1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996 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 October 17, 1996 - ------------------------------------ ----------------------------------------- Common stock, par value $1 2,861,399
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 September 30, 1996 and December 31, 1995 2 Consolidated Statements of Operations Three- and nine-month periods ended September 30, 1996 and 1995 3 Consolidated Statements of Cash Flows Nine-month periods ended September 30, 1996 and 1995 4 Consolidated Statements of Shareholders' Equity Nine-month periods ended September 30, 1996 and 1995 5 Notes to Interim Consolidated Financial Statements Three- and nine-month periods ended September 30, 1996 and 1995 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7-15 PART II - Other Information ----------------- Item 6. Exhibits & Reports on Form 8-K 16 </TABLE>
3 Part I. INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition <TABLE> <CAPTION> September 30, December 31, 1996 1995 -------------- -------------- (unaudited) -------------- -------------- <S> <C> <C> Assets Cash and due from banks $ 26,601,000 $ 17,208,000 Securities available for sale 122,487,000 87,553,000 Securities held to maturity (fair value of $27,698,000 at September 30,1996; $29,031,000 at December 31, 1995) 26,874,000 27,906,000 Federal Home Loan Bank stock, at cost 10,198,000 7,710,000 Loans held for sale 10,389,000 16,047,000 Loans Commercial and agricultural 141,747,000 108,879,000 Real estate mortgage 310,079,000 225,900,000 Installment 113,592,000 83,265,000 -------------- -------------- Total Loans 565,418,000 418,044,000 Allowance for loan losses (6,720,000) (5,243,000) -------------- -------------- Net Loans 558,698,000 412,801,000 Property and equipment, net 16,624,000 9,931,000 Accrued income and other assets 21,281,000 10,991,000 -------------- -------------- Total Assets $ 793,152,000 $ 590,147,000 ============== ============== Liabilities and Shareholders' Equity Deposits Non-interest bearing $ 68,685,000 $ 46,168,000 Savings and NOW 263,841,000 215,336,000 Time 209,255,000 150,120,000 -------------- -------------- Total Deposits 541,781,000 411,624,000 Federal funds purchased 37,100,000 13,400,000 Other borrowings 153,859,000 110,894,000 Accrued expenses and other liabilities 9,679,000 7,204,000 -------------- -------------- Total Liabilities 742,419,000 543,122,000 -------------- -------------- 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: 2,861,399 shares at September 30, 1996 and 2,704,038 shares at December 31, 1995 2,861,000 2,704,000 Capital surplus 24,256,000 19,924,000 Retained earnings 23,447,000 23,683,000 Net unrealized gain on securities available for sale, net of related tax effect 169,000 714,000 -------------- -------------- Total Shareholders' Equity 50,733,000 47,025,000 -------------- -------------- Total Liabilities and Shareholders' Equity $ 793,152,000 $ 590,147,000 ============== ============== </TABLE> See notes to interim consolidated financial statements. 2
4 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, 1996 1995 1996 1995 ------------- ------------- --------------- ------------- (unaudited) (unaudited) -------------------------------- ----------------------------------- <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $ 13,498,000 $ 9,976,000 $ 35,587,000 $ 27,370,000 Securities Taxable 1,905,000 1,402,000 4,873,000 4,572,000 Tax-exempt 571,000 447,000 1,502,000 1,328,000 Other investments 287,000 116,000 636,000 264,000 ------------- ------------- --------------- ------------- Total Interest Income 16,261,000 11,941,000 42,598,000 33,534,000 ------------- ------------- --------------- ------------- Interest Expense Deposits 4,480,000 3,169,000 11,598,000 9,193,000 Other borrowings 2,503,000 1,584,000 5,950,000 3,688,000 ------------- ------------- --------------- ------------- Total Interest Expense 6,983,000 4,753,000 17,548,000 12,881,000 ------------- ------------- --------------- ------------- Net Interest Income 9,278,000 7,188,000 25,050,000 20,653,000 Provision for loan losses 253,000 159,000 942,000 477,000 ------------- ------------- --------------- ------------- Net Interest Income After Provision for Loan Losses 9,025,000 7,029,000 24,108,000 20,176,000 ------------- ------------- --------------- ------------- Non-interest Income Service charges on deposit accounts 630,000 492,000 1,641,000 1,439,000 Net gains (losses) on asset sales Real estate mortgage loans 363,000 301,000 1,251,000 405,000 Securities 16,000 (24,000) (130,000) (110,000) Other income 403,000 288,000 1,219,000 922,000 ------------- ------------- --------------- ------------- Total Non-interest Income 1,412,000 1,057,000 3,981,000 2,656,000 ------------- ------------- --------------- ------------- Non-interest Expense Salaries and employee benefits 4,240,000 3,186,000 11,404,000 8,903,000 Occupancy, net 563,000 405,000 1,458,000 1,135,000 Furniture and fixtures 553,000 341,000 1,337,000 975,000 Other expenses 2,278,000 1,646,000 5,605,000 4,884,000 ------------- ------------- --------------- ------------- Total Non-interest Expense 7,634,000 5,578,000 19,804,000 15,897,000 ------------- ------------- --------------- ------------- Income Before Federal Income Tax 2,803,000 2,508,000 8,285,000 6,935,000 Federal income tax expense 826,000 713,000 2,466,000 1,948,000 ------------- ------------- --------------- ------------- Net Income $ 1,977,000 $ 1,795,000 $ 5,819,000 $ 4,987,000 ============= ============= =============== ============= Net Income Per Share $ .69 $ .63 $ 2.02 $ 1.74 Dividends Per Share Declared $ .25 $ .22 $ .74 $ .66 Paid .25 .22 .71 .62 </TABLE> See notes to interim consolidated financial statements. 3
5 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows <TABLE> <CAPTION> Nine months ended September 30, 1996 1995 -------------- -------------- (unaudited) --------------------------------------- <S> <C> <C> Net Income $ 5,819,000 $ 4,987,000 Adjustments to Reconcile Net Income to Net Cash from Operating Activities Proceeds from sales of loans held for sale 78,515,000 33,439,000 Disbursements for loans held for sale (69,135,000) (31,883,000) Provision for loan losses 942,000 477,000 Deferred loan fees 158,000 23,000 Depreciation, amortization of intangible assets and premiums and accretion of discounts on investment securities and loans 1,899,000 1,679,000 Net losses on sales of securities 130,000 110,000 Net gains on sales of real estate mortgage loans (1,251,000) (405,000) (Increase) decrease in accrued income and other assets (7,784,000) (751,000) Increase in accrued expenses and other liabilities 1,114,000 1,993,000 -------------- -------------- Total Adjustments 4,588,000 4,682,000 -------------- -------------- Net Cash from Operating Activities 10,407,000 9,669,000 -------------- -------------- Cash Flow from Investing Activities Proceeds from sales of securities available for sale 15,907,000 13,152,000 Proceeds from maturities of securities held to maturity 8,898,000 10,925,000 Principal payments received on securities available for sale 6,785,000 863,000 Principal payments received on securities held to maturity 601,000 3,867,000 Purchases of securities available for sale (30,839,000) Purchases of securities held to maturity (295,000) (15,715,000) Portfolio loans made to customers net of principal payments received (63,355,000) (75,788,000) Acquisition of branch office, less cash received 13,949,000 Acquisition of bank, less cash received 9,478,000 Capital expenditures (2,607,000) (1,133,000) -------------- -------------- Net Cash from Investing Activities (55,427,000) (49,880,000) -------------- -------------- Cash Flow from Financing Activities Net decrease in total deposits (1,378,000) (15,371,000) Net increase in short-term borrowings 20,165,000 6,663,000 Proceeds from Federal Home Loan Bank advances 45,000,000 76,000,000 Payments of Federal Home Loan Bank advances (17,000,000) (30,000,000) Proceeds from issuance of long-term borrowings 10,000,000 Retirement of debt (500,000) Dividends paid (1,933,000) (1,758,000) Proceeds from issuance of common stock 59,000 81,000 Repurchase of common stock (755,000) -------------- -------------- Net Cash from Financing Activities 54,413,000 34,860,000 -------------- -------------- Net Increase (Decrease) in Cash and Cash Equivalents 9,393,000 (5,351,000) Cash and Cash Equivalents at Beginning of Period 17,208,000 23,719,000 -------------- -------------- Cash and Cash Equivalents at End of Period $ 26,601,000 $ 18,368,000 ============== ============== Cash paid during the period for: Interest $ 16,935,000 $ 12,530,000 Income taxes 2,990,000 2,150,000 Transfer of loans to other real estate 808,000 367,000 </TABLE> See notes to interim consolidated financial statements. 4
