 812,482 24.7 632,691 24.9
Residential real estate mortgages.. 1,772,385 53.9 1,295,484 50.9
Installment loans.................. 703,221 21.4 615,597 24.2
---------- ----- ---------- -----
Total portfolio loans........... $3,288,088 100.0% $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 September 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:
September 30, December 31,
(Dollars in thousands) 1999 1998
- ---------------------------------------------------------- -------------- -------------
Non-Performing Assets:
Non-accrual loans:
Commercial.............................................. $ 5,533 $ 6,141
Residential real estate mortgages....................... 10,953 12,011
Installment............................................. 3,158 1,826
------- -------
Total non-accrual loans................................ 19,644 19,978
Restructured loans....................................... - -
------- -------
Total non-performing loans............................. 19,644 19,978
Other real estate owned.................................. 3,755 5,648
------- -------
Total non-performing assets............................ $23,399 $25,626
======= =======
Non-performing assets as a percentage of:
Portfolio loans and OREO ............................... .71% 1.01%
Portfolio loans, mortgage loans held for
sale and OREO....................................... .63% .77%
Total assets............................................ .55% .61%
Loans past due 90 days or more and still
accruing interest:
Commercial............................................... $ - $ 112
Residential real estate.................................. - -
Installment.............................................. 2 -
------- -------
Total loans past due 90 days or more................... $ 2 $ 112
======= =======
At September 30, 1999, approximately $23.5 million, or .72% 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 $6.4 million for the nine
months ended September 30, 1999 compared to $2.5 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 $9.7 million for the
first nine months of 1999 compared to $5.2 million in 1998.
The following table provides an analysis of the allowance for loan losses:
Nine Months Ended
September 30,
------------------
(Dollars in thousands) 1999 1998
------- -------
Allowance for loan losses:
Balance at January 1................................................... $21,446 $17,883
Loans charged off..................................................... (6,420) (2,475)
Recoveries of loans previously charged off............................ 1,167 412
------- -------
Net charge-offs...................................................... (5,253) (2,063)
Provision charged to expense.......................................... 9,675 5,200
------- -------
Balance at September 30................................................ $25,868 $21,020
======= =======
Annualized net charge-offs as a percentage of average portfolio loans
(including loans held for sale)...................................... .21% .09%
Allowance for loan losses as a percentage of total portfolio loans
outstanding at period-end............................................ .79 .86
Allowance for loan losses as a percentage of non-performing
loans................................................................ 131.68 96.55
Off-Balance Sheet Instruments
Unused commitments to extend credit totaled $741.8 million for residential real
estate loans and $281.9 million for commercial real estate loans at September
30, 1999.
At September 30, 1999, the Company had outstanding $379 million of commitments
to fund residential real estate loan applications with agreed-upon rates,
including $78.9 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 September 30, 1999, the Company had outstanding mandatory forward commitments
to sell $626.7 million of residential mortgage loans, of which $362.1 million
covered mortgage loans held for sale and $264.6 million
18
covered commitments to fund residential real estate loan applications with
agreed-upon rates. These outstanding forward commitments to sell mortgage loans
are expected to settle in the fourth quarter of 1999 without producing any
material gains or losses. At September 30, 1999, the mortgage loans held for
sale balance included $78.4 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 $56.2 million, or 72%, of
these loans were loans that had been committed for bulk sale to third parties
prior to September 30, 1999 or were floating rate residential loans.
LIABILITIES.
Total liabilities were $3.94 billion, a slight increase from $3.92 billion at
December 31, 1998. This increase was primarily due to an increase in short-term
FHLB advances that was partially offset by decreases in deposits and long-term
FHLB advances.
Deposits
Total deposits decreased $120.4 million, or 5%, to $2.52 billion at September
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 nine months ended September
30, 1999 and the year ended December 31, 1998, were as follows:
September 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........... $42,000 $39,742 5.27% $73,285 $ 35,717 5.59%
Securities sold under agreements
to repurchase.................... - 25,002 5.31 18,153 85,499 5.58
Other short-term borrowings....... 3,625 1,847 5.20 5,500 3,077 5.03
------- ------- ---- ------- -------- ----
Total short-term borrowings...... $45,625 $66,591 5.30% $96,938 $124,293 5.57%
======= ======= ==== ======= ======== ====
At September 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 September 30, 1999 and December 31, 1998, were as
follows:
September 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.................................... $ 635,000 5.35% $208,000 5.74%,
Long-term FHLB advances...................................... 583,911 5.60 778,571 6.09
---------- ---- -------- ----
Total...................................................... $1,218,911 5.48% $986,571 5.83%
========== ==== ======== ====
The long-term FHLB advances have original maturities ranging from November 1999
to July 2008.
19
Long-Term Debt
Obligations with original maturities of more than one year consisted of the
following:
September 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............ 3,791 4,694
------- -------
Total long-term debt $51,291 $52,194
======= =======
CAPITAL
Shareholders' equity was $260.6 million at September 30, 1999, a $5.3 million,
or 2%, decrease from $265.9 million at December 31, 1998. This decrease
primarily resulted from the reduction of retained earnings by the declaration of
$10 million in dividends which was partially offset by $4.1 million of net
income for the nine months ended September 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 September 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:
September 30, December 31,
1999 1998
------------- ------------
Total capital to risk-weighted assets (1)... 10.13% 10.55%
Tier 1 capital to risk-weighted assets (1).. 9.26 9.80
Tier 1 capital to average assets (1)........ 6.75 6.54
(1) As defined by the regulations.
As of September 30, 1999, the Company's total risk-based capital was $302.5
million and Tier 1 risk-based capital was $276.6 million, an excess of $3.8
million and $97.4 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 September 30,
1999, the Company's cumulative one-year gap was a negative 10% 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 September 30, 1999, the earnings simulation model projects net interest
income would decrease by 11.9% of base net interest income, assuming an
immediate parallel shift upward in market interest rates by 200 basis points.
If market interest rates fall by 200 basis points, the model projects net
interest income would increase by 10.7%. 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.
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.
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. All third party vendors with a direct
interface to the Company's computer 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
22
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 89% of the Company's commercial loan portfolio being secured by real estate.
The Company has prepared 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 has also enhanced 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.
As part of the business resumption plan, the Company has developed an Event
Management Plan, including an Evaluation and Recovery Team to monitor, assess
and report on the operational status of all of its affilitates during the Year
2000 date changes. This plan provides a structure to ensure that appropriate
information is provided to management in a timely fashion.
The Company has developed a communications plan to inform its customers of
its Year 2000 readiness. This plan has included statement stuffers to bank
customers, branch information packets, web site and voice response unit
updates and participation in community forums.
The total Year 2000 project cost for the Company is estimated at $800,000 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 $725,000 ($245,000
expensed and $480,000 capitalized for new systems hardware and software). The
remaining $75,000 relates principally to incremental salaries and wages,
communications to customers and training and is not expected to have a material
effect on the Company's results of operations, liquidity or capital resources.
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 the 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.
23
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.
24
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 August 19, 1999, the Board of Directors declared a quarterly cash
dividend of $0.09 per share of common stock, payable on October 8, 1999
to shareholders of record September 3, 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/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.
25
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: November 15, 1999 BY: /s/ Thomas F. Menacher
----------------------
Thomas F. Menacher
Executive Vice President,
Treasurer and Chief
Financial Officer
(Principal Financial and
Accounting Officer)
26
EXHIBIT INDEX
Sequential
Exhibit Number Exhibit Page Number
-------------- ------- -----------
27 Financial Data Schedule 27
27