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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 [No Fee Required]
For the Fiscal Year Ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the Transition Period From __________ to ___________
Commission File Number: 0-15734
REPUBLIC BANCORP INC.
(Exact name of registrant as specified in its charter)
Michigan 38-2604669
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1070 East Main Street, Owosso, Michigan 48867
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (517) 725-7337
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $5.00 Par Value
(Title of class)
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
The aggregate market value of the Registrant's common stock held by
non-affiliates, based on the closing price on March 6, 1998 of $19.00, was
$313.8 million.
Number of shares of Registrant's common stock outstanding as of March 6,
1998: 18,678,846
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of Registrant's definitive proxy statement dated March 18, 1998
("1998 Proxy Statement") filed with the Commission (Part III).
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FORM 10-K TABLE OF CONTENTS
Part I Page
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Item 1 - Business................................................. 2
General Description.................................... 2
Business Segments...................................... 3
Competition............................................ 4
Employees.............................................. 5
Principal Sources of Revenue........................... 5
Monetary Policy and Economic Controls.................. 5
Supervision and Regulation............................. 5
Forward-Looking Statements............................. 9
Executive Officers of the Registrant................... 9
Item 2 - Properties............................................... 10
Item 3 - Legal Proceedings........................................ 10
Item 4 - Submission of Matters to a Vote of Security Holders...... 10
Part II
Item 5 - Market for Registrant's Common Stock and Related
Stockholder Matters.................................... 10
Item 6 - Selected Financial Data.................................. 11
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 12
Item 7A- Quantitative and Qualitative Disclosures
about Market Risk...................................... 31
Item 8 - Financial Statements and Supplementary Data.............. 32
Item 9 - Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 62
Part III
Item 10 - Directors and Executive Officers of the Registrant....... 62
Item 11 - Executive Compensation................................... 62
Item 12 - Security Ownership of Certain Beneficial Owners
and Management......................................... 62
Item 13 - Certain Relationships and Related Transactions........... 62
Part IV
Item 14 - Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................ 63
Signatures.......................................................... 65
1
PART I
ITEM 1. BUSINESS
General Description
Republic Bancorp Inc. (the "Company") is a bank holding company incorporated
under the laws of the State of Michigan in 1986. The Company's principal
office is located in Ann Arbor, Michigan. Currently, the Company has 112
banking and mortgage banking offices in 21 states.
Through its two wholly-owned banking subsidiaries--Republic Bank and
Republic Savings Bank--the Company provides commercial and retail banking
products and services. Together, the subsidiary banks operate 35 commercial
and retail banking offices and 9 mortgage loan production offices in
Michigan, Ohio and Indiana. Republic Bank, a state-chartered bank
headquartered in Ann Arbor, Michigan, exercises the powers of a full-service
commercial bank and operates 26 offices in seven market areas in Michigan. At
December 31, 1997, Republic Bank had $1.3 billion in assets and $894 million
in deposits. Republic Savings Bank, a state-chartered savings bank
headquartered in Pepper Pike, Ohio, exercises the powers of a full-service
savings bank and operates 18 offices primarily in the greater Cleveland area
as well as Columbus, Dayton and Cincinnati, Ohio and Indianapolis, Indiana.
At December 31, 1997, Republic Savings Bank had $492 million in assets and
$320 million in deposits.
To complement its commercial and retail banking activities, the Company
has grown a nationwide mortgage lending network through various nonbank
companies engaged in the mortgage banking business. Market Street Mortgage
Corporation ("Market Street Mortgage") is an 80% majority-owned mortgage
banking subsidiary of Republic Bank with headquarters in Clearwater, Florida,
and 44 offices in 13 states. Republic Bancorp Mortgage Inc. ("Republic
Bancorp Mortgage") is a wholly-owned mortgage banking subsidiary of Republic
Bank with headquarters in Farmington Hills, Michigan, and 17 offices in 5
states. CUB Funding Corporation ("CUB Funding") is a wholly-owned mortgage
banking subsidiary of Republic Bank with headquarters in Clearwater, Florida,
and 7 offices in 3 states.
The Company, on an ongoing basis, evaluates its existing business
operations and organizational structures and routinely explores opportunities
to acquire financial institutions and other financial services-related
businesses, particularly mortgage origination networks and related assets. In
September 1997, the Company acquired certain assets and the mortgage
origination network of Exchange Mortgage Corporation of Southfield, Michigan,
including its sub-prime mortgage lending division, Union Mortgage Services,
Inc. In July 1997, the parent company transferred its 80% ownership interest
in Market Street Mortgage to Republic Bank, effectively reducing funding
costs. In May 1997, the Company completed the sale of four southern Michigan
branches of Republic Bank to concentrate the expansion of its
deposit-gathering capabilities in more growth-oriented areas of the state.
Also, in 1997, Market Street Mortgage assumed responsibility for the
management of CUB Funding Corporation to allow for the sharing of best
practices between the two organizations, marketing synergies, enhanced sales
efforts, and improved operating results.
At December 31, 1997, the Company had consolidated total assets of $1.9
billion, total deposits of $1.2 billion and shareholders' equity of $131.1
million. For the year ended December 31, 1997, the Company reported net
income of $18.8 million, compared to $14.7 million for 1996. Residential
mortgage loan closings totaled $3.9 billion in 1997, compared to $3.6 billion
in 1996. Commercial loan closings totaled $178 million in 1997 versus $122
million in 1996. Small Business Administration (SBA) loan closings totaled
$28 million in 1997, compared to $24 million in 1996. At December 31, 1997,
the Company's mortgage loan servicing portfolio was $3.1 billion, compared to
$2.7 billion at year-end 1996.
2
Business Segments
The Company engages in two lines of business--Commercial and Retail Banking
and Mortgage Banking.
Commercial and Retail Banking
- -----------------------------
Commercial and retail banking is conducted at 35 branches of Republic
Bank and Republic Savings Bank by providing traditional commercial and retail
banking products and services to consumers and small- to medium-size
businesses. Products and services offered include commercial loans; small
business loans; mortgage portfolio loans; home equity loans and lines of
credit; other types of installment loans; and demand, savings and time
deposit accounts. Lending activity at the banking subsidiaries is primarily
focused on real estate-secured lending to minimize credit risk (e.g., fixed
rate and variable rate residential mortgage loans; residential construction
loans; commercial real estate mortgage loans; and commercial real estate
construction loans). In addition, emphasis is placed on loans that are
government guaranteed or insured, such as Small Business Administration (SBA)
loans, United States Department of Agriculture (USDA) loans, and FHA/VA
loans. Commercial and industrial loans are made to a lesser extent and are
typically secured by the customer's assets at a 75% or less loan-to-value
ratio and by personal guarantees.
The Company's banking subsidiaries target their marketing efforts toward
a particular segment of the consumer population that is interested in
receiving personalized banking service and attention when handling
transactions related to their deposit accounts. The Company's deposit base
consists primarily of retail deposits gathered from within local markets
served. At December 31, 1997, retail deposits comprised 83% of total
deposits.
Mortgage Banking
- ----------------
Mortgage banking activities encompass two areas: mortgage loan production
and mortgage loan servicing. Mortgage loan production involves the
origination and sale of single-family residential mortgage loans. Mortgage
lending is conducted by all of the Company's affiliates. All mortgage loan
originations are funded by the Company's banking subsidiaries.
Retail residential mortgage loans are originated by the Company's own
sales staff through 76 retail mortgage loan production offices and 35 retail
banking offices located in Michigan, Alabama, Arizona, California, Colorado,
Connecticut, Florida, Georgia, Illinois, Indiana, Maryland, Massachusetts,
Missouri, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Texas, Utah
and Virginia. Each retail loan production office is responsible for
processing loan applications received and preparing loan documentation. Loan
applications are then evaluated by the underwriting departments of either the
Company's banking or mortgage banking affiliates for compliance with the
Company's underwriting criteria, including loan-to-value ratios, borrower
qualifications and required insurance. The Company also maintains a wholesale
production office in California that engages in the purchase of residential
loans from brokers. Residential loans purchased through the wholesale
operation are processed and prepared by the brokers. The Company's quality
control personnel subsequently review these loans using certain verification
procedures.
The Company originates primarily conventional mortgage loans secured by
residential properties which conform to the underwriting guidelines for sale
to the Federal National Mortgage Association (FNMA) and the Federal Home Loan
Mortgage Corporation (FHLMC). Loans guaranteed by the Department of Veterans
Affairs (VA) and insured through the Federal Housing Administration (FHA) are
originated in compliance with their underwriting guidelines permitting
conversion of such loans into mortgage-backed securities issued by the
Government National Mortgage Association (GNMA).
Growth in the Company's residential mortgage origination business during
1997 was funded primarily with the subsidiary banks' retail deposits and
short-term borrowings, including federal funds purchased and Federal Home
Loan Bank (FHLB) advances. The majority of all mortgage loans originated are
held for a short period of time (generally less than 60 days) with the intent
of selling them to investors in the secondary market. These loans are
classified as mortgage loans held for sale in the Company's consolidated
balance sheet. Mortgage loans held for sale consist of loans that will be
sold directly to secondary market investors or loans that are being prepared
for securitization into mortgage-backed securities; however, the
mortgage-backed security has not yet been formed and issued. These mortgage
loans held for sale are typically sold without recourse to the Company in the
event of default by the borrowers. To minimize interest rate risk, the
Company obtains mandatory purchase commitments from investors prior to
funding the loans.
3
Consistent with the Company's strategy of managing interest rate risk,
substantially all long-term fixed rate mortgages originated are typically
securitized and sold or sold directly to secondary market investors. The
majority of short-term fixed rate mortgages and variable rate mortgages are
typically securitized and sold or sold directly to secondary market
investors, although a portion of the variable rate mortgages may be retained
in the loan portfolios of Republic Bank and Republic Savings Bank for
investment purposes. Portfolio loans may be securitized and reclassified as
securities available for sale.
When the Company sells originated or purchased residential mortgage loans
to investors, it makes a determination to either retain or sell the rights to
service those loans. Servicing rights may also be acquired through bulk
purchases of loans. While there is an active market for selling servicing
rights (which are generally valued in relation to the present value of the
anticipated cash flow generated by the servicing rights), the aggregation of
a servicing portfolio creates a substantial continuing source of income and
enables the Company to reduce the sensitivity of its earnings to changes in
interest rates.