6 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity <TABLE> <CAPTION> Nine months ended September 30 1996 1995 ------------- ------------- (unaudited) --------------------------------- <S> <C> <C> Balance at beginning of period $ 47,025,000 $ 40,311,000 Net income 5,819,000 4,987,000 Cash dividends declared (2,125,000) (1,861,000) Issuance of common stock 559,000 430,000 Repurchase of common stock (755,000) Net change in unrealized gain on securities available for sale, net of related tax effect (545,000) 1,794,000 ------------- ------------- Balance at end of period $ 50,733,000 $ 44,906,000 ============= ============= </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 September 30, 1996 and December 31, 1995, and the results of operations for the three- and nine-month periods ended September 30, 1996 and 1995. 2. Management's assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions and other pertinent factors. Loans on non-accrual status, past due more than 90 days, or restructured amounted to $3,451,000 at September 30, 1996, and $2,560,000 at December 31, 1995. (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 results of operations for the nine-month period ended September 30, 1996, are not necessarily indicative of the results to be expected for the full year. 5. The Company adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights", effective January 1, 1996. (See Management's Discussion and Analysis of Financial Condition and Results of Operations). 6
8 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION This section presents Management's discussion and analysis of financial condition and results of operation for the Registrant and its bank subsidiaries (the "Banks"). Its purpose is to provide additional information that may be necessary to assess the consolidated financial statements contained elsewhere in this report. This section should be read in conjunction with the Registrant's 1995 Annual Report on Form 10-K. NBC ACQUISITION The Registrant consummated its acquisition of the outstanding common stock of North Bank Corporation (the "NBC Acquisition") as of June 1, 1996. At that date, NBC's assets totaled $151.9 million and its loans and deposits totaled $84.5 million and $131.6 million, respectively. Cash consideration and goodwill totaled approximately $15.8 million and $7.5 million, respectively. NBC's banking subsidiary consolidated with an existing subsidiary of the Registrant during the third-quarter of 1996. The unaudited pro forma combined results for the Registrant and NBC set forth below are presented as if the acquisition had occurred at the beginning of the periods presented. <TABLE> <CAPTION> Nine months ended September 30, 1996 1995 ---------- ---------- <S> <C> <C> Revenues, net $51,700,000 $45,800,000 Net income 5,600,000 4,600,000 Net income per common share $1.93 $1.60 </TABLE> PENDING ACQUISITION On August 20, 1996, the Registrant announced that one of the Banks had agreed to purchase certain loans and real and personal property and assume deposit liabilities associated with eight branch facilities, located in Michigan's thumb region ("Pending Acquisition"). At September 30, 1996, loans to be purchased and deposit liabilities to be assumed totaled $21.5 million and $121.5 million, respectively. The estimated purchase price based on September 30, 1996, financial information is anticipated to be approximately $10.2 million, and goodwill is expected to total approximately $8.4 million. The transaction is subject to regulatory approval and will likely be completed during December of 1996. The Company expects to raise additional tier 1 capital to assist the Registrant in maintaining its capital ratios following consummation of the Pending Acquisition. 7
9 FINANCIAL CONDITION SUMMARY The Registrant's loans, excluding loans held for sale ("Portfolio Loans"), totaled $565.4 million at September 30, 1996, compared to $418.0 million at December 31, 1995. The NBC Acquisition and an increase in rate-sensitive real estate mortgage loans account for the majority of the $147.4 million increase in Portfolio Loans. (See "Asset/liability management.") Excluding the impact of the NBC Acquisition, the increase in Portfolio Loans has been funded by increased federal funds purchased and advances from the Federal Home Loan Bank ("FHLB"). The use of non-deposit sources of funds is structured to complement the Banks' interest-rate risk profile and the cost of such borrowings is a principal consideration in the Banks' deposit pricing strategies. (See "Asset/liability management" and "Liquidity and capital resources.") ASSET QUALITY Management believes that its decentralized structure provides the Banks with important advantages in serving the needs of its principal lending markets. Although the Management and Board of Directors of each of the Banks retain authority and responsibility for all credit decisions, each of the Banks has adopted uniform underwriting standards. Management believes that the Registrant's Corporate Loan Committee and the centralization of loan review and other credit services ensures the consistent application of such underwriting standards and provides the controls that are consistent with the needs of the Registrant's decentralized structure. Non-performing loans totaled $3,451,000 and non-performing assets totaled $4,407,000 at September 30, 1996. The increase in non-performing loans and assets during 1996 were the result of the NBC Acquisition. 8
