1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000 Commission file number 0-7818 --------- INDEPENDENT BANK CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Michigan 38-2032782 - ------------------------------------- ------------------------------------------ (State or jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) Number) 230 West Main Street, P.O. Box 491, Ionia, Michigan 48846 - -------------------------------------------------------------------------------- (Address of principal executive offices) (616) 527-9450 -------------- (Registrant's telephone number, including area code) NONE - -------------------------------------------------------------------------------- Former name, address and fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at May 12, 2000 - ------------------------------------- ------------------------------------------ Common stock, par value $1 11,237,505
2 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES INDEX <TABLE> <CAPTION> Page Number(s) --------- PART I - Financial Information --------------------- <S> <C> <C> Item 1. Consolidated Statements of Financial Condition March 31, 2000 and December 31, 1999 2 Consolidated Statements of Operations Three-month periods ended March 31, 2000 and 1999 3 Consolidated Statements of Cash Flows Three-month periods ended March 31, 2000 and 1999 4 Consolidated Statements of Shareholders' Equity Three-month periods ended March 31, 2000 and 1999 5 Notes to Interim Consolidated Financial Statements Three-month periods ended March 31, 2000 and 1999 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-17 Item 3. Quantitative and Qualitative Disclosures about Market Risk 18 PART II - Other Information Item 6. Exhibits & Reports on Form 8-K 19 </TABLE>
3 Part I. INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition <TABLE> <CAPTION> March 31, December 31, 2000 1999 ---------------- ---------------- Assets (unaudited) ---------------- ---------------- <S> <C> <C> Cash and due from banks $ 45,655,000 $ 58,646,000 Securities available for sale 205,450,000 195,300,000 Securities held to maturity (Fair value of $65,585,000 at March 31, 2000; $70,486,000 at December 31, 1999) 67,211,000 71,115,000 Federal Home Loan Bank stock, at cost 19,612,000 19,612,000 Loans held for sale 12,991,000 12,950,000 Loans Commercial and agricultural 353,524,000 334,212,000 Real estate mortgage 757,545,000 757,019,000 Installment 200,804,000 199,410,000 ---------------- ---------------- Total Loans 1,311,873,000 1,290,641,000 Allowance for loan losses (13,277,000) (12,985,000) ---------------- ---------------- Net Loans 1,298,596,000 1,277,656,000 Property and equipment, net 36,732,000 37,582,000 Accrued income and other assets 52,765,000 52,344,000 ---------------- ---------------- Total Assets $ 1,739,012,000 $ 1,725,205,000 ================ ================ Liabilities and Shareholders' Equity Deposits Non-interest bearing $ 127,309,000 $ 135,868,000 Savings and NOW 588,992,000 567,108,000 Time 632,688,000 607,626,000 ---------------- ---------------- Total Deposits 1,348,989,000 1,310,602,000 Federal funds purchased 31,449,000 42,350,000 Other borrowings 204,655,000 224,570,000 Guaranteed preferred beneficial interests in Company's subordinated debentures 17,250,000 17,250,000 Accrued expenses and other liabilities 20,161,000 16,687,000 ---------------- ---------------- Total Liabilities 1,622,504,000 1,611,459,000 ---------------- ---------------- Shareholders' Equity Preferred stock, no par value--200,000 shares authorized; none outstanding Common stock, $1.00 par value--14,000,000 shares authorized; issued and outstanding: 11,221,723 shares at March 31, 2000 and 11,235,088 shares at December 31, 1999 11,222,000 11,235,000 Capital surplus 71,216,000 71,672,000 Retained earnings 36,721,000 33,921,000 Accumulated other comprehensive loss (1,852,000) (2,283,000) Unearned employee stock ownership plan shares (799,000) (799,000) ---------------- ---------------- Total Shareholders' Equity 116,508,000 113,746,000 ---------------- ---------------- Total Liabilities and Shareholders' Equity $ 1,739,012,000 $ 1,725,205,000 ================ ================ </TABLE> See notes to interim consolidated financial statements. 2
