[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-22461
LENAWEE BANCORP, INC.
(Exact name of registrant as specified in its charter)
|
Michigan (State or other jurisdiction of Incorporation or organization) 135 East Maumee Street Adrian, Michigan (Address of principal executive offices) |
38-3088340 (I.R.S. Employer Identification No.) 49221 (Zip Code) |
517-265-5144
517-265-3926 (FAX)
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
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 amendments to this Form 10-K. X
Documents Incorporated by Reference:
Portions of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held
April 18, 2002 are incorporated by reference into Parts II and III of this
report.
Lenawee Bancorp, Inc. (the Company), a bank holding company, which was incorporated in Michigan in 1993, has two wholly-owned bank subsidiaries, Bank of Lenawee and Bank of Washtenaw (the “Banks”). On April 15, 1993, the Company acquired all of the stock of the Bank of Lenawee, a Michigan banking corporation chartered in 1869. On January 1, 2001 the Bank of Lenawee made the real estate origination component of its business a separate entity named Pavilion Mortgage Company. On January 8, 2001 the Company opened a new bank, the Bank of Washtenaw. The new bank is operating the former Saline Michigan branch of the Bank of Lenawee and has opened a new branch and administrative offices in Ann Arbor, Michigan.
Business is concentrated primarily in a single industry segment - commercial banking. Each Bank provides a full range of banking services to individuals, commercial businesses and industries located in its service area. Each Bank maintains diversified loan portfolios, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. Each Bank offers a variety of deposit products, including checking, savings, money market, individual retirement accounts and certificates of deposit.
The principal markets for financial services are the mid-Michigan communities in which the Banks are located and the areas immediately surrounding these communities. The Banks serve these markets through 11 locations in or near their communities. The Banks do not have any material foreign assets or income.
The principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 77% of total revenue in 2001 compared to 84% in 2000. The significant reductions in interest rates during 2001 resulted in a significant increase in the volume of loan sale activity and gains on sales of mortgage loans. These gains accounted for 11% of the Company’s total revenue in 2001 as compared to 3% in 2000.
The Banks’ principal competitors are United Bank & Trust, Key Bank, Sky Bank, Standard Federal Bank, and TLC Community Credit Union. With the exception of United Bank & Trust and TLC Community Credit Union, each of these financial institutions has headquarters in larger metropolitan areas, and has significantly greater assets and financial resources than the Company. Based on deposit information as of December 31, 2001, the Bank of Lenawee holds an estimated 26 % of the deposits in Lenawee County and the Bank of Washtenaw holds an estimated .7 % of the deposits in Washtenaw County. Information as to asset size of competitor financial institutions is derived from publicly available reports filed by and with regulatory agencies.
The following is a summary of certain statutes and regulations affecting the Company and the Banks. This summary is qualified in its entirety by such statutes and regulations. A change in applicable laws or regulations may have a material effect on the Company, the Banks and the business of the Company and the Banks.
Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, the growth and earnings performance of the Company and the Banks can be affected not only by management decisions and general economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the FDIC, the Commissioner of the Michigan Office of Financial and Insurance Services (“Commissioner”), the Internal Revenue Service, and state taxing authorities. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Banks establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the depositors of the Banks, and the public, rather than shareholders of the Banks or the Company.
Federal law and regulations establish supervisory standards applicable to the lending activities of the Banks, including internal controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by real property.
General. The Company is a bank holding company and, as such, is registered with, and subject to regulation by, the Federal Reserve Board under the Bank Holding Company Act, as amended (the “BHCA”). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.
In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Banks and to commit resources to support the Banks in circumstances where the Company might not do so absent such policy. In addition, if the Commissioner deems a Bank’s capital to be impaired, the Commissioner may require the Bank to restore its capital by a special assessment upon the Company as the Bank’s sole shareholder. If the Company were to fail to pay any such assessment, the directors of the Banks would be required, under Michigan law, to sell the shares of the Bank’s stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank’s capital.
Investments and Activities. 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 company, will require the prior written approval of the Federal Reserve Board under the BHCA. 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 BHCA. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the BHCA and/or the Commissioner under the Michigan Banking Code, may be required.
With certain limited exceptions, the BHCA prohibits any bank company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling banks unless the proposed non-banking activity is one that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under current Federal Reserve Board regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. Well-capitalized and well-managed bank holding companies may engage de novo in certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve Board, provided that written notice of the new activity is given to the Federal Reserve Board within 10 business days after the activity is commenced. If a bank holding company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank holding company.
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Eligible bank holding companies that elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The Bank Holding Company Act generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank or financial holding companies. While the Company believes it is eligible to elect to operate as a financial holding company, as of the date of this filing, it has not applied for approval to operate as a financial holding company.
Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total average assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of shareholders’ equity) to total average assets of 3% for the most highly rated companies, with minimum requirements of 4% to 5% for all others. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital.
The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. The Federal Reserve Board has not advised the Company of any specific minimum Tier 1 Capital leverage ratio applicable to it.