10 NON-PERFORMING ASSETS <TABLE> <CAPTION> September 30, December 31, 1996 1995 ------------- ------------ <S> <C> <C> Non-accrual loans $2,089,000 $1,886,000 Loans 90 days or more past due and still accruing interest 1,159,000 427,000 Restructured loans 203,000 247,000 ---------- ---------- Total non-performing loans 3,451,000 2,560,000 Other real estate 956,000 760,000 ---------- ---------- Total non-performing assets $4,407,000 $3,320,000 ========== ========== As a percent of total loans Total non-performing loans 0.61% 0.61% Total non-performing assets 0.78% 0.79% </TABLE> In the absence of the NBC Acquisition, non-performing loans would have declined to .52% of total loans, from .61% at December 31, 1995. During that nine-month period, total non-performing assets would have declined to .68% of total loans from .79% at December 31, 1995. Impaired loans totaled approximately $2,200,000 and $3,200,000 at September 30, 1996 and December 31, 1995, respectively. In addition to certain non-performing loans, such impaired loans include commercial and agricultural loans totaling $800,000 and $1,800,000 at September 30, 1996 and December 31, 1995, respectively that have been separately identified as impaired. Certain impaired loans with a balance of approximately $1,000,000 and $700,000 had specific allocations of the allowance for loan losses totaling approximately $125,000 and $250,000 at September 30, 1996 and December 31, 1995, respectively. The Banks' average investment in impaired loans was approximately $2,500,000 and $2,000,000 during the nine-month periods ended September 30, 1996 and 1995, respectively. Interest income recognized on impaired loans during the nine-month periods ended September 30, 1996 and 1995, totaled approximately $110,000 and $40,000, respectively. Management's assessment of the allowance for loan losses is based on the amount and composition of the loan portfolio, an evaluation of specific credits, the historical loss experience of each portfolio as well as the level of non-performing and impaired loans. Partially based upon the application of its allocation methodology to the loans associated with the NBC Acquisition, Management elected to increase the provision for loan losses to $942,000 during the nine months ended September 30, 1996, from $477,000 during the comparable period of 1995. At September 30, 1996, approximately 43% of the allowance for loan losses was allocated to specific loans or loan portfolios compared to 45% at December 31, 1995. 9
11 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES <TABLE> <CAPTION> September 30, 1996 December 31, 1995 --------------------------------- -------------------------- Percent of Percent of Allowance Loans to Allowance Loans to Amount Total Loans Amount Total Loans ----------- ---------------- ---------- -------------- <S> <C> <C> <C> <C> Commercial and agricultural $1,761,000 25.1% $1,612,000 26.0% Real estate mortgage 229,000 54.8 162,000 54.0 Installment 879,000 20.1 597,000 20.0 Unallocated 3,851,000 2,872,000 ----------- ----- ---------- ----- Total $6,720,000 100.0% $5,243,000 100.0% =========== ===== ========== ===== </TABLE> During the nine-month period in 1996, loans charged against the allowance, net of recoveries ("Net Loan Losses"), were $270,000, compared to $282,000 during the comparable period of 1995. On an annual basis, loans charged against the allowance, net of recoveries, were equal to 0.11% and 0.10% of average Portfolio Loans during the nine month periods ended September 30, 1996 and 1995, respectively. The NBC Acquisition accounts for $90,000 of the Net Loan Losses in 1996. ALLOWANCE FOR LOAN LOSSES <TABLE> <CAPTION> Nine months ended September 30, 1996 1995 ----------- ----------- <S> <C> <C> Balance at beginning of period $5,243,000 $5,054,000 Additions (deduction) Allowance on loans acquired 930,000 Provision charged to operating expense 942,000 477,000 Recoveries credited to allowance 395,000 245,000 Loans charged against the