Mortgage loan servicing is conducted primarily by Market Street Mortgage,
which receives servicing fees ranging from 25 to 45 basis points per annum on
its servicing portfolio. The mortgage loan servicing function involves the
administration of loans; collection and remittance of loan payments; receipt
of escrow funds for payment of taxes and insurance; counseling of delinquent
mortgagors and supervision of foreclosures and property dispositions in the
event of unremedied defaults.
The Company's current operating strategy for the mortgage banking segment
is to continue growing mortgage banking revenue and related interest income
while managing interest rate and liquidity risks. To help accomplish this
objective, the Company expanded its target market for mortgage customers
during 1997 by opening 13 new mortgage loan production offices and by
entering the sub-prime mortgage lending market in the Midwest. (All sub-prime
mortgage loans originated are sold to the secondary market.) Selling mortgage
loans to investors in the secondary market provides additional revenue,
although the level of this activity is dependent upon market conditions at
the time of sale. The Company also earns fees for originating and servicing
loans. In addition, the mortgage banking segment effectively earns long-term
interest rates on mortgage loans held for sale which helps the Company to
minimize interest rate risk.
Competition
Commercial and Retail Banking and Mortgage Banking are highly competitive
businesses in which the Company faces numerous banking and non-banking
institutions as competitors. By reason of changes in Federal law (which
became effective on September 29, 1995) and Michigan law (which became
effective on November 29, 1995) the number and types of potential depository
institution competitors have substantially increased.
In addition to competition from other banks, the Company continues to
face increased competition from other types of financial services
organizations. Competition from finance companies and credit unions has
increased in the areas of consumer lending and deposit gathering. The
Company's mortgage banking affiliates also face significant competition from
numerous bank and non-bank companies in the area of mortgage lending.
Generally, other financial institutions have greater resources to use in
making acquisitions and higher lending limits than those of the Company's
banking subsidiaries or any banking institution that the Company could
acquire. Such institutions may also provide certain non-traditional financial
products and services to their customers which the Company's banking
subsidiaries currently do not offer (e.g., trust services, brokerage services
and insurance products).
The principal factors of competition in the markets for deposits and
loans are price (interest rates paid and/or fees charged) and customer
service. The Company's banking subsidiaries compete for deposits by offering
depositors a variety of checking and savings accounts, time deposits,
convenient office locations and personalized customer services. The Company
competes for loans through the efficiency and quality of the services it
provides to borrowers, real estate brokers and home builders. The Company
seeks to compete for loans primarily on the basis of customer service,
including prompt underwriting decisions and funding of loans, and by offering
a variety of loan programs as well as competitive interest rates.
4
Employees
As of December 31, 1997, the Company and its subsidiaries had 1,426 full-time
equivalent employees.
Principal Sources of Revenue
The principal sources of revenue for the Company are interest income from
interest and fees on loans and mortgage banking revenue. Interest and fees on
loans totaled $105.8 million in 1997, an increase of 32% from $80.4 million
in 1996 and up 48% from $71.5 million in 1995. In 1997, interest and fees on
loans accounted for 48% of total revenues, compared to 42% of total revenues
in both 1996 and 1995. Mortgage banking revenue, the largest component of
noninterest income, totaled $93.7 million in 1997, an increase of 8% from
$86.4 million in 1996 and up 32% from $71.0 million in 1995. Mortgage banking
revenue represented 42% of total revenues in 1997, compared to 45% in 1996
and 42% in 1995.
Monetary Policy and Economic Controls
The earnings of the banking subsidiaries, and, therefore, the earnings of the
Company, are affected by the policies of regulatory authorities, including
the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board"). An important function of the Federal Reserve Board is to promote
orderly economic growth by influencing interest rates and the supply of money
and credit. Among the methods that have been used to achieve this objective
are open market operations in U.S. government securities, changes in the
discount rate on member bank borrowings, and changes in reserve requirements
against bank deposits. These methods are used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, interest rates on loans and securities, and rates paid for
deposits.
The Federal Reserve Board's monetary policies strongly influence the
behavior of interest rates and can have a significant effect on the operating
results of commercial banks and mortgage banking companies. Continued
moderate price inflation in 1997 contributed to the decision of the Federal
Reserve Board to hold short-term interest rates stable. The effects of the
various Federal Reserve Board policies on the future business and earnings of
the Company cannot be predicted. Other economic controls also have affected
the Company's operations in the past. The Company cannot predict the nature
or extent of any effects that possible future governmental controls or
legislation may have on its business and earnings.
Supervision and Regulation
General
- -------
Bank holding companies, banks and savings banks are highly regulated at both
the state and federal level. As a bank holding company, the Company is
subject to supervision and regulation by the Federal Reserve Board under the
Bank Holding Company Act of 1956, as amended (the "BHC Act"). Under the BHC
Act, the Company is prohibited from engaging in activities other than those
of banking or of managing or controlling banks and from acquiring or
retaining direct or indirect ownership or control of voting shares of any
company which is not a bank or bank holding company, unless the activities
engaged in by the Company or the company whose voting shares are acquired by
the Company are activities which the Federal Reserve Board determines to be
so closely related to the business of banking as to be a proper incident
thereto.
Republic Bank is chartered by the State of Michigan and is supervised and
regulated by the Financial Institutions Bureau of the State of Michigan (the
"FIB"). Republic Savings Bank is chartered by the State of Ohio and is
supervised and regulated by the Ohio Superintendent of the Division of
Financial Institutions. As insured state banks, Republic Bank and Republic
Savings Bank are also regulated by the Federal Deposit Insurance Company
("FDIC").
The Company is a legal entity separate and distinct from its banking
subsidiaries. Most of the Company's revenues result from dividends paid to it
by its bank subsidiaries. There are statutory and regulatory requirements
applicable to the payment of dividends by subsidiary banks to the Company as
well as by the Company to its shareholders.
5
Under Federal Reserve Board policy, the Company is expected to act as a
source of financial and managerial strength to Republic Bank and to Republic
Savings Bank and to commit resources to support them. This support may be
required at times when, in the absence of such Federal Reserve Board policy,
the Company would not otherwise be required to provide it.
Interstate Banking and Branching
- --------------------------------
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Act"), among other things: (i) permits bank holding companies to
acquire control of banks in any state, subject to (a) specified maximum
national state deposit concentration limits; (b) any applicable state law
provisions requiring the acquired bank to be in existence for a specified
period of up to five years; (c) any applicable nondiscriminatory state
provisions that make an acquisition of a bank contingent upon a requirement
to hold a portion of such bank's assets available for call by a state
sponsored housing entity; and (d) applicable anti-trust laws; (ii) authorizes
interstate mergers by banks in different states (and retention of interstate
branches resulting from such mergers) beginning June 1, 1997, subject to the
provisions noted in (i) and to any state laws that "opt-out" of the provision
entirely; and (iii) authorizes states to enact legislation permitting
interstate de novo branching.
The Michigan Banking Code permits, in appropriate circumstances and with
notice to, or the approval of the Commissioner of the FIB, (i) acquisition of
Michigan-chartered banks (such as Republic Bank) by FDIC-insured banks,
savings banks or savings and loan associations located in other states, (ii)
the sale by a Michigan-chartered bank of one or more of its branches (not
comprising all or substantially all of its assets) to an FDIC-insured bank,
savings bank or savings and loan association located in a state in which a
Michigan-chartered bank could purchase one or more branches of the purchasing
entity, (iii) the acquisition by a Michigan-chartered bank of an FDIC-insured
bank, savings bank or savings and loan association located in another state,
(iv) the acquisition by a Michigan-chartered bank of one or more branches
(not comprising all or substantially all of the assets) of an FDIC-insured
bank, savings bank or savings and loan association located in another state,
(v) the consolidation of one or more Michigan-chartered banks and
FDIC-insured banks, savings banks or savings and loan associations located in
other states with the resulting organization chartered either by Michigan or
one of such other states, (vi) the establishment by Michigan-chartered banks
of branches located in other states, the District of Columbia, or U.S.
territories or protectorates, (vii) the establishment of branches in Michigan
by FDIC-insured banks located in other states, the District of Columbia, or
U.S. territories or protectorates having laws permitting a Michigan-chartered
bank to establish a branch in such jurisdiction, and (viii) the establishment
by foreign banks of branches located in Michigan.
Dividends
- ---------
Michigan and Ohio law, respectively, place specific limits on the source and
amount of dividends which may be paid by Republic Bank and Republic Savings
Bank, respectively. The payment of dividends by the Company and its bank
subsidiaries is also affected by various regulatory requirements and
policies, such as the requirement to maintain adequate capital above
regulatory guidelines. The "prompt corrective action" provisions of the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
impose further restrictions on the payment of dividends by insured banks
which fail to meet specified capital levels and, in some cases, their parent
bank holding companies. FDICIA generally prohibits a depository institution
from making any capital distribution (including payment of a dividend) or
paying any management fee to its holding company if the depository
institution would thereafter be undercapitalized.
The FDIC may prevent an insured bank from paying dividends if the bank is
in default of payment of any assessment due to the FDIC. In addition, payment
of dividends by a bank may be prevented by the applicable federal regulatory
authority if such payment is determined, by reason of the financial condition
of such bank, to be an unsafe and unsound banking practice. The Federal
Reserve Board has issued a policy statement providing that bank holding
companies and insured banks should generally only pay dividends out of
current operating earnings.
These regulations and restrictions may limit the Company's ability to
obtain funds from its subsidiaries for its cash needs, including funds for
acquisitions, payment of dividends and interest and the payment of operating
expenses.
6
FIRREA
- ------
Banking legislation, including the Financial Institutions Reform and Recovery
and Enforcement Act of 1989 ("FIRREA") and FDICIA, has broadened the
regulatory powers of the federal bank regulatory agencies. Under FIRREA, a
depository institution insured by the FDIC shall be liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC in connection
with (i) the default of a commonly controlled FDIC-insured depository
institution, or (ii) any assistance provided by the FDIC to any commonly
controlled FDIC-insured depository institution "in danger of default."