4 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations <TABLE> <CAPTION> Three Months Ended March 31, 2000 1999 -------------- ------------ (unaudited) --------------------------- <S> <C> <C> Interest Income Interest and fees on loans $ 28,486,000 $ 25,934,000 Securities Taxable 2,465,000 3,605,000 Tax-exempt 1,663,000 823,000 Other investments 391,000 417,000 ------------ ----------- Total Interest Income 33,005,000 30,779,000 ------------ ----------- Interest Expense Deposits 11,741,000 10,776,000 Other borrowings 4,106,000 3,827,000 ------------ ----------- Total Interest Expense 15,847,000 14,603,000 ------------ ----------- Net Interest Income 17,158,000 16,176,000 Provision for loan losses 557,000 666,000 ------------ ----------- Net Interest Income After Provision for Loan Losses 16,601,000 15,510,000 ------------ ----------- Non-interest Income Service charges on deposit accounts 1,501,000 1,207,000 Net gains (losses) on asset sales Real estate mortgage loans 380,000 1,531,000 Securities (16,000) 14,000 Other income 2,279,000 1,995,000 ------------ ----------- Total Non-interest Income 4,144,000 4,747,000 ------------ ----------- Non-interest Expense Salaries and employee benefits 8,392,000 8,445,000 Occupancy, net 1,178,000 1,150,000 Furniture and fixtures 1,141,000 968,000 Other expenses 4,000,000 5,027,000 ------------ ----------- Total Non-interest Expense 14,711,000 15,590,000 ------------ ----------- Income Before Federal Income Tax 6,034,000 4,667,000 Federal income tax expense 1,548,000 1,396,000 ============ =========== Net Income $ 4,486,000 $ 3,271,000 ============ =========== Net income per common share Basic $ .40 $ .29 Diluted .40 .28 Dividends Per Common Share Declared $ .15 $ .09 Paid .14 .09 </TABLE> See notes to interim consolidated financial statements. 3
5 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows <TABLE> <CAPTION> Three months ended March 31, 2000 1999 --------------- --------------- (unaudited) ------------------------------- Net Income $ 4,486,000 $ 3,271,000 --------------- ------------- <S> <C> <C> Adjustments to Reconcile Net Income to Net Cash from Operating Activities Proceeds from sales of loans held for sale 28,155,000 98,378,000 Disbursements for loans held for sale (27,816,000) (85,649,000) Provision for loan losses 557,000 666,000 Deferred loan fees 122,000 (14,000) Amortization of intangible assets 432,000 442,000 Depreciation and amortization of premiums and accretion of discounts on securities and loans 1,173,000 822,000 Net gains on sales of real estate mortgage loans (380,000) (1,531,000) Net (gains) losses on sales of securities 16,000 (14,000) Increase in accrued income and other assets (853,000) (1,987,000) Increase in accrued expenses and other liabilities 3,182,000 904,000 --------------- ------------- Total Adjustments 4,588,000 12,017,000 --------------- ------------- Net Cash from Operating Activities 9,074,000 15,288,000 --------------- ------------- Cash Flow from Investing Activities Proceeds from the sale of securities available for sale 4,933,000 267,000 Proceeds from the maturity of securities available for sale 345,000 7,000,000 Proceeds from the maturity of securities held to maturity 1,010,000 149,868,000 Principal payments received on securities available for sale 2,968,000 4,398,000 Principal payments received on securities held to maturity 4,269,000 306,000 Purchases of securities available for sale (19,242,000) (6,719,000) Purchases of securities held to maturity (128,649,000) Principal payments on portfolio loans purchased 905,000 3,995,000 Portfolio loans made to customers, net of principal payments received (22,524,000) (21,771,000) Capital expenditures (215,000) (2,272,000) --------------- ------------- Net Cash from Investing Activities (27,551,000) 6,423,000 --------------- ------------- Cash Flow from Financing Activities Net increase (decrease) in total deposits 38,387,000 (10,052,000) Net decrease in short-term borrowings (29,755,000) (7,191,000) Proceeds from Federal Home Loan Bank advances 147,770,000 Payments of Federal Home Loan Bank advances (148,331,000) (11,000,000) Retirement of long-term debt (500,000) (500,000) Dividends paid (1,572,000) (960,000) Proceeds from issuance of common stock 293,000 194,000 Repurchase of common stock (806,000) --------------- ------------- Net Cash from Financing Activities 5,486,000 (29,509,000) --------------- ------------- Net Decrease in Cash and Cash Equivalents (12,991,000) (7,798,000) Cash and Cash Equivalents at Beginning of Period 58,646,000 57,610,000 --------------- ------------- Cash and Cash Equivalents at End of Period $ 45,655,000 $ 49,812,000 =============== ============= Cash paid during the period for interest $ 16,144,000 $ 14,587,000 Transfer of loans to other real estate 1,534,000 827,000 </TABLE> See notes to interim consolidated financial statements 4
6 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity <TABLE> <CAPTION> Three months ended March 31, 2000 1999 -------------- ------------ (unaudited) ---------------------------- <S> <C> <C> Balance at beginning of period $ 113,746,000 $ 117,042,000 Net income 4,486,000 3,271,000 Cash dividends declared (1,684,000) (1,040,000) Issuance of common stock 335,000 850,000 Repurchase of common stock (806,000) ESOP valuation adjustment (16,000) Net change in unrealized loss on securities available for sale, net of related tax effect (note 4) 431,000 (545,000) --------------- -------------- Balance at end of period $ 116,508,000 $ 119,562,000 =============== ============== </TABLE> See notes to interim consolidated financial statements. 5