allowance (665,000) (527,000) ---------- ---------- Balance at end of period $6,720,000 $5,249,000 ========== ========== Net loans charged against the allowance to average Portfolio Loans (annualized) 0.11% 0.10% Allowance for loan losses as a percent of non-performing loans 195% 164% </TABLE> LIQUIDITY AND CAPITAL RESOURCES Management views its ability to profitably deploy capital or otherwise maintain financial leverage as a prerequisite to the Registrant's continued success. Management's strategies to maintain financial leverage include the acquisition of other financial institutions as well as the Banks' ability to profitably fund Portfolio Loans with advances from the FHLB and other non-deposit funding sources ("Alternate Loan Funding Strategy"). (See "Asset/liability management.") The 10
12 Registrant's dividend policies are also important components of Management's strategies to maintain financial leverage. <TABLE> <CAPTION> CAPITAL RATIOS September 30, 1996 December 31, 1995 ------------------ ----------------- <S> <C> <C> Equity capital 6.40% 7.97% Tangible equity capital 5.23 7.58 Primary capital 7.18 8.78 Tangible primary capital 6.04 8.39 Risk-based capital 9.44 12.75 </TABLE> Notwithstanding a $545,000 decline in net unrealized gains on securities available for sale, after consideration of related taxes, shareholders' equity increased by $3.7 million during the nine months ended September 30, 1996. The increase reflects the retention of earnings as well as the value of common shares issued pursuant to the Registrant's Incentive Share Grant Plan and its various stock option plans. As a result of the NBC Acquisition, shareholders' equity declined to 6.40% of total assets at September 30, 1996, from 7.97% at December 31, 1995. In the absence of that transaction, however, shareholders' equity would have been largely unchanged from December 31, 1995. (See "Pending Acquisition".) ASSET/LIABILITY MANAGEMENT The retention of 15- and 30-year fixed-rate real estate mortgage loans is not consistent with Management's Alternate Loan Funding Strategy or the Banks' asset/liability needs. Accordingly, the majority of such loans are sold to mitigate exposure to changes in interest rates. Adjustable-rate and balloon real estate mortgage loans may, however, be profitably funded with FHLB advances and the retention of such loans is a principal focus of Management's Internal Growth Strategies. (See "Non-interest income".) The Bank's 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 continue to employ pricing tactics that are intended to enhance the value of core deposits and use federal funds and other borrowings, principally advances from the FHLB to fund increases in Portfolio Loans. (See "Net interest income".) At September 30, 1996, advances from the FHLB totaled $131.0 million. The Banks maintain diversified investment portfolios that are consistent with Management's Alternate Loan Funding Strategy and the asset/liability and liquidity needs of the Banks. Such portfolios are comprised of securities issued by the U.S. Treasury and government sponsored agencies as well as obligations of states and political subdivisions and mortgage-backed securities. Sales of securities available for sale are dependent upon Management's assessment of reinvestment opportunities and the Banks' asset/liability management needs. (See "Non-interest income.") The following table sets forth certain information with respect to the securities portfolios, including gross unrealized gains and losses: <TABLE> <CAPTION> Unrealized Amortized ---------- Fair SECURITIES Cost Gains Losses Value --------- ----- ------ ----- (in thousands) <S> <C> <C> <C> <C> Securities available for sale September 30, 1996 ..................... $122,231 $ 980 $ 724 $122,487 December 31, 1995 ...................... 86,471 1,538 456 87,553 Securities held to maturity September 30, 1996 ..................... $26,874 $ 891 $ 67 $ 27,698 December 31, 1995 ...................... 27,906 1,157 32 29,031 </TABLE> 11