"Default" is defined generally as the appointment of a conservator or
receiver and "in danger of default" is defined as the existence of certain
conditions indicating that a default is likely to occur in the absence of
regulatory assistance.
FDICIA
- ------
In December 1991, FDICIA was enacted, substantially revising the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and
making revisions to several other federal banking statutes. Among other
things, FDICIA requires the federal banking agencies to take "prompt
corrective action" in respect of depository institutions that do not meet
minimum capital requirements. FDICIA establishes five capital tiers:
"well-capitalized," "adequately capitalized," "undercapitalized,"
"significantly under capitalized" and "critically undercapitalized." A
depository institution's capital tier will depend upon where its capital
levels are in relation to various relevant capital measures, which will
include a risk-based capital measure and a leverage ratio capital measure,
and certain other factors.
Regulations establishing the specific capital tiers provide that, for an
institution to be well capitalized it must have a total risk-based capital
ratio of at least 10 percent, a Tier 1 risk-based capital ratio of at least 6
percent, a Tier 1 leverage ratio of at least 5 percent, and not be subject to
any specific capital order or directive. For an institution to be adequately
capitalized it must have a total risk-based capital ratio of at least 8
percent, a Tier 1 risk-based capital ratio of at least 4 percent, and a Tier
1 leverage ratio of at least 4 percent (and in some cases 3 percent). Under
these regulations, the banking subsidiaries of the Company would be
considered to be well capitalized as of December 31, 1997.
FDICIA directs that each federal banking agency prescribe standards for
depository institutions and depository institution holding companies relating
to internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, asset quality, earnings, stock valuation and other standards as
they deem appropriate. Such standards were issued jointly by the agencies on
August 9, 1995, in guideline form.
FDICIA also contains a variety of other provisions that may affect the
operations of depository institutions including new reporting requirements,
regulatory standards for real estate lending, "truth in savings" provisions,
the requirement that a depository institution give 90 days prior notice to
customers and regulatory authorities before closing any branch and a
prohibition on the acceptance or renewal of brokered deposits by depository
institutions that are not well capitalized or are adequately capitalized and
have not received a waiver from the FDIC. Under regulations relating to the
brokered deposit prohibition, the Company's subsidiary banks are all
well-capitalized and may accept brokered deposits without restriction.
FDIC Insurance Assessments
- --------------------------
Republic Bank is generally subject to FDIC deposit insurance assessments paid
to the Bank Insurance Fund ("BIF"). Republic Savings is subject to FDIC
deposit insurance assessments paid to the Savings Association Insurance Fund
("SAIF"). Pursuant to FDICIA, the FDIC has implemented a risk-based
assessment scheme. Under this arrangement, each depository institution is
assigned to one of nine categories (based upon three categories of capital
adequacy and three categories of perceived risk to the applicable insurance
fund). Pursuant to the Omnibus Consolidated Appropriations Act, 1997
("OCAA"), a special one-time assessment was made by the FDIC in October 1996,
on SAIF-insured deposits to bring the SAIF to its mandated reserve ratio of
1.25% of aggregate SAIF-insured deposits by January 1, 1997. OCAA
contemplates the merger of the BIF and SAIF into a single Deposit Insurance
Fund ("DIF") on January 1, 1999, under certain conditions.
7
Mortgage Banking Affiliates
- ---------------------------
The Company's non-depository mortgage banking affiliates, Market Street
Mortgage, Republic Bancorp Mortgage and CUB Funding (collectively referred to
as the "mortgage companies") are engaged in the business of originating,
selling and servicing mortgage loans secured by residential real estate. In
the origination of mortgage loans, the mortgage companies are subject to
State usury and licensing laws and to various federal statutes, such as the
Equal Credit Opportunity Act, Fair Credit Reporting Act, Truth in Lending
Act, Real Estate Settlement Procedures Act, and Home Mortgage Disclosure Act,
and the regulations promulgated thereunder, which prohibit discrimination,
specify disclosures to be made to borrowers regarding credit and settlement
costs, and regulate the mortgage loan servicing activities of such entities,
including the maintenance and operation of escrow accounts and the transfer
of mortgage loan servicing.
CUB Funding purchases mortgage loans from approved brokers after they
perform their own underwriting review of the mortgage loans. Brokers qualify
to participate in CUB Funding's wholesale program only after a review of
their financial condition, including a review of references and financial
statements. In such activities, CUB Funding is also subject to applicable
usury and other state and federal laws, including various states' licensing
statutes.
As sellers and servicers of mortgage loans, the mortgage companies are
participants in the secondary mortgage market with some or all of the
following: private institutional investors, FNMA, GNMA, FHLMC, VA and FHA. In
their dealings with these agencies, the mortgage companies are subject to
various eligibility requirements prescribed by the agencies, including but
not limited to net worth, quality control, bonding, financial reporting and
compliance reporting requirements. The mortgage loans which they originate
and purchase are subject to agency-prescribed procedures, including, without
limitation, inspection and appraisal of properties, maximum loan-to-value
ratios, and obtaining credit reports on prospective borrowers. On some types
of loans, the agencies prescribe maximum loan amounts, interest rates and
fees. When selling mortgage loans to FNMA, FHLMC, GNMA, VA and FHA, each of
the mortgage companies represents and warrants that all such mortgage loans
sold by it conform to their requirements. If the mortgage loans sold are
found to be non-conforming mortgage loans, such agency may require the seller
(i.e., Republic Bancorp Mortgage, Market Street Mortgage or CUB Funding) to
repurchase the non-conforming mortgage loans. Additionally, FNMA, FHLMC,
GNMA, VA and FHA may require the mortgage companies to indemnify them against
all losses arising from their failure to perform their contractual
obligations under the applicable selling or servicing contract. Certain
provisions of the Housing and Community Development Act of 1992, and
regulations adopted thereunder may affect the operations and programs of FNMA
and FHLMC.
Regulation of Proposed Acquisitions
- -----------------------------------
In general, any direct or indirect acquisition by the Company of any voting
shares of any bank which would result in the Company's direct or indirect
ownership or control of more than 5% of any class of voting shares of such
bank, and any merger or consolidation of the Company with another bank
holding company, will require the prior written approval of the Federal
Reserve Board under the BHC Act. In acting on such applications, the Federal
Reserve Board must consider various statutory factors, including among
others, the effect of the proposed transaction on competition in relevant
geographic and product markets, and each party's financial condition,
managerial resources, and record of performance under the Community
Reinvestment Act.
The merger or consolidation of an existing bank subsidiary of the Company
with another bank, or the acquisition by such a subsidiary of assets of
another bank, or the assumption of liability by such a subsidiary to pay any
deposits in another bank, will require the prior written approval of the
responsible Federal depository institution regulatory agency under the Bank
Merger Act, based upon a consideration of statutory factors similar to those
outlined above with respect to the BHC Act. In addition, an application to,
and the prior approval of, the Federal Reserve Board may be required under
the BHC Act, in certain such cases.
Each of the foregoing types of applications is subject to public notice
and comment procedures, and, in many cases, to prior notice and/or approval
of Federal and State bank regulatory authorities. Adverse public comments
received, or adverse considerations raised by the regulatory agencies, may
delay or prevent consummation of the proposed transaction.
8
Forward-Looking Statements
Certain statements contained in this Annual Report on Form 10-K which are not
statements of historical fact constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act (the "Act"),
including, without limitation, the statements specifically identified as
forward-looking statements within this document. In addition, certain
statements in future filings by the Company with the Securities and Exchange
Commission, in press releases, or in oral and written statements made by or
with the approval of the Company which are not statements of historical fact
constitute forward-looking statements within the meaning of the Act. Examples
of forward-looking statements include, but are not limited to: (i)
projections of revenues, income or loss, earnings or loss per share, the
payment or non-payment of dividends, capital structure and other financial
items, (ii) statements of plans and objectives of the Company or its
management or Board of Directors, including those relating to products or
services, (iii) statements of future economic performance and (iv) statements
of assumptions underlying such statements. Words such as "believes",
"anticipates", "expects", "intends", "plans", "targets" and similar
expressions are intended to identify forward-looking statements but are not
the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties which may
cause actual results to differ materially from those in such statements.
Factors that could cause actual results to differ from those discussed in the
forward-looking statements include, but are not limited to: (i) the strength
of the U.S. economy in general and the strength of the local economies in
which operations are conducted; (ii) the effects of and changes in trade,
monetary and fiscal policies and laws, including interest rate policies of
the Federal Reserve Board; (iii) inflation, interest rate, market and
monetary fluctuations; (iv) the timely development of and acceptance of new
products and services and perceived overall value of these products and
services by users; (v) changes in consumer spending, borrowing and saving
habits; (vi) technological changes; (vii) acquisitions; (viii) the ability to
increase market share and control expenses; (ix) the effect of changes in
laws and regulations (including laws and regulations concerning taxes,
banking, and securities) with which the Company and its subsidiaries must
comply; (x) the effect of changes in accounting policies and practices, as
may be adopted by the regulatory agencies as well as the Financial Accounting
Standards Board, (xi) changes in the Company's organization, compensation and
benefit plans; (xii) the costs and effects of litigation and of unexpected or
adverse outcomes in such litigation; and (xiii) the success of the Company at
managing risks involved in the foregoing.
Such forward-looking statements speak only as of the date on which such
statements are made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date
on which such statement is made to reflect the occurrence of unanticipated
events.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of all the executive officers (5) of the Company
as of December 31, 1997. All of these officers are elected annually by the
Board of Directors. Excluding Mr. Parker, each of the executive officers has
served as an officer of the Company for more than five years. Prior to
joining the Company in 1997, Mr. Parker was a principal in the law firm of
Miller, Canfield, Paddock & Stone, PLC, Detroit, Michigan, for more than
twenty-five years. There are no family relationships among any of the
executive officers.