7 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. In the opinion of management of the Registrant, the accompanying unaudited consolidated financial statements contain all the adjustments (consisting only of normal recurring accruals) necessary to present fairly the consolidated financial condition of the Registrant as of March 31, 2000 and December 31, 1999, and the results of operations for the three-month periods ended March 31, 2000 and 1999. 2. In determining the allowance and the related provision for loan losses, Management considers four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated loans, (iii) allocations based principally on historical loan loss experience and (iv) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios. Loans on non-accrual status, past due more than 90 days, or restructured amounted to $5,435,000 at March 31, 2000, and $5,279,000 at December 31, 1999. (See Management's Discussion and Analysis of Financial Condition and Results of Operations). 3. The provision for income taxes represents federal income tax expense calculated using annualized rates on taxable income generated during the respective periods. 4. The Registrant adopted Statement of Financial Accounting Standards, No. 130, "Reporting Comprehensive Income", (SFAS #130) effective January 1, 1998. SFAS #130 establishes standards for reporting and displaying comprehensive income and its components, including but not limited to unrealized gains and losses on securities available for sale. Comprehensive income for the three-month periods ending March 31 follows: <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ------------- ------------ <S> <C> <C> Net income $ 4,486,000 $ 3,271,000 Net change in unrealized loss on securities available for sale, net of related tax effect 431,000 (585,000) ------------ ------------ Comprehensive income $ 4,917,000 $ 2,686,000 ============ ============ </TABLE> 5. The Registrant's reportable segments are based upon legal entities. The Registrant has five reportable segments: Independent Bank ("IB"), Independent Bank West Michigan ("IBWM"), Independent Bank South Michigan ("IBSM"), Independent Bank East Michigan ("IBEM") and Independent Bank MSB ("IBMSB"). The Registrant evaluates performance based principally on net income of the respective reportable segments. 6
8 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) A summary of selected financial information for the Registrant's reportable segments at March 31, follows: <TABLE> <CAPTION> IB IBWM IBSM IBEM IBMSB OTHER(1) TOTAL -------------------------------------------------------------------------------------------- (in thousands) <S> <C> <C> <C> <C> <C> <C> <C> 2000 Total assets $ 421,335 $ 329,536 $ 201,223 $ 306,848 $ 471,525 $ 8,545 $ 1,739,012 Interest income 8,091 7,037 3,934 5,601 8,340 2 33,005 Net interest income 4,725 4,159 2,224 3,276 3,395 (621) 17,158 Provision for loan losses 150 135 60 120 92 557 Income (loss) before Income tax 1,978 1,663 884 1,169 1,476 (1,136) 6,034 Net income (loss) 1,415 1,157 683 920 1,106 (795) 4,486 1999 Total assets $ 358,112 $ 268,308 $ 161,955 $ 260,757 $ 580,314 $ 5,174 $ 1,634,620 Interest income 7,217 6,207 3,357 4,861 9,132 5 30,779 Net interest income 4,466 3,875 2,068 3,022 3,307 (562) 16,176 Provision for loan losses 150 135 90 150 141 666 Income (loss) before Income tax 1,667 1,436 793 905 778 (912) 4,667 Net income (loss) 1,150 989 577 680 506 (631) 3,271 </TABLE> (1) Includes items relating to the Registrant and certain insignificant operations. 6. A reconciliation of basic and diluted earnings per share for the three-month periods ending, March 31 follows: <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ------------- ------------- <S> <C> <C> Net income $ 4,486,000 $ 3,271,000 ============= ============= Shares outstanding (Basic) (1) 11,191,000 11,350,000 Effect of dilutive securities - stock options 81,000 140,000 ------------- ------------- Shares outstanding (Diluted) 11,272,000 11,490,000 ============= ============= Earnings per share Basic $ .40 $ .29 Diluted .40 .28 </TABLE> (1) Shares outstanding have been adjusted for a 5% stock dividend in 1999 7