Dividends. The Company is a corporation separate and distinct from the Banks. Most of the Company’s revenues are received by it in the form of dividends paid by the Banks. Thus, the Company’s ability to pay dividends to its shareholders is indirectly limited by statutory restrictions on the Banks’ ability to pay dividends described below. Further, the Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the Federal Reserve Board expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. Additionally, the Federal Reserve Board possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Similar enforcement powers over the Banks are possessed by the FDIC. The “prompt corrective action” provisions of federal law and regulation authorizes the Federal Reserve Board to restrict the payment of dividends by the Company for an insured bank which fails to meet specified capital levels.
In addition to the restrictions on dividends imposed by the Federal Reserve Board, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if after the distribution a corporation, such as the Company, can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution. The Company’s Articles of Incorporation do not authorize the issuance of preferred stock and there are no current plans to seek such authorization.
General. The Banks are Michigan banking corporations, are members of the Federal Reserve System and their deposit accounts are insured by the Bank Insurance Fund (the “BIF”) of the FDIC. As Federal Reserve System members and Michigan chartered banks, the Banks are subject to the examination, supervision, reporting and enforcement requirements of the Federal Reserve Board as their primary federal regulator and the Commissioner, as the chartering authority for Michigan banks. These agencies and the federal and state laws applicable to the Banks and their operations, extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.
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Deposit Insurance. As FDIC-insured institutions, the Banks are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their respective levels of capital and results of supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.
The Federal Deposit Insurance Act (“FDIA”) requires the FDIC to establish assessment rates at levels which will maintain the Deposit Insurance Fund at a mandated reserve ratio of not less than 1.25% of estimated insured deposits. For several years, the BIF reserve ratio has been at or above the mandated ratio and assessments have ranged from 0% of deposits for institutions in the lowest risk category to .27% of deposits in the highest risk category. However, there is speculation that the reserve may fall below the mandated ratio resulting in increased assessments in the second half of 2002.
FICO Assessments. The Banks, as members of the BIF, are subject to assessments to cover the payments on outstanding obligations of the Financing Corporation (“FICO”). FICO was created to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the FDIC’s Savings Association Insurance Fund (the “SAIF”) which insures the deposits of thrift institutions. From now until the maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. It is estimated that FICO assessments during this period will be less than 0.025% of deposits.
Commissioner Assessments. Michigan banks are required to pay supervisory fees to the Commissioner to fund the operations of the Commissioner. The amount of supervisory fees paid by a bank is based upon the bank’s total assets, as reported to the Commissioner.
Capital Requirements. The Federal Reserve has established the following minimum capital standards for state-chartered, member banks, such as the Banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, Federal Reserve regulations provide that higher capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities or securities trading activities.
Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Federal regulations define these capital categories as follows:
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| Total Risk-Based Capital Ratio |
Tier 1 Risk-Based Capital Ratio |
Leverage Ratio | |
| Well capitalized | 10% or above | 6% or above | 5% or above |
| Adequately capitalized | 8% or above | 4% or above | 4% or above |
| Undercapitalized | Less than 8% | Less than 4% | Less than 4% |
| Significantly undercapitalized | Less than 6% | Less than 3% | Less than 3% |
| Critically undercapitalized | -- | -- | A ratio of tangible equity to total assets of 2% or less |
As of December 31, 2001, each of the Bank’s ratios exceeded minimum requirements for the well capitalized category.
Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.
In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution, following receipt of a less-than-satisfactory rating on its most recent examination report, to correct the deficiency.
Dividends. Under Michigan law, the Banks are restricted as to the maximum amount of dividends they may pay on their common stock. The Banks may not pay dividends except out of net income after deducting their losses and bad debts. A Michigan state bank may not declare or pay a dividend unless the bank will have surplus amounting to at least 20% of its capital after the payment of the dividend.
As a member of the Federal Reserve System, each of the Banks is required by federal law to obtain the prior approval of the Federal Reserve Board for the declaration or payment of a dividend, if the total of all dividends declared by the Bank’s Board of Directors in any year will exceed the total of (i) the Bank’s retained net income (as defined and interpreted by regulation) for that year plus (ii) the retained net income for the preceding two years, less any required transfers to surplus. Federal law 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. Further, federal regulatory agencies can prohibit a banking institution or bank holding company from engaging in unsafe and unsound business practices and could prohibit payment of dividends if such payment could be deemed an unsafe and unsound business practice.
Insider Transactions. The Banks are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company or its subsidiaries, on investments in the stock or other securities of the Company or its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by each Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company, and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Banks maintain a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines to promote the safety and soundness of federally insured depository institutions. These guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
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Investments and Other Activities. Under federal law and regulations, Federal Reserve System member banks and FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by regulations, also prohibits state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the bank’s primary federal regulator determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the bank’s primary federal regulator in accordance with federal law. These restrictions are not currently expected to have a material impact on the operations of the Bank.
Consumer Protection Laws. The Banks’ businesses include making a variety of types of loans to individuals. In making these loans, the Banks are subject to State usury and regulatory laws and to various federal statutes, including the privacy of consumer financial information provisions of the Gramm-Leach-Bliley Act and regulations promulgated thereunder, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the 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 the Banks, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, the Banks are subject to extensive regulation under State and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Banks and their directors and officers.
Branching Authority. Michigan banks, such as the