Name Age Position
- ---- --- --------
Jerry D. Campbell.................. 57 Chairman of the Board and Chief
Executive Officer (Since 1985)
Dana M. Cluckey, CPA............... 38 President and Chief Operating
Officer (Since 1986)
Barry J. Eckhold................... 51 Vice President and Chief Credit
Officer (Since 1990)
Thomas F. Menacher, CPA............ 41 Senior Vice President, Treasurer
and Chief Financial Officer
(Since 1992)
George E. Parker III............... 63 General Counsel and Corporate
Secretary (Since 1997)
9
ITEM 2. PROPERTIES
The Company's executive offices are located at 1070 East Main Street,
Owosso, Michigan 48867. At December 31, 1997, the Company had 35 banking
locations, of which eight were owned and 27 were leased, and 77 mortgage loan
production offices, all of which were leased. All of these offices are
considered by management to be well maintained and adequate for the purpose
intended. See Note 7 of the Notes to Consolidated Financial Statements
included under Item 8 of this document for further information on properties.
ITEM 3. LEGAL PROCEEDINGS
The information required by this Item is set forth in Note 17 of the
Notes to Consolidated Financial Statements included under Item 8 of this
document and is expressly incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Quarterly Dividends and Market Price Summary
Common Stock
Dividends Price Range (1)
Declared ----------------
Per Share (1) High Low
------------- ---- ---
1997
Fourth quarter .......... $ 0.100 $21.375 $15.250
Third quarter ........... 0.091 15.000 13.000
Second quarter .......... 0.091 13.250 11.500
First quarter ........... 0.091 12.375 10.750
-------
Year ................ $ 0.373 $21.375 $10.750
=======
1996
Fourth quarter .......... $ 0.091 $11.250 $ 9.875
Third quarter ........... 0.083 10.000 9.000
Second quarter .......... 0.083 9.750 9.125
First quarter ........... 0.083 9.875 8.750
-------
Year ................ $ 0.340 $11.250 $ 8.750
=======
- ---------
(1) Dividends and market price data have been restated to reflect the
issuance of stock dividends.
The principal market for the quotations of stock prices of the Company's
common stock is The Nasdaq Stock Market. The Company's common stock trades
under the symbol RBNC. There were approximately 13,800 shareholders of record
of the Company's common stock as of March 6, 1998.
10
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Earnings Summary (in thousands)
Interest income $118,852 $ 99,147 $ 95,597 $ 78,219 $ 78,831
Interest expense 71,912 62,427 65,192 44,999 42,268
Net interest income 46,940 36,720 30,405 33,220 36,563
Provision for loan losses 3,031 290 24 94 603
Mortgage banking revenue 93,700 86,377 70,960 69,899 85,128
Other noninterest income 8,815 4,469 4,241 5,762 6,992
Noninterest expense 117,742 104,492(1) 83,152 85,021 93,539
Income before cumulative effect
of a change in accounting principle
and extraordinary item 18,789 15,066 14,264 15,719 22,233
Net income 18,789 14,678 14,264 15,719 23,183
-------- -------- -------- -------- --------
Per Common Share(2)
Basic earnings $ 1.01 $ .76 $ .71 $ .77 $ 1.19
Diluted earnings .99 .74 .69 .75 1.13
Cash dividends declared .37 .34 .28 .22 .15
Book value (year-end) 7.02 6.47 6.34 5.78 5.54
Closing price of common stock (year-end) 21.38 10.57 8.88 7.42 9.39
Dividend payout ratio 37% 46% 40% 30% 13%
-------- -------- -------- -------- --------
Operating Data (in millions)
Loan closings:
Residential mortgage loans $ 3,892 $ 3,581 $ 2,847 $ 2,837 $ 4,911
Commercial loans 175 122 50 27 20
SBA loans 28 24 17 12 7
Mortgage loan servicing portfolio (year-end) 3,113 2,706 3,967 4,669 3,023
-------- -------- -------- -------- --------
Year-End Balances (in millions)
Total assets $ 1,873 $ 1,490 $ 1,473 $ 1,364 $ 1,171
Total earning assets 1,731 1,349 1,323 1,224 1,078
Mortgage loans held for sale 514 329 423 152 508
Total portfolio loans 1,096 785 578 605 407
Total deposits 1,177 1,014 905 819 834
Total short-term borrowings and
FHLB advances 425 255 344 327 160
Long-term debt 48 49 52 56 20
Shareholders' equity 131 122 126 118 111
-------- -------- -------- -------- --------
Ratios
Return on average assets 1.16% 1.02% 1.00% 1.23% 1.94%
Return on average equity 15.09 11.95 11.71 13.43 23.72
Net interest margin (3) 3.16 2.88 2.38 2.88 3.29
Net loan charge-offs to average
total loans (4) .03 .06 .06 .20 .06
Allowance for loan losses as a percentage
of year-end portfolio loans .67 .60 .87 .92 1.77
Non-performing assets as a percentage
of year-end total assets .68 .44 .20 .30 .45
Average shareholders' equity to
average assets 7.69 8.52 8.56 9.14 8.16
Tier 1 risk-based capital 9.75 13.30 15.72 17.57 16.35
Total risk-based capital 10.35 13.84 18.63 21.05 20.19
Tier 1 leverage 6.58 8.16 8.31 8.43 8.43
-------- -------- -------- -------- --------
- ---------
(1) Includes a one-time assessment of $1.5 million ($975,000 after tax, or
$.05 per share) for the recapitalization of the SAIF.
(2) The basic earnings per share amounts prior to 1997 have been restated as
required to comply with Statement of Financial Accounting Standards No.
128, Earnings Per Share. For further discussion of earnings per share and
the impact of Statement No. 128, see the Notes to the Consolidated
Financial Statements beginning on page 37. All per share amounts
presented have been adjusted to reflect the issuance of stock dividends.
(3) Net interest income (FTE) expressed as a percentage of average
interest-earning assets.
(4) Includes mortgage loans held for sale.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Net income for 1997 was $18.8 million, an increase of 28% from net income of
$14.7 million in 1996. Diluted earnings per share rose 34% during the year to
$.99 from $.74 in 1996. In 1995, net income was $14.3 million, or $.69 per
common share. Return on average assets was 1.16% in 1997, compared with 1.02%
in 1996 and 1.00% in 1995. Return on average equity for 1997 was 15.09%,
compared with 11.95% in 1996 and 11.71% in 1995.
Net income for 1996 included an extraordinary loss from the early
redemption of Subordinated Notes of $388,000, after tax, and the after-tax
charge of $975,000 for a one-time special FDIC assessment. Excluding these
items, operating earnings for 1996 were $16.0 million, or $.79 per share.
Return on average assets and return on average equity, excluding these
charges, would have been 1.11% and 13.06%, respectively.
The Company's 1997 results of operations reflected the following trends
in earnings:
o Net interest income increased 28% during 1997 following an increase
of 21% in 1996. Increasing average earning asset balances during
these periods contributed to the growth in net interest income.
o The net interest margin expanded further to 3.16% in 1997, compared
to 2.88% in 1996 and 2.38% in 1995. A shift in average earning assets
away from investment securities and toward higher-yielding loans over
the past two years helped widen the net interest margin.
o Mortgage banking revenue grew 8% during 1997 after climbing 22% in
1996, as a result of record retail lending production volumes.
Shareholders' equity totaled $131.1 million at December 31, 1997. Market
capitalization, which is computed by multiplying the number of shares
outstanding by the closing price of the Company's common stock at year-end,
was $399.2 million at December 31, 1997, a 100% increase from a year earlier.
Capital ratios, by all measures, remain in excess of regulatory requirements.
Acquisitions and Divestitures
In May 1997, the Company completed the sale of four southern Michigan
branches of Republic Bank. The sale included the fixed assets of the
Hillsdale, Litchfield, Somerset Center and Spring Arbor branch offices and
deposits totaling $52 million. The Company recognized a gain of $4.4 million
on the sale.
In September 1997, the Company acquired certain assets and the mortgage
origination network of Exchange Mortgage Corporation of Southfield, Michigan.
The mortgage operation has three offices in Michigan, including a sub-prime
mortgage lending division, Union Mortgage Services. Exchange Mortgage
operates as a division of Republic Bancorp Mortgage Inc. The purchase price
for the assets of Exchange Mortgage was not significant.
Business Segments
The Company's operations are managed as two major business segments: (1)
commercial and retail banking and (2) mortgage banking. Table 1 presents the
financial results of each business segment for the last three years. Business
segment performance is determined based on the Company's management
accounting process, which assigns revenue, expenses and assets to a business
segment using specific identification and an allocation methodology. This
process is somewhat subjective; therefore, the information presented is not
necessarily comparable with similar information for any other financial
institution. Changes in the allocation methodology may result in changes in
allocations and assignments. In that case, however, results for prior periods
would be restated to allow comparability between periods.
The Company's internal management reporting system allocates interest
income and interest expense items by matching the earning asset with the
related funding source. Noninterest income and expenses directly attributable
to a business segment's operations are assigned to that business segment.
Expenses supporting more than one business segment are allocated to each
segment based on the number of employees dedicated to the segment's
operations.
12
Table 1
Business Segment Results
Commercial and
Retail Banking Mortgage Banking Consolidated
------------------------------ ------------------------------ -----------------------------
(In thousands) 1997 1996 1995 1997 1996 1995 1997 1996 1995
- -------------- ---- ---- ---- ---- ---- ---- ---- ---- ----
Interest income $ 93,730 $ 72,706 $ 74,496 $ 25,122 $ 26,441 $ 21,101 $118,852 $ 99,147 $ 95,597
Interest expense 49,052 40,812 43,831 22,860 21,615 21,361 71,912 62,427 65,192
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net interest income(1) 44,678 31,894 30,665 2,262 4,826 (260) 46,940 36,720 30,405
Provision for loan
losses 3,031 290 24 -- -- -- 3,031 290 24
Noninterest
income (3) 8,102 4,469 4,241 94,413 86,377 70,960 102,515 90,846 75,201
Noninterest
expense(2) 28,585 21,221 16,410 89,157 83,271 66,742 117,742 104,492 83,152
-------- -------- -------- -------- -------- -------- -------- -------- --------
Income before taxes $ 21,164 $ 14,852 $ 18,472 $ 7,518 $ 7,932 $ 3,958 $ 28,682 $ 22,784 $ 22,430
======== ======== ======== ======== ======== ======== ======== ======== ========
Depreciation and
amortization $ 2,422 $ 2,265 $ 2,484 $ 9,595 $ 10,609 $ 10,036 $ 12,017 $ 12,874 $ 12,520
Capital expenditures $ 1,640 $ 2,298 $ 2,294 $ 2,360 $ 1,544 $ 1,265 $ 4,000 $ 3,842 $ 3,559
(In millions)
Identifiable assets $ 1,261 $ 1,072 $ 951 $ 612 $ 418 $ 522 $ 1,873 $ 1,490 $ 1,473
- ---------
(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) Noninterest expense for the commercial and retail banking segment in 1996
includes the $1.5 million, pre-tax, SAIF assessment.