9 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) 7. The Financial Accounting Standards Board adopted Statement of Financial Accounting Standards, No. 133, "Accounting for Derivative Instruments and Hedging Activities", ("SFAS #133") in June 1998. SFAS #133, which has been subsequently amended by SFAS #137, requires companies to record derivatives on the balance sheet as assets and liabilities measured at fair value. The accounting for increases and decreases in the value of those derivatives will depend upon the use of those derivatives and whether or not they qualify for hedge accounting. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000 with earlier application allowed and is to be applied prospectively. The adoption of this statement is not expected to have a material impact on the Registrant's financial statements. 8. Prior period financial information has been restated to reflect the acquisition of Mutual Savings Bank, f.s.b., ("MSB") completed September 15, 1999, which has been accounted for as a pooling of interests. 9. The results of operations for the three-month period ended March 31, 2000, are not necessarily indicative of the results to be expected for the full year. 8
10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis of financial condition and results of operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in such forward-looking statements. The following section presents additional information that may be necessary to assess the financial condition and results of operations of the Registrant and its subsidiary banks (the "Banks"). This section should be read in conjunction with the consolidated financial statements contained elsewhere in this report as well as the Registrant's 1999 Annual Report on Form 10-K. FINANCIAL CONDITION SUMMARY Loans, excluding loans held for sale ("Portfolio Loans"), increased to $1.312 billion at March 31, 2000, from $1.291 billion at December 31, 1999. Commercial and agricultural loans grew by $19.3 million to $353.5 million and account for substantially all of the $21.2 million increase in Portfolio Loans. (See "Portfolio loans and asset quality.") Deposits grew to $1.349 billion at March 31, 2000, from $1.311 billion at December 31, 1999. Savings and NOW accounts grew by $21.9 million during the three-month period and account for approximately 57% of the $38.4 million increase in total deposits. The $25.1 million increase in time deposits reflects the Banks' use of brokered certificates of deposits. (See "Deposits and borrowings.") SECURITIES The Banks maintain diversified securities portfolios, which include obligations of the U.S. Treasury and government-sponsored agencies as well as securities issued by states and political subdivisions, corporate securities and mortgage-backed securities. Management continually evaluates the Banks' asset/liability management needs and attempts to maintain a portfolio structure that provides sufficient liquidity and cash flow. (See "Asset/liability management.") SECURITIES <TABLE> <CAPTION> Unrealized ---------------------------- Amortized Fair Cost Gains Losses Value -------------- -------------- ------------- ------------- <S> <C> <C> <C> <C> (in thousands) Securities available for sale March 31, 2000 $208,256 $ 898 $3,704 $205,450 December 31, 1999 198,764 1,234 4,698 195,300 Securities held to maturity March 31, 2000 $ 67,211 $ 192 $1,818 $ 65,585 December 31, 1999 71,115 237 866 70,486 </TABLE> The purchase or sale of securities is dependent upon Management's assessment of investment and funding opportunities as well as the Banks' asset/liability management needs. The Banks sold securities designated as available for sale with an aggregate market value of $4.9 million during 9
11 the three months ended March 31, 2000. The Banks sold securities with a market value of $267,000 during the corresponding period of 1999. SALES OF SECURITIES AVAILABLE FOR SALE <TABLE> <CAPTION> Three months ended March 31, 2000 1999 -------------- --------------- <S> <C> <C> Proceeds $4,933,000 $ 267,000 ============== =============== Gross gains $ 7,000 $ 14,000 Gross losses (23,000) -------------- --------------- Net gains (losses) $ (16,000) $ 14,000 ============== =============== </TABLE> PORTFOLIO LOANS AND ASSET QUALITY Management believes that the Registrant's decentralized structure provides important advantages in serving the credit needs of the Banks' principal lending markets. In addition to the communities served by the Banks' branch networks, principal lending markets include nearby communities and metropolitan areas. Subject to established underwriting criteria, the Banks also participate in commercial lending transactions with certain non-affiliated banks and may also purchase real estate mortgage loans from third-party originators. Although the Management and Board of Directors of each Bank retain authority and responsibility for credit decisions, each of the Banks has adopted uniform underwriting standards. Further, the