13 RESULTS OF OPERATIONS SUMMARY Net income increased by 10% to $1,977,000 during the three months ended September 30, 1996, from $1,795,000 during the comparable period of 1995. During the nine-month period in 1996, net income totaled $5,819,000 compared to $4,987,000 in 1995. The increases are the result of increases in net interest income and non-interest income that were partially offset by increases in the provision for loan losses, non-interest expense and federal income tax expense. Key performance ratios for the three- and nine-month periods ended September 30, 1996 and 1995, are set forth below. KEY PERFORMANCE RATIOS <TABLE> <CAPTION> Three months Nine months ended September 30, ended September 30, 1996 1995 1996 1995 --------------------- ----------------------- <S> <C> <C> <C> <C> Return on Average assets 1.01% 1.28% 1.16% 1.26% Average equity 15.58 16.07 15.78 15.60 Earnings per common share(1) $ .69 $ .63 $ 2.02 $ 1.74 </TABLE> (1) Adjusted to give retroactive effect to 5% stock dividends in 1996 and 1995. NET INTEREST INCOME Net interest income increased by $2,090,000 to $9,278,000 during the three months ended September 30, 1996, and by $4,397,000 to $25,050,000 during the nine-month period. The increases principally reflect increases in average earning assets that resulted from the NBC Acquisition and the implementation of Management's Alternate Loan Funding Strategy. Although the NBC Acquisition and Management's Alternate Loan Funding Strategy have a positive impact on net interest income and have contributed to the increase in the Registrant's return on average equity, such strategies have an adverse impact on tax equivalent net interest income as a percent of average earning assets. Tax equivalent net interest income was equal to 5.23% and 5.45% during the three- and nine-month periods ended September 30, 1996. The declines from the comparable periods of 1995 reflect the NBC Acquisition, including interest paid on the debt that was used to finance the transaction, as well as the average cost of FHLB advances relative to the cost of the Banks' core deposits. (See "Asset/liability management.") Management expects that the consummation of the Pending Acquisition will initially reduce loans as a percent of average earning assets and will have a corresponding negative impact on the Company's tax equivalent net interest income as a percent of average earning assets. Management expects overtime to reinvest the assets into loans following consummation of the transaction. 12
14 NET INTEREST INCOME AND SELECTED RATIOS <TABLE> <CAPTION> Three months Nine Months ended September 30 ended September 30, 1996 1995 1996 1995 -------- -------- -------- -------- <S> <C> <C> <C> <C> Average earning assets (In thousands) $727,854 $524,797 $634,128 $501,274 As a percent of average earning assets Tax equivalent interest income 9.05% 9.20% 9.14% 9.13% Interest expense 3.82 3.59 3.70 3.44 Tax equivalent net interest income 5.23 5.61 5.45 5.69 Average earning assets as a percent of average assets 93.24% 94.51% 94.25% 94.34% Free-funds ratio 11.18% 11.74% 11.80% 12.41% </TABLE> NON-INTEREST INCOME Non-interest income increased during both the three- and nine-month periods ended September 30, 1996. Non-interest income increased by $355,000 to $1,412,000 during the three-month period and by $1,325,000 to $3,981,000 during the nine-month period. The increases are principally the result of increases in net gains on the sale of real estate mortgage loans and the impact of the NBC Acquisition. Net gains on the sale of real estate mortgage loans totaled $363,000 during the three months ended September 30, 1996, compared to $301,000 during the comparable period of 1995. During the nine-month periods in 1996 and 1995, such net gains totaled $1,251,000 and $405,000, respectively. Although the majority of the increase in such net gains reflects favorable economic conditions and an increase in loans sold, Management attributes 45% of the increase to the impact of SFAS #122 and the sale of related servicing rights on loans totaling approximately $28.8 million. A year earlier, the related servicing rights were sold on loans totaling approximately $11.9 million. (See "Statements of Financial Accounting Standards.") <TABLE> <CAPTION> Three months ended Nine months ended September 30, September 30, 1996 1995 1996 1995 ---------- ----------- ------------ ----------- <S> <C> <C> <C> <C> Real estate mortgage loan originations $57,400,000 $55,900,000 $166,100,000 $118,100,000 Real estate mortgage loan sales 20,700,000 18,700,000 80,000,000 33,400,000 Net gains on the sale of real estate mortgage loans 363,000 301,000 1,251,000 405,000 Net gains as a percent of real estate mortgage loans sold 1.75% 1.61% 1.56% 1.21% </TABLE> 13