(3) Noninterest income for the commercial and retail banking segment in 1997
includes a gain of $4.4 million on the sale of bank branches and
deposits.
Mortgage Banking
The Mortgage Banking segment is comprised of mortgage loan production and
mortgage loan servicing.
Table 2
Residential Mortgage Loan Closings
Year Ended December 31
(Dollars in thousands) 1997 1996 1995
- ---------------------- ---------- --------- ----------
Total closings $3,891,894 $3,580,700 $2,847,490
Retail loans percentage 88% 76% 68%
Wholesale loans percentage 12 24 32
The Company's total closings of single-family residential mortgage loans
increased $311.2 million, or 9%, to $3.9 billion in 1997. The retail portion
of this volume reached a record $3.4 billion in 1997, up 25% from 1996.
Successful sales efforts by our mortgage loan originators and a declining
interest rate environment were major contributors to the growth in retail
loan closings. In addition, total closings for 1997 reflected a full year of
operations for Unlimited Mortgage Services, which was acquired in July 1996.
In 1996, total mortgage loan closings rose $733.2 million, or 26%, to $3.6
billion, reflecting the dual impact on production of a relatively low
interest rate environment and strong retail lending efforts. Retail mortgage
loan closings totaled $2.7 billion in 1996, a 42% increase from 1995.
Wholesale mortgage loan volume declined 43% since 1996 as the Company placed
more emphasis on its more profitable retail mortgage lending. Refinances
totaled $950.3 million, or 24% of total closings in 1997, compared to $937.3
million, or 26% of total closings, a year earlier. The Company's pipeline of
mortgage loan applications in process was $895.1 million at December 31,
1997, compared to $930.4 million at December 31, 1996.
13
Table 3
Mortgage Banking Revenue
Year Ended December 31
(In thousands) 1997 1996 1995
- -------------- ---- ---- ----
Mortgage loan production revenue (1) $85,655 $70,499 $49,656
Net mortgage loan servicing revenue (2) 6,428 8,220 9,596
Gain on bulk sales of mortgage servicing rights 1,617 7,658 11,708
------- ------- -------
Total mortgage banking revenue $93,700 $86,377 $70,960
======= ======= =======
- ---------
(1) Includes fee revenue derived from the loan origination process (i.e.,
points collected), gains on the sale of mortgage loans and the related
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.
Mortgage banking revenue, the largest component of total noninterest
income, rose $7.3 million, or 8%, to $93.7 million in 1997, after increasing
22% in 1996. This increase resulted as growth in mortgage loan production
revenue more than offset declines in net mortgage loan servicing revenue and
gains on bulk sales of mortgage servicing rights.
Mortgage loan production revenue increased $15.2 million, or 21%, in
1997. This increase resulted primarily as volume and profitability levels
improved in retail mortgage production activities, but was partially offset
by a decline in wholesale mortgage production volume. The Company sold $3.55
billion of single-family residential mortgages in both 1997 and 1996,
compared to $2.65 billion in 1995. The ratio of mortgage production revenue
to mortgage loans sold rose 43 basis points to 2.42% in 1997, compared to
1.99% in 1996 and 1.87% in 1995.
Net mortgage loan servicing revenue decreased 22% to $6.4 million in
1997, after declining 14% in 1996. These declines correspond to a decrease in
the average size of the mortgage servicing portfolio over the past two years.
Loans serviced for others averaged $2.9 billion in 1997, down 17% from a year
earlier. In 1996, average loans serviced for others totaled $3.5 billion,
which was 11% lower than the 1995 average. This reduction in the mortgage
servicing portfolio resulted primarily from the sale of servicing rights at
Republic Bancorp Mortgage and CUB Funding as the Company focused all
servicing activity at Market Street Mortgage.
Amortization of mortgage servicing rights totaled $6.9 million in 1997,
compared to $7.6 million in 1996 and $7.0 million in 1995. The Company
evaluates its mortgage servicing rights for impairment on a quarterly basis.
No impairment reserves were required in 1997 and 1996 in accordance with
Statement of Financial Accounting Standards (SFAS) No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.
The Company may elect to sell mortgage servicing rights concurrently with
the sale of the underlying loans or retain the servicing rights. Any
servicing rights retained may subsequently be sold in bulk form. The level of
bulk servicing sales is dependent upon the Company's strategy to either build
or reduce the servicing portfolio and is further based upon current market
conditions. In 1997, bulk sales of mortgage servicing rights for loans with
principal balances of $345.2 million resulted in gains of $1.6 million. In
1996 and 1995, bulk sales of mortgage servicing rights for loans with
principal balances of $2.3 billion and $2.5 billion, respectively, resulted
in gains of $7.7 million and $11.7 million, respectively.
14
Commercial and Retail Banking
The Commercial and Retail Banking segment consists of commercial lending to
small- and medium-sized companies, primarily in the form of commercial real
estate and Small Business Administration (SBA) loans; mortgage portfolio
lending; home equity lending; and the deposit-gathering function. Deposits
and loan products are offered through the 35 retail branch offices of
Republic Bank and Republic Savings Bank, which are staffed by personal
bankers and loan originators. The remaining disclosures and analyses within
this Management's Discussion and Analysis of the Company's results of
operations and financial condition relate principally to the commercial and
retail banking segment.
Results of Operations
Net Interest Income
Net interest income is defined as the difference between total interest
income generated by earning assets and the cost of funding those assets. To
permit the comparable analysis of tax-exempt and fully taxable income, net
interest income is stated on a fully taxable equivalent (FTE) basis,
reflecting adjustments made to the yields of tax-exempt investment securities
included in earning assets. The net interest margin is net interest income
(FTE) expressed as a percentage of average earning assets and measures how
effectively the Company utilizes its earning assets in relationship to the
interest cost of funding them.
Net interest income (FTE) rose 26% to $47.3 million in 1997, compared to
$37.5 million in 1996, primarily due to growth in average earning assets.
Average earning assets rose $196.0 million, or 15%, to $1.5 billion in 1997,
as a $324.9 million increase in average portfolio loans more than offset a
reduction in average investment securities and a slight decrease in average
mortgage loans held for sale. Net interest income growth also benefited as
the mix of earning assets continued to favor higher-yielding commercial,
residential and installment loan balances rather than lower-yielding
investment securities. Partially offsetting the increase in net interest
income was the incremental interest expense associated with a $197.1 million,
or 17%, increase in interest-bearing liabilities.
The net interest margin widened by 28 basis points to 3.16% in 1997,
compared to 2.88% in 1996. The improved margin was largely attributable to
the continued shift in the mix of earning assets to higher-yielding
commercial, residential and installment loan balances during 1997. This
strategy led to a 28 basis point rise in the yield on average earning assets.
The net interest margin also benefited from a decline in short-term interest
rates during much of 1997, which contributed to a 10 basis point decrease in
the average cost of funds.
In 1996, net interest income (FTE) increased 23% to $37.5 million from
$30.4 million in 1995, primarily due to growth in average earning assets with
higher yields and a decline in average short-term borrowings. Average earning
assets rose $24.7 million, or 2%, to $1.3 billion. Average short-term
borrowings decreased $99.7 million, or 36%, to $174.7 million, reflecting the
replacement of third-party warehousing lines of credit with less expensive
interest-bearing deposits and short-term borrowings as funded by the
Company's banking subsidiaries. This switch from external to internal
funding, along with a shift in the mix of earning assets toward
higher-yielding portfolio loan balances, led to a 50 basis point increase in
the net interest margin to 2.88% in 1996 from 2.38% in 1995.
15
Table 4
Analysis of Net Interest Income (FTE)
Year Ended December 31
(Dollar amounts in thousands) 1997 1996 1995
- ----------------------------- ------------------------------ ---------------------------- -----------------------------
Average Avg. Average Avg. Average Avg.
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
Average Assets:
Short-term investments $ 5,917 $ 264 4.46% $ 9,155 $ 438 4.78% $ 16,801 $ 954 5.68%
Mortgage loans held for sale 317,114 24,235 7.64 340,375 26,392 7.75 268,788 21,100 7.85
Investment securities 198,946 13,102 6.59 301,338 19,054 6.32 382,242 23,155 6.06
Portfolio loans: (1)
Commercial loans 251,299 24,139 9.61 162,463 15,183 9.35 109,063 10,843 9.94
Real estate mortgage loans 631,638 48,065 7.61 415,981 31,521 7.58 443,928 33,633 7.58
Installment loans 92,963 9,380 10.09 72,565 7,340 10.12 56,370 5,912 10.49
---------- -------- ---- ---------- ------- ----- ---------- ------- ----
Total loans, net of
unearned income 975,900 81,584 8.36 651,009 54,044 8.30 609,361 50,388 8.27
---------- -------- ---- ---------- ------- ----- ---------- ------- ----
Total interest-earning assets 1,497,877 119,185 7.96 1,301,877 99,928 7.68 1,277,192 95,597 7.48
Allowance for loan losses (6,281) (4,819) (5,264)
Cash and due from banks 22,270 26,213 24,460
Other assets 106,038 118,782 126,339
---------- --------- ----------
Total assets $1,619,904 $1,442,053 $1,422,727
========== ========== ==========
Average Liabilities and
Shareholders' Equity:
Interest-bearing demand
deposits $ 44,933 993 2.21 $ 57,754 1,358 2.35 $ 63,516 1,554 2.45
Savings deposits 298,104 12,331 4.14 215,357 8,882 4.12 177,978 6,677 3.75
Time deposits 619,371 35,662 5.76 545,151 32,028 5.88 517,663 30,567 5.90
---------- -------- ---- ---------- ------- ----- ----------- ------- ----
Total interest-bearing
deposits 962,408 48,986 5.09 818,262 42,268 5.17 759,157 38,798 5.11
Short-term borrowings 107,271 6,181 5.76 174,734 10,322 5.91 274,454 18,396 6.70
FHLB advances 226,634 13,275 5.86 103,244 6,094 5.90 40,004 2,431 6.08
Long-term debt 47,948 3,470 7.23 50,873 3,743 7.36 63,256 5,567 8.80
---------- -------- ---- ---------- ------- ----- ----------- ------- ----
Total interest-bearing
liabilities 1,344,261 71,912 5.34 1,147,113 62,427 5.44 1,136,871 65,192 5.73
Noninterest-bearing deposits 108,667 124,976 128,640
Other liabilities 42,452 47,172 35,435
---------- ---------- ---------
Total liabilities 1,495,380 1,319,261 1,300,946
Shareholders' equity 124,524 122,792 121,781
---------- ---------- ----------
Total liabilities and
shareholders' equity $1,619,904 $1,442,053 $1,422,727
========== ========== ==========
Net interest income/
Rate spread (FTE) $ 47,273 2.60% $37,501 2.24% $30,405 1.75%
-------- ======= =======
FTE adjustment(2) $ 333 $ 781 $ --
======== ======= =======
Impact of net noninterest-
bearing sources of funds .56 .64 .63
---- ----- ----
Net interest margin (FTE) 3.16% 2.88% 2.38%
==== ===== =====
- ---------
(1) Non-accrual loans and overdrafts are included in average balances.