Registrant's loan committee as well as the centralization of commercial loan credit services and loan review functions promote compliance with such established underwriting standards. The centralization of retail loan services also provides for consistent service quality and facilitates compliance with consumer protection laws and regulations. The Banks generally retain loans that may be profitably funded within established risk parameters. (See "Asset/liability management.") As a result, the Banks often retain adjustable-rate and balloon real estate mortgage loans, while 15- and 30-year, fixed-rate obligations are sold to mitigate exposure to changes in interest rates. (See "Non-interest income.") The increase in commercial and agricultural loans principally reflects Management's emphasis on lending opportunities within the Lansing and Grand Rapids markets. Commercial real estate projects, including land development and construction comprise the majority of new loans. Although demand for such loans is dependent upon a number of factors, Management currently anticipates continued growth within this segment of Portfolio Loans. 10
12 NON-PERFORMING ASSETS <TABLE> <CAPTION> March 31, December 31, 2000 1999 ---------------- ---------------- <S> <C> <C> Non-accrual loans $ 3,119,000 $ 2,980,000 Loans 90 days or more past due and still accruing interest 2,050,000 2,029,000 Restructured loans 266,000 270,000 ---------------- ---------------- Total non-performing loans 5,435,000 5,279,000 Other real estate 1,452,000 1,315,000 ---------------- ---------------- Total non-performing assets $ 6,887,000 $ 6,594,000 ================ ================ As a percent of Portfolio Loans Non-performing loans 0.41 % 0.41 % Non-performing assets 0.53 0.51 Allowance for loan losses 1.01 1.01 Allowance for loan losses as a percent of non-performing loans 244 246 </TABLE> Impaired loans totaled approximately $3,300,000 at March 31, 2000. At that same date, certain impaired loans with a balance of approximately $1,100,000, had specific allocations of the allowance for loan losses, which totaled approximately $400,000. The Banks' average investment in impaired loans was approximately $3,300,000, for the three-month period ended March 31, 2000. Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance. Interest recognized on impaired loans during that three-month period was approximately $50,000. ALLOWANCE FOR LOAN LOSSES <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ---------------- -------------- <S> <C> <C> Balance at beginning of period $ 12,985,000 $ 11,557,000 Additions (deduction) Provision charged to operating expense 557,000 666,000 Recoveries credited to allowance 160,000 173,000 Loans charged against the allowance (425,000) (516,000) ---------------- -------------- Balance at end of period $ 13,277,000 $ 11,880,000 ================ ============== Net loans charged against the allowance to average Portfolio Loans (annualized) 0.08% 0.12% </TABLE> In determining the allowance and the related provision for loan losses, Management considers four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated loans, (iii) allocations based principally on historical loan loss experience and (iv) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios. Loans charged against the allowance for loan losses, net of recoveries, were equal to .08% of average loans during the three months ended March 31, 2000, compared to .12% during the comparable period of 1999. (See "Provision for loan losses.") 11
13 DEPOSITS AND BORROWINGS The Banks' competitive position within many of the markets served by the branch networks limits the ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits. Accordingly, the Banks compete on the basis of convenience and personal service, while employing pricing tactics that are intended to enhance the value of core deposits. The Banks have implemented funding strategies that incorporate other borrowings and Brokered CDs to finance a portion of the Portfolio Loans. The use of such alternate sources of funds supplements the Banks' core deposits and is also an integral part of the Banks' asset/liability management efforts. Derivative financial instruments are employed to reduce the cost of alternate sources of funds and to manage the Banks' exposure to changes in interest rates. (See "Asset/liability management.") <TABLE> <CAPTION> March 31, 2000 December 31, 1999 --------------------------------- ----------------------------------- Average Average Amount Maturity Rate Amount Maturity Rate ------ -------- ---- ------ -------- ---- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Brokered CDs $140,270 6.0 years 6.71% $101,029 6.0 years 6.24% Fixed rate FHLB advances 76,087 5.2 years 5.92 131,592 3.2 