15 Consistent with Management's Alternate Loan Funding Strategy, The Banks' retain the majority of adjustable-rate and balloon real estate mortgage loans. (See "Asset/liability management.") Accordingly, the volume of loans sold is dependent upon the Banks' ability to originate real estate mortgage loans as well as consumer demand for fixed-rate loans. Net gains on the sale of 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 realized net gains of $16,000 on the sale of securities available for sale during the three months ended September 30, 1996, compared to net losses of $24,000 during the comparable period of 1995. During the nine-month periods in 1996 and 1995, the Banks realized net losses of $130,000 and $110,000, respectively. (See "Asset/liability management.") SALES OF SECURITIES AVAILABLE FOR SALE <TABLE> <CAPTION> Nine months ended September 30, 1996 1995 ----------- ----------- <S> <C> <C> Proceeds $15,907,000 $13,152,000 =========== =========== Gross gains $ 44,000 $ 7,000 Gross losses (174,000) (117,000) ----------- ----------- Net losses $ (130,000) $ (110,000) =========== =========== </TABLE> NON-INTEREST EXPENSE Non-interest expense totaled $7,634,000 during the three months ended September 30, 1996, compared to $5,578,000 during the comparable period of 1995. During the nine-month periods in 1996 and 1995, non-interest expense totaled $19,804,000 and $15,897,000, respectively. The NBC Acquisition accounts for approximately $1,300,000 and $1,700,000 of the increase in non-interest expense during the three- and nine-month periods, respectively. Costs associated with the origination and sale of real estate mortgage loans also accounts for a substantial portion of the increase in non-interest expense. Management estimates that such costs, including, but not limited to, commissions and other variable expenses, account for approximately 35% of the increase in total non-interest expense during the nine month period. Costs associated with new branch facilities, a write down of other real estate as well as the introduction of the new "EZ Money" check card and the related ATM conversion also contributed to the increase in non-interest expense. A reduction in FDIC insurance expense, however, offset a portion of the increase in total non-interest expense. During the three months ended September 30, 1996, the Banks' insurance assessment totaled $64,000 compared to $10,000 in 1995. The Banks' insurance assessment for the nine-month periods in 1996 and 1995 totaled $92,000 and $454,000, respectively. 14
16 STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS The Company adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights," ("SFAS #122") effective January 1, 1996. SFAS #122 requires the Banks to recognize as separate assets the rights to service mortgage loans for others that have been acquired through either a purchase or origination of a loan. The fair value of capitalized originated mortgage servicing rights has been determined based on market value quotes for similar servicing. These mortgage servicing rights are amortized in proportion to and over the period of estimated net loan servicing income. SFAS #122 also require the Banks to assess these mortgage servicing rights for impairment based on the fair value of those rights. For purposes of measuring impairment, the risk characteristics used by the Banks include the underlying loans' interest rates, term of loan and loan types. The Banks had no valuation allowance relating to impairment at September 30, 1996. The Banks capitalized approximately $258,000 of originated servicing rights during the nine months ended September 30, 1996, of which approximately $34,000 has been amortized. The Company also adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS #123"), effective January 1, 1996. SFAS #123 encourages companies to adopt a fair value method of accounting for stock compensation plans. Those companies not adopting a fair value method are required to make pro-forma disclosures of net income and earnings per share, on an annual basis, as if they had adopted the fair value accounting method. Management has elected the pro-forma disclosure method and will do so on an annual basis. 15
17 Item 6. Exhibits & Reports on Form 8-K (a) Exhibit Number & Description Exhibit 27 Financial Data Schedule (b) Reports on Form 8-K A report on Form 8-K/A was filed August 9, 1996 amending an 8-K previously filed on June 13, 1996. 16
18 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 October 17, 1996 By s/William R. Kohls ---------------- ------------------------------------- William R. Kohls, Principal Financial Officer Date October 17, 1996 By s/James J. Twarozynski ---------------- ------------------------------------- James J. Twarozynski, Principal Accounting Officer 17
19 EXHIBIT INDEX <TABLE> <CAPTION> Exhibit No. Description Page - ------- ----------- ---- <S> <C> <C> 27 Financial Data Schedule </TABLE>