(2) The amount of tax-exempt income earned in 1995 was not material.
16
Table 5
Rate/Volume Analysis (FTE)
1997/1996 1996/1995
--------------------------------- ---------------------------------
Increase/(Decrease) Increase/(Decrease)
Due to Change in: Due to Change in:
--------------------------------- ---------------------------------
Average Average Net Average Average Net
(In thousands) Balance(1) Rate(1) Change Balance(1) Rate(1) Change
- -------------- --------- ------- ------ ---------- ------- ------
Interest Income:
Short-term investments $ (147) $ (27) $ (174) $ (383) $ (133) $ (516)
Mortgage loans held for sale (1,786) (371) (2,157) 5,563 (271) 5,292
Investment securities (6,733) 781 (5,952) (5,062) 961 (4,101)
Loans, net of unearned income (2) 27,003 537 27,540 3,472 184 3,656
-------- -------- -------- -------- -------- ---------
Total interest income 18,337 920 19,257 3,590 741 4,331
Interest Expense:
Interest-bearing demand deposits (288) (77) (365) (135) (61) (196)
Savings deposits 3,406 43 3,449 1,500 705 2,205
Time deposits 4,298 (664) 3,634 1,568 (107) 1,461
-------- -------- -------- -------- -------- ---------
Total interest-bearing deposits 7,416 (698) 6,718 2,933 537 3,470
Short-term borrowings (3,886) (255) (4,141) (6,096) (1,978) (8,074)
FHLB advances 7,222 (41) 7,181 3,737 (74) 3,663
Long-term debt (209) (64) (273) (994) (830) (1,824)
-------- -------- -------- -------- -------- ---------
Total interest expense 10,543 (1,058) 9,485 (420) (2,345) (2,765)
-------- -------- -------- -------- -------- ---------
Net interest income (FTE) $ 7,794 $ 1,978 $ 9,772 $ 4,010 $ 3,086 $ 7,096
======== ======== ======== ======== ======== ========
- ---------
(1) Variances attributable jointly to volume and rate changes are allocated
to volume and rate in proportion to the relationship of the absolute
dollar amount of the change in each.
(2) Non-accrual loans are included in average balances.
Noninterest Income
Noninterest income is a significant source of revenue for the Company,
contributing 46% of total revenues in 1997, compared to 48% in 1996 and 44%
in 1995. Details of the largest component of noninterest income are presented
in the "Mortgage Banking" section, beginning on page 13. Exclusive of
mortgage banking revenue, noninterest income increased to $8.8 million in
1997 from $4.5 million in 1996, primarily due to the $4.4 million pre-tax
gain on the sale of four Republic Bank branches and the related deposits in
the second quarter of 1997.
Table 6
Noninterest Income
Year Ended December 31
(In thousands) 1997 1996 1995
- -------------- ---- ---- ----
Mortgage banking revenue $ 93,700 $86,377 $70,960
Service charges 1,446 1,218 1,297
Investment securities gains (losses) (497) 766 1,061
Gain on sale of bank branches and deposits 4,442 -- --
Gain on sale of SBA loans 1,065 1,242 873
Other noninterest income 2,359 1,243 1,010
-------- ------- -------
Total noninterest income $102,515 $90,846 $75,201
======== ======= =======
17
As part of management's strategy to support further loan growth, efforts
have been made to reduce the investment securities portfolio through sales
and maturities. In 1997, the Company sold $189.7 million of investment
securities for a net loss of $497,000. This activity included $47.1 million
of lower-yielding securities that were sold during the second quarter of 1997
at a loss of $850,000. In 1996, the Company sold $144.7 million of investment
securities, compared to $232.0 million in 1995.
The guaranteed portions of Small Business Administration (SBA) loans are
regularly sold to investors. In 1997, the Company sold $13.8 million of the
guaranteed portion of SBA loans, compared to $17.9 million in 1996 and $10.8
million in 1995.
Noninterest Expense
Noninterest expense increased 13% in 1997 to $117.7 million, after rising 26%
in 1996. Salaries and employee benefits expense increased $5.8 million, or
14%, in 1997, following an increase of $10.5 million, or 33%, in 1996. This
year's increase resulted primarily from the net addition of 69 employees to
the Company's payroll. Mortgage loan commissions paid to mortgage loan
originators and processors rose $5.2 million, or 21%, after increasing $6.9
million, or 39%, in 1996. The increase in mortgage loan commissions
corresponds to the 25% growth rate in the volume of retail mortgage loans
originated during 1997, compared to a 42% growth rate in 1996. The commission
rate paid on retail loan closings, which make up a substantial majority of
total closings, is significantly higher than the commission rate paid on
wholesale closings.
Table 7
Noninterest Expense
Year Ended December 31
(In thousands) 1997 1996 1995
- -------------- ---- ---- ----
Salaries and employee benefits $ 48,358 $ 42,589 $32,081
Mortgage loan commissions 29,767 24,590 17,710
Net occupancy expense of premises 7,022 6,145 5,274
Equipment expense 4,538 4,626 4,395
SAIF assessment fee -- 1,500 --
Other noninterest expense 28,057 25,042 23,692
-------- -------- -------
Total noninterest expense $117,742 $104,492 $83,152
======== ======== =======
Net occupancy expense increased 14% in 1997, following a 17% increase in
1996, due to the net addition of 19 retail bank and mortgage loan production
offices during 1997, most of which are leased. Equipment expense has remained
relatively stable over the past several years, reflecting consistent levels
of purchasing activity.
Included in noninterest expense for 1996 was a one-time pre-tax
assessment of $1.5 million levied on the Company's banking subsidiaries by
the Federal Deposit Insurance Corporation (FDIC) as a result of legislation
passed by Congress to recapitalize the Savings Association Insurance Fund
(SAIF). This one-time charge related to $212 million in SAIF-insured deposits
at Republic Savings Bank and $17 million in SAIF-insured deposits at Republic
Bank.
Income Taxes
The provision for income taxes was $9.9 million in 1997, compared to $7.5
million in 1996 (inclusive of the tax benefit arising from the extraordinary
item) and $8.2 million in 1995. The effective tax rate, computed by dividing
the provision for income taxes by pre-tax income, was 34.5% for 1997,
compared to 33.8% for 1996 and 36.4% for 1995. Pre-tax income in 1997
contained a lower amount of tax-exempt interest income on bank-qualified
municipal securities than in 1996. Pre-tax income in 1995 contained a higher
amount of non-deductible expenses than in 1997 and 1996.
18
Financial Condition
Total assets were $1.9 billion at December 31, 1997, an increase of 26% from
$1.5 billion at December 31, 1996. Average total assets rose $177.9 million,
or 12%, to $1.6 billion during the year. This increase primarily reflects
strong growth in the portfolio loan balance, which was funded by a reduction
in investment securities as well as increases in deposits and FHLB advances.
Assets
- ------
Portfolio Loans
The Company's loan portfolio is comprised of domestic loans to businesses and
consumers. At December 31, 1997 and 1996, there were no loans to foreign
debtors outstanding and the amount of agribusiness loans outstanding were
insignificant. Loans to businesses are classified as commercial loans and are
further segregated as commercial and industrial loans and commercial real
estate loans. Commercial and industrial loans are made to local small- and
medium-sized corporations primarily to finance working capital and equipment
purchases.
Commercial real estate loans represent loans secured by real estate and
consist of real estate construction loans and commercial real estate mortgage
loans. Real estate construction loans are made to builders or developers of
real estate properties and are typically refinanced at completion, becoming
either income-producing or owner-occupied properties. Commercial real estate
mortgage loans are secured by owner-occupied or income-producing properties.
For owner-occupied property loans, the primary source of repayment is the
cash flow of the owner with the real estate serving as a secondary repayment
source. Income-producing property loans are made to entities or individuals
engaged in real estate investment, and the primary source of repayment is
derived from the rental or sale of the property.
Loans to consumers include residential real estate mortgage loans and
installment loans. Installment loans, predominantly home equity loans, are
made for various purposes, including home improvement, automobile purchases
and college tuition. The Company emphasizes home equity lending above all
other installment lending. Other types of installment loans are generally
made to accommodate customers who have an existing banking relationship with
the Company.