years 5.98 Variable rate FHLB advances 113,995 0.5 years 5.97 59,056 0.4 years 4.63 </TABLE> Other borrowed funds, principally advances from the Federal Home Loan Bank (the "FHLB"), decreased to $204.7 million at March 31, 2000, from $224.6 million at December 31, 1999. On those same dates, federal funds purchased totaled $31.4 million and $42.4 million, respectively. The decline in other borrowed funds and federal funds purchased principally reflects the competitive cost of Brokered CDs as well as Management's efforts to diversify the Banks' funding sources. Brokered CDs totaled $140.3 million and $101.0 million at March 31, 2000 and December 31, 1999, respectively. INTEREST-RATE DERIVATIVE FINANCIAL INSTRUMENTS <TABLE> <CAPTION> SWAPS ------------------------------- CAPS FLOORS COLLARS PAY FIXED PAY VARIABLE - -------------------- ----------------- ---------------- ----------------- ----------------- ---------------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Notional amount $63,500 $8,000 $7,000 $70,000 $121,000 Weighted-average maturity 3.7 years 2.0 years 0.8 years 2.5 years 6.7 years Cap strike 6.87% 6.38% Floor strike 5.17% 5.75 Rate paying 5.58% 6.03% Rate receiving 6.04 6.73 Premium paid $ 1,638 $ 31 Annual cost .60% .15% Amortized cost $ 1,407 $ 25 Fair value 1,413 3 $ 13 $ 1,630 $ (4,262) </TABLE> At March 31, 2000, the Company employed interest-rate caps, floors and collars with an aggregate notional amount of $78.5 million. The Banks also employed interest-rate swaps with an aggregate notional amount of $191.0 million. 12
14 LIQUIDITY AND CAPITAL RESOURCES Effective management of the Registrant's capital resources is critical to Management's mission to create value for the Registrant's shareholders. The cost of capital is an important factor in creating shareholder value and, accordingly, the Registrant's capital structure includes unsecured debt and Preferred Securities. To profitably deploy capital within existing markets, the Banks have implemented balance sheet management strategies that combine efforts to originate Portfolio Loans with disciplined funding strategies. Acquisitions are also integral components of Management's capital management strategies. (See "Stock repurchase plan.") CAPITALIZATION <TABLE> <CAPTION> March 31, December 31, 2000 1999 ----------------- ------------------- <S> <C> <C> Unsecured debt $ 13,500,000 $12,500,000 Preferred Securities 17,250,000 17,250,000 Shareholders' Equity Preferred stock, no par value Common Stock, par value $1.00 per share 11,222,000 11,235,000 Capital surplus 71,216,000 71,672,000 Retained earnings 36,721,000 33,921,000 Accumulated other comprehensive loss (1,852,000) (2,283,000) Unearned employee stock ownership plan shares (799,000) (799,000) ------------ ------------ Total shareholders' equity 116,508,000 113,746,000 ------------ ------------ Total capitalization $147,258,000 $143,496,000 ============ ============ </TABLE> Shareholders' equity totaled $116.5 million at March 31, 2000. The $2.8 million increase from $113.7 million at December 31, 1999, reflects the retention of earnings as well as the issuance of common stock pursuant to various equity-based incentive compensation plans. A decline in unrealized losses on securities available for sale also contributed to the increase in shareholders equity. Shareholders' equity was equal to 6.70% of total assets at March 31, 2000, compared to 6.59% at December 31, 1999. CAPITAL RATIOS <TABLE> <CAPTION> March 31, 2000 December 31, 1999 ---------------------- ---------------------- <S> <C> <C> Equity capital 6.70% 6.59% Average shareholders equity to average assets(1) 6.68 7.16 Tier 1 leverage (tangible equity capital) 6.78 6.52 Tier 1 risk-based capital 9.62 9.33 Total risk-based capital 10.72 10.41 </TABLE> (1) Based on year to date average balances for the respective periods ASSET/LIABILITY MANAGEMENT Interest-rate risk is created by differences in the pricing characteristics of the Banks' assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers' rights to prepay fixed-rate loans also create interest-rate risk. The asset/liability management efforts of the Registrant and the Banks are intended to identify sources of interest-rate risk and to evaluate opportunities to structure the balance sheet in a 13