Table 8
Loan Portfolio Analysis
December 31
(Dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------- ----------------- --------------- ------------- --------------- ----------------
Amount % Amount % Amount % Amount % Amount %
------ - ------ - ------ - ------ - ------ -
Commercial loans:
Commercial and
industrial $ 41,095 3.7% $ 29,483 3.8% $ 22,523 3.9% $ 20,556 3.4% $ 27,025 6.6%
Real estate
construction 48,346 4.4 32,946 4.2 11,625 2.0 11,259 1.9 28,509 7.0
Commercial real
estate mortgages 233,078 21.3 132,763 16.9 98,285 17.0 66,096 10.8 71,008 17.5
---------- ----- -------- ----- -------- ----- ------- ----- -------- -----
Total commercial
loans 322,519 29.4 195,192 24.9 132,433 22.9 97,911 16.1 126,542 31.1
Residential real
estate mortgages 669,203 61.1 506,944 64.6 381,803 66.0 457,755 75.7 229,203 56.3
Installment loans 104,022 9.5 82,492 10.5 63,876 11.1 49,423 8.2 51,372 12.6
---------- ----- -------- ----- -------- ----- ------- ----- -------- -----
Total portfolio
loans $1,095,744 100.0% $784,628 100.0% $578,112 100.0% $605,089 100.0% $407,117 100.0%
========== ===== ======== ===== ======== ===== ======== ===== ======== =====
The total portfolio loans balance grew $311.1 million, or 40%, to $1.1
billion at December 31, 1997, after increasing 36% in 1996. Lending remained
strong across all major categories in 1997 as more residential mortgage loans
were originated and retained in the loan portfolio. Also, commercial lending
programs were successful in local markets served by the Company and marketing
efforts directed at existing customers yielded additional home equity loans.
The overall growth of the loan portfolio stems from the Company's efforts to
enhance long-term profitability by improving the mix of earning assets on the
balance sheet.
19
Commercial loans increased $127.3 million, or 65%, to $322.5 million at
December 31, 1997, after climbing 47% in 1996. This growth, which was
concentrated primarily in commercial real estate loans, reflects the
Company's efforts to complement traditional residential mortgage lending with
commercial lending. Residential real estate mortgage loans rose $162.3
million, or 32%, to $669.2 million at December 31, 1997, after growing 33% a
year earlier, as the Company retained a higher percentage of variable rate
residential real estate loans compared to prior years. Installment loans
increased $21.5 million, or 26%, to $104.0 million at December 31, 1997,
after rising 29% a year ago, reflecting the continued success of specifically
targeted sales and marketing efforts in home equity lending.
Table 9
Maturity Distribution and Interest Rate Sensitivity of Commercial Loans
After One
December 31, 1997 Within But Within After
(In thousands) One Year Five Years Five Years Total
- ----------------- -------- ---------- ---------- -----
Commercial loans:
Commercial and industrial $ 9,260 $ 15,035 $ 16,800 $ 41,095
Real estate construction 17,190 27,815 3,341 48,346
Commercial real estate mortgages 37,008 117,195 78,875 233,078
-------- --------- --------- ---------
Total commercial loans $ 63,458 $ 160,045 $ 99,016 $ 322,519
======== ========= ========= =========
Commercial Loans Maturing After
One Year With:
Predetermined rates $ 111,694 $ 15,052
Floating or adjustable rates 48,351 83,964
--------- ---------
Total $ 160,045 $ 99,016
========= =========
The commercial loan portfolio contained no aggregate loans to any one
industry that exceeded 10% of total portfolio loans outstanding at December
31, 1997. The Company's total loan portfolio is geographically concentrated
primarily in Michigan and Ohio as shown in the following table.
Table 10
Geographic Distribution of Loan Portfolio
December 31, 1997 Percent
(Dollars in thousands) Amount of Total
- ---------------------- ------ --------
Michigan $ 635,000 58%
Ohio 375,825 34
Indiana 27,563 3
Other states 57,356 5
---------- ---
Total $1,095,744 100%
========== ===
Mortgage Loans Held for Sale
Mortgage loans held for sale increased $184.4 million, or 56%, to $513.5
million at December 31, 1997, after decreasing 22% to $329.2 million at
December 31, 1996, primarily due to strong fourth quarter 1997 mortgage loan
production volumes. Decreasing just 7% from the average balance a year
earlier, average mortgage loans held for sale remained relatively consistent
as the Company retained a higher percentage of residential mortgage loans in
the loan portfolio.
20
Credit Risk Management
Extending credit to businesses and consumers exposes the Company to credit
risk. Credit risk is the risk that the principal balance of a loan and/or the
related interest will not be collected due to the inability of the borrower
to repay the loan. The Company manages credit risk in the loan portfolio
through adherence to consistent standards, guidelines and limitations
established by senior management. Written loan policies establish
underwriting standards, lending limits and other standards or limits as
deemed necessary and prudent. Various approval levels, based on the amount of
the loan and whether the loan is secured or unsecured, have also been
established. Loan approval authority ranges from the individual loan officer
to the Board of Directors' Loan Committee.
The Loan Review group within the Company's Internal Audit Department
conducts ongoing, independent reviews of the lending process to ensure
adherence to established policies and procedures, monitor compliance with
applicable laws and regulations, provide objective measurement of the risk
inherent in the loan portfolio, and ensure proper documentation exists. The
results of these periodic reviews are reported to the Audit Committee of the
Company's Board of Directors.
The following discussion summarizes the underwriting policies and
procedures for the major categories within the loan portfolio and addresses
the Company's strategies for managing the related credit risk.
Commercial Loans
Credit risk associated with commercial loans is primarily influenced by
prevailing and expected economic conditions and the level of underwriting
risk the Company is willing to assume. To manage credit risk when extending
commercial credit, the Company focuses on adequately assessing the borrower's
ability to repay and on obtaining sufficient collateral. To minimize credit
risk, the Company concentrates its commercial lending efforts on commercial
real estate loans. At December 31, 1997 and 1996, commercial real estate
loans accounted for 87% and 85%, respectively, of total commercial loans.
Emphasis is also placed on loans that are government guaranteed, such as SBA
loans. Commercial and industrial loans are generally secured by company
assets at a 75% or less loan-to-value ratio and by personal guarantees.
Management closely monitors the composition and quality of the total
commercial loan portfolio to ensure that significant credit concentrations by
borrower or industry do not exist.
Residential Real Estate Mortgage Loans
The Company originates fixed rate and variable rate residential mortgage
loans which are secured by the underlying 1-4 family residential property. At
December 31, 1997 and 1996, these loans accounted for 61% and 65%,
respectively, of total portfolio loans. Credit risk exposure in this area of
lending is minimized by the assessment of the creditworthiness of the
borrower and adherence to underwriting policies that emphasize conservative
loan-to-value ratios of generally no more than 80%. Residential mortgage
loans granted in excess of the 80% loan-to-value ratio criterion are
generally insured by private mortgage insurance, unless otherwise guaranteed
or insured by the Federal, state or local government. Credit risk is further
reduced since the majority of the Company's fixed rate, long- and short-term
mortgage loan production and all of its sub-prime mortgage loan production
are sold to investors in the secondary market.
Installment Loans
Credit risk in the installment loan portfolio is controlled through
consistent adherence to conservative underwriting standards that consider
debt to income levels and the creditworthiness of the borrower. In the home
equity lending category, loan-to-value ratios generally are limited to 80% of
collateral value. However, the Company may lend in excess of 80% of
collateral value and often utilizes an unaffiliated insurance company to
minimize the risk.
21
Asset Quality
Non-Performing Assets
Non-performing assets consist of non-accrual loans, restructured loans
and other real estate owned (OREO). OREO represents real estate properties
acquired by the Company through foreclosure or by deed in lieu of
foreclosure. Commercial loans, residential real estate mortgage 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. In all cases, 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. When
a loan is placed on non-accrual status, interest accruals cease and any
uncollected interest is charged against current income. Interest subsequently
received on non-accrual loans is applied against the principal balance.
Table 11
Non-Performing Assets
December 31
(Dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------- ---- ---- ---- ---- ----
Non-accrual loans:
Commercial $ 1,457 $ 1,321 $ 848 $ 982 $ 1,812
Residential real estate
mortgages 9,217 3,968 313 1,304 803
Installment 307 50 131 79 108
------- ------- ------- ------- -------
Total non-accrual loans 10,981 5,339 1,292 2,365 2,723
Restructured loans -- -- 688 1,130 2,140
------- ------- ------- ------- -------
Total non-performing loans 10,981 5,339 1,980 3,495 4,863
Other real estate owned 1,671 1,250 980 586 405
------- ------- ------- ------- -------
Total non-performing assets $12,652 $ 6,589 $ 2,960 $ 4,081 $ 5,268
======= ======= ======= ======= =======
Non-performing assets as a
percentage of:
Portfolio loans and OREO 1.15% .84% .51% .67% 1.29%
Portfolio loans, mortgage
loans held for sale
and OREO .79 .59 .30 .54 .58
Total assets .68 .44 .20 .30 .45
Loans past due 90 days or more
and still accruing interest:
Commercial $ -- $ -- $ 209 $ 104 $ 217
Residential real estate
mortgages 228 548 42 -- --
Installment 6 22 94 35 93
------- ------- ------- ------- -------
Total loans past due 90 days
or more $ 234 $ 570 $ 345 $ 139 $ 310
======= ======= ======= ======= =======
Non-performing assets totaled $12.7 million at December 31, 1997, up $6.1
million from $6.6 million at December 31, 1996. The increase in non-accrual
residential real estate mortgage loans accounted for 87% of the overall
increase in total non-performing assets. The primary cause for the rise in
non-accrual residential mortgages was growth in portfolio residential
mortgage loans. Historically, credit losses on loans secured by residential
property have been minimal as demonstrated by the Company's low level of net
loan charge-offs. The Company's actual losses have, generally, been limited
to forgone interest and costs related to the foreclosure process, which may
take several months to complete.
Approximately $8.2 million, or .75%, of the loans in the loan portfolio
at December 31, 1997, were 30 to 89 days delinquent, compared to $4.8
million, or .61% of portfolio loans, at December 31, 1996. The Company also
maintains a watch list for loans identified as requiring a higher level of
monitoring by management because of one or more characteristics, such as
economic conditions, industry trends, nature of collateral, collateral
margin, payment history or other factors. As of December 31, 1997, total
loans on the watch list, excluding those categorized as non-performing loans
and loans past due 90 days and still accruing interest, were $3.7 million, or
.3% of total portfolio loans, compared to $2.2 million, or .3% of total
portfolio loans, at December 31, 1996.
22
The following table presents the amount of interest income that would
have been earned on non-performing loans outstanding at December 31, 1997,
1996 and 1995 had those loans been accruing interest in accordance with the
original terms of the loan agreement, as well as the amount of interest
income earned and included in net interest income for each of those years.
Table 12
Forgone Interest on Non-Performing Loans
For the Year Ended
December 31
(In thousands) 1997 1996 1995
- ------------------ ------------------------- ------------------------- ------------------------
Non-Accrual Restructured Non-Accrual Restructured Non-Accrual Restructured
----------- ------------ ----------- ------------ ----------- ------------
Pro forma interest income $ 856 $ -- $ 259 $ -- $ 135 $ 67
Interest income earned 478 -- 34 -- 44 38
------ ----- ----- ------ ----- -----
Forgone interest income $ 378 $ -- $ 225 $ -- $ 91 $ 29
====== ===== ===== ====== ===== =====
Impaired Loans
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of
Loans (SFAS No. 114), impaired loans are those loans for which it is probable
that payment of principal and interest will not be collected in accordance
with the contractual terms of the original loan agreement. Consistent with
this definition, all non-accrual and restructured loans (with the exception
of residential mortgage and consumer installment loans) are impaired. At
December 31, 1997 and 1996, the gross recorded investment in impaired loans
totaled $1.5 million and $1.4 million, respectively. Similar to non-accrual
loans, interest payments subsequently received on impaired loans are applied
against the principal balance. See Note 5 of the Notes to Consolidated
Financial Statements for further discussion of impaired loans.
Provision and Allowance for Loan Losses
The allowance for loan losses represents management's assessment of the
potential losses inherent in the Company's loan portfolio. An appropriate
level of the allowance is determined based on the application of projected
loss percentages to risk-rated loans, both individually and by category. The
projected loss percentages were developed giving consideration to actual loan
loss experience, adjusted for current and prospective economic conditions.
Management also considers other factors when assessing the adequacy of the
allowance for loan losses, including loan quality, changes in the size and
character of the loan portfolio, and consultation with regulatory
authorities. In addition, specific reserves are established for individual
loans when deemed necessary by management.
Management believes that the allowance for loan losses is adequate to
meet potential losses in the loan portfolio. 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 declined $150,000 to $608,000 in 1997, compared to
$758,000 in 1996 and $845,000 in 1995. The ratio of net loan charge-offs to
average loans, including loans held for sale, was .03% for 1997, compared to
.06% for both 1996 and 1995. Commercial loan net charge-offs as a percentage
of average commercial loans was .14% for 1997, compared to .24% for 1996 and
.43% for 1995. Residential real estate mortgage loan net charge-offs as a
percentage of average residential mortgage loans, including loans held for
sale, was zero for 1997 and .001% for 1996, versus a net recovery of (.002)%
for 1995. Installment loan net charge-offs as a percentage of average
installment loans was .06% for 1997, compared to .26% for 1996 and .19% for
1995.
23
Table 13
Analysis of the Allowance for Loan Losses
Year Ended December 31
(Dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------- ---- ---- ---- ---- ----
Balance at beginning of year $ 4,709 $ 5,002 $ 5,544 $ 7,214 $ 7,684
Loan charge-offs:
Commercial loans 468 494 661 1,521 612
Residential real estate mortgage loans 13 11 34 70 49
Installment loans 127 253 150 114 101
------- -------- ------- ----- -------
Total loan charge-offs 608 758 845 1,705 762
Recoveries:
Commercial loans 115 112 189 219 170
Residential real estate mortgage loans 20 2 47 -- 36
Installment loans 67 61 43 72 73
------- -------- ------- ----- -------
Total recoveries 202 175 279 291 279
------- -------- ------- ----- -------
Net loan charge-offs 406 583 566 1,414 483
Provision charged to expense 3,031 290 24 94 603
Allowance for commercial loans sold -- -- -- (350) (590)
------- -------- ------- ----- -----
Balance at end of year $ 7,334 $ 4,709 $ 5,002 $ 5,544 $ 7,214
======= ======== ======= ======= =======
Allowance for loan losses as a
percentage of year-end portfolio loans .67% .60% .87% .92% 1.77%
Allowance for loan losses as a
percentage of year-end non-performing
loans 66.79 88.18 252.64 158.61 148.34
Net charge-offs as a percentage of
average total loans (including loans
held for sale) .03 .06 .06 .20 .06
The Company's policy for charging off loans varies with respect to the
category of and specific circumstances surrounding each loan under
consideration. Installment loans are generally charged off when deemed to be
uncollectible or 180 days past due, whichever comes first. Charge-offs of
commercial loans and residential real estate mortgage loans are made on the
basis of management's ongoing evaluation of non-performing loans.
The following table summarizes the Company's allocation of the allowance
for loan losses by loan type and the percentage of each loan type to total
portfolio loans. The entire allowance, however, is available for use against
any type of loan charge-off deemed necessary.
Table 14
Allocation of the Allowance for Loan Losses
December 31
(Dollars in thousands) 1997 1996 1995 1994 1993
- ---------------------- --------------- --------------- --------------- -------------- ---------------
% of % of % of % of % of
total total total total total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Commercial loans $2,173 29% $1,973 25% $1,522 23% $2,221 16% $3,382 31%
Residential real
estate mortgage
loans 3,795 61 1,543 65 971 66 598 76 1,298 56
Installment loans 432 10 307 10 212 11 501 8 559 13
Unallocated 934 n/a 886 n/a 2,297 n/a 2,224 n/a 1,975 n/a
------ --- ------ --- ------ --- ------ --- ------ ---
Total allowance
for loan losses $7,334 100% $4,709 100% $5,002 100% $5,544 100% $7,214 100%
====== === ====== === ====== === ====== === ====== ===
- ---------
n/a -- Not applicable.
24
Securities Available for Sale
The Company's investment securities portfolio, while serving as a secondary
source of earnings, carries relatively minimal principal risk and contributes
to the management of interest rate risk and liquidity risk. The portfolio is
comprised principally of U.S. Government agency obligations, obligations
collateralized by U.S. Government-sponsored agencies, mainly in the form of
collateralized mortgage obligations and mortgage-backed securities. The
maturity structure of the portfolio is generally short-term in nature or
indexed to variable rates. At December 31, 1997, the estimated average
maturity of fixed rate investment securities within the portfolio, excluding
municipal securities, ranged from 1.5 years to 2.3 years.
Investment securities totaled $119.9 million at December 31, 1997, a
$108.7 million, or 48%, decrease from $228.6 million at December 31, 1996.
This decrease reflects sales and maturities of securities primarily to fund
growth in higher-yielding portfolio loans. The investment securities
portfolio constituted 6.4% of the Company's assets at year-end 1997, compared
to 15.3% a year earlier.
The following table summarizes the composition of the Company's
investment securities portfolio at December 31, 1997 and 1996.
Table 15
Securities Available For Sale Portfolio
December 31
(In thousands) 1997 1996
- -------------- ---- ----
U.S. Treasury and Government agency securities $ 40,806 $ 35,806
Collateralized mortgage obligations 24,249 81,539
Mortgage-backed securities 23,568 60,233
Municipal and other securities 3,185 31,823
Equity securities 28,073 19,220
-------- --------
Total securities available for sale $119,881 $228,621
======== ========
The maturity distribution of and average yield information for investment
securities held as of December 31, 1997 is provided in the following table.
Table 16
Maturity Distribution of Securities Available for Sale Portfolio
December 31, 1997 Due Within One to Five to After
(Dollars in thousands) One Year Five Years Ten Years Ten Years Total
- ---------------------- ---------------- ---------------- ---------------- ----------------- -----------------
Estimated Estimated Estimated Estimated Estimated
Market Avg. Market Avg. Market Avg. Market Avg. Market Avg.
Value Yield Value Yield Value Yield Value Yield Value Yield
--------- ----- --------- ----- --------- ----- --------- ----- --------- -----
U.S. Treasury and
Government agency
securities $ 21 8.95% $ -- --% $ -- --% $40,785 6.47% $ 40,806 6.47%
Collateralized mortgage
obligations (2) (3) -- -- -- -- -- -- 24,249 6.80 24,249 6.80
Mortgage-backed
securities (2) (3) -- -- 129 8.35 -- -- 23,439 5.95 23,568 5.96
Municipal and other
securities (1) 30 9.95 148 9.95 417 7.25 2,590 7.63 3,185 7.71
Equity securities 28,073 6.91 -- -- -- -- -- -- 28,073 6.91
------- ---- ----- ---- ----- ---- ------- ---- -------- ----
Total securities
available for sale $28,124 6.91% $ 277 9.20% $ 417 7.25% $91,063 6.46% $119,881 6.57%
======= ==== ===== ==== ===== ==== ======= ==== ======== ====
- ---------
(1) Average yields on tax-exempt obligations have been computed on a tax
equivalent basis, based on a 35% federal tax rate.
(2) Collateral guaranteed by U.S. Government agencies.
(3) All maturities beyond ten years are at variable rates or have estimated
average lives of less than 2.3 years. The average yield presented
represents the current yield on these securities.
25
Liabilities
- -----------
Deposits
Total deposits, the Company's primary source of funding, grew 16% to nearly
$1.18 billion at December 31, 1997, after increasing 12% a year earlier. The
Company's core deposits represent the largest and most stable component of
total deposits and consist of demand deposits, NOW accounts, regular savings
accounts, money market accounts, Individual Retirement Accounts (IRAs) and
retail certificates of deposit. At year-end 1997, core deposits totaled
$976.8 million, a 6% increase when compared to $922.5 million at year-end
1996.
The Company also funds mortgage loans with brokered certificates of
deposit and municipal certificates of deposit. At December 31, 1997, these
deposits totaled $83.5 million and $117.0 million, respectively, and
represented 17% of total deposits on a combined basis. At December 31, 1996,
brokered certificates of deposit totaled $56.9 million and municipal
certificates of deposit totaled $34.3 million, representing 9% of total
deposits on a combined basis.
Tabl