15 manner that is consistent with Management's mission to maintain profitable financial leverage. The marginal cost of funds is a principal consideration in the implementation of the Banks' balance sheet management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. Management employs simulation analyses to monitor the Banks' interest-rate risk profiles and evaluate potential changes in the Banks' net interest income and market value of portfolio equity that result from changes in interest rates. RESULTS OF OPERATIONS SUMMARY Net income totaled $4,486,000 during the three months ended March 31, 2000. The $1,215,000 increase from $3,271,000 during the comparable period in 1999, principally reflects an increase in net interest income as well as a decline in non-interest expense. A decrease in the provision for loan losses also contributed to the increase in net income. A decline in non-interest income, which is attributable to the Banks' mortgage-banking activities, as well as an increase in federal income tax expense limited the increase in net income. KEY PERFORMANCE RATIOS <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ---------------------------- <S> <C> <C> Net income to Average assets 1.05% .81% Average equity 15.74 11.14 Earnings per common share Basic $.40 $.29 Diluted .40 .28 Cash basis income to(A) Average tangible assets 1.15% .91% Average tangible equity 19.89 14.64 Cash basis income per share(A) Basic $.43 $.32 Diluted .43 .32 </TABLE> (A) Cash basis financial data exclude intangible assets and the related amortization expense NET INTEREST INCOME Tax equivalent net interest income totaled $18,111,000 during the three months ended March 31, 2000. The $2,168,000 increase from $16,643,000 during the comparable period of 1999 reflects an increase in average earning assets as well as an increase in Net Yield. Average earning assets totaled $1.602 billion during the three-month period in 2000. The $76 million increase from $1.526 billion during the comparable period in 1999 principally reflects an increase in Portfolio Loans. 14
16 Tax equivalent net interest income as a percent of average earning assets ("Net Yield") was equal to 4.52% of average earning assets during the three months ended March 31, 2000, compared to 4.37% during the corresponding period of 1999. A portion of the 15 basis point increase in Net Yield may be attributed to the scheduled maturity of certain low-yielding assets and high-cost liabilities at MSB. Increases in Net Yield also reflect increases in Portfolio Loans as a percent of average earning assets. Portfolio Loans were equal to 80.2% and 75.2% of average earning assets for the three months ended March 31, 2000 and 1999, respectively. NET INTEREST INCOME AND SELECTED RATIOS <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ----------- ------------ <S> <C> <C> Average earning assets (in thousands) $1,602,804 $1,526,178 Tax equivalent net interest income 18,111 16,643 As a percent of average earning assets Tax equivalent interest income 8.50 % 8.25 % Interest expense 3.98 3.88 Tax equivalent net interest income 4.52 4.37 Average earning assets as a percent of average assets 93.48 % 92.81 % Free-funds ratio 8.58 % 10.04 % </TABLE> PROVISION FOR LOAN LOSSES The provision for loan losses was $557,000 during the three months ended March 31, 2000, compared to $666,000 during the three-month period in 1999. The decrease in the provision reflects Management's assessment of the allowance for loan losses. (See "Asset quality.") NON-INTEREST INCOME Non-interest income totaled $4,144,000 during the three months ended March 31, 2000, compared to $4,747,000 during the comparable period in 1999. The decline in non-interest income reflects a decrease in net gains on the sale of real estate mortgage loans. Increases in service charges on deposit accounts partially offset the decline in net gains. Loan servicing fees, mutual fund and annuity commissions as well as fees associated with the origination of manufactured home loans also increased from the comparable period in 1999. 15
17 NON-INTEREST INCOME <TABLE> <CAPTION> Three months ended March 31, 2000 1999 --------------- -------------- <S> <C> <C> Service charges on deposit accounts $1,501,000 $ 1,207,000 Net gains (losses) on asset sales Real estate mortgage loans 380,000 1,531,000 Securities (16,000) 14,000 First Home Financial 508,000 426,000 Title insurance fees 160,000 185,000 Real estate mortgage loan servicing fees 376,000 288,000 Mutual fund and annuity commissions 405,000 317,000 Other 830,000 779,000 -------------- -------------- Total non-interest income $4,144,000 $4,747,000 ============== ============== </TABLE> Net gains on the sale of real estate mortgage loans totaled $380,000 during the three months ended March 31, 2000, compared to $1,531,000 during the comparable period in 1999. The decline in such net gains principally reflects a decline in loans sold. <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ------------------------------------ <S> <C> <C> Real estate mortgage loans originated $66,954,000 $148,080,000 Real estate mortgage loan sales 27,775,000 96,847,000 Real estate mortgage loan servicing rights sold 2,642,000 5,014,000 Net gains on the sale of real estate mortgage loans 380,000 1,531,000 Net gains as a percent of real estate mortgage loans sold 1.37% 1.58% </TABLE> The volume of loans sold is dependent upon the Banks' ability to originate real estate mortgage loans as well as the demand for fixed-rate obligations and other loans that the Banks cannot profitably fund within established interest-rate risk parameters. (See "Portfolio loans and asset quality.") Net gains on real estate mortgage loans are also dependent upon economic and competitive factors as well as the Banks' ability to effectively manage exposure to changes in interest rates. The Banks capitalized approximately $200,000 and $750,000 of related servicing rights during the three-month periods ended March 31, 2000 and 1999, respectively. Amortization of capitalized servicing rights for those periods was $267,000 and $324,000, respectively. The book value of capitalized mortgage servicing rights was $4,645,000 at March 31, 2000. The fair value of capitalized servicing rights, which relate to approximately $770 million of loans sold and serviced, approximated $8 million at that same date, and therefore, no valuation allowance was considered necessary. Service charges on deposit accounts increased by 24% to $1,501,000 during the three months ended March 31, 2000, from $1,207,000 during the comparable period in 1999. The increase in 16
18 service charges principally relate to certain deposit account promotions, which includes direct mail solicitations, at each of the Banks. NON-INTEREST EXPENSE Non-interest expense totaled $14,711,000 during the three months ended March 31, 2000. The $879,000 decrease from $15,590,000 during the comparable period of 1999 reflects a $290,000 decline in FDIC insurance assessments. A decrease in costs relating to the origination of real estate mortgage loans as well as a decline in legal and professional fees also contributed to the decrease in non-interest expense. NON-INTEREST EXPENSE <TABLE> <CAPTION> Three months ended March 31, 2000 1999 ------------ ------------- <S> <C> <C> Salaries $ 5,824,000 $ 5,715,000 Performance-based compensation and benefits 1,201,000 1,309,000 Other benefits 1,367,000 1,421,000 ----------- ----------- Salaries and benefits 8,392,000 8,445,000 Occupancy, net 1,178,000 1,150,000 Furniture and fixtures 1,141,000 968,000 Computer processing 693,000 784,000 Communications 565,000 593,000 Advertising 457,000 719,000 Amortization of intangible assets 432,000 442,000 Supplies 395,000 351,000 Loan and collection 307,000 439,000 FDIC insurance 71,000 361,000 Other 1,080,000 1,338,000 ----------- ----------- Total non-interest expense $14,711,000 $15,590,000 =========== =========== </TABLE> STOCK REPURCHASE PLAN On October 21, 1999, the Registrant announced that its board of directors has adopted a share repurchase plan. The plan authorizes the Registrant to acquire up to 325,000 shares of its common stock in open market transactions. The Registrant has since purchased 325,000 shares. RECENT ACQUISITION On September 15, 1999, the Registrant completed its acquisition of Mutual Savings Bank, f.s.b. ("MSB"). On September 30, 1999, MSB's assets and shareholders' equity totaled $582.0 million and $43.9 million, respectively. The markets served by MSB's 22 offices are located within the Lower Peninsula of Michigan and are generally contiguous to markets that are served by the remaining Banks. Consideration consisted of 3,436,000 shares of Registrant's common stock (3,608,000 shares adjusted for the Registrant's 5% stock dividend declared September 21, 1999) with an aggregate value of approximately $54.8 million. The transaction qualified as a "pooling of interests" and the Registrant's results of operations for the corresponding period of 1999 has been restated. 17
19 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. No material changes in the market risk faced by the Registrant has occurred since December 31, 1999. 18
20 Item 6. Exhibits & Reports on Form 8-K (a) Exhibit Number & Description 11. Computation of Earnings Per Share 27. Financial Data Schedule (b) Reports on Form 8-K During the quarter ended March 31, 2000, there were no reports filed on Form 8-K. 19
21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date May 12, 2000 By s/ William R. Kohls ------------------------- ----------------------------------------- William R. Kohls, Principal Financial Officer Date May 12, 2000 By s/ James J. Twarozynski ------------------------- ---------------------------------------- James J. Twarozynski, Principal Accounting Officer 20
22 Exhibit Index ------------- <TABLE> <CAPTION> Exhibit No. Description - ----------- ----------- <S> <C> 11 Computation of Earnings Per Share 27 Financial Data Schedule </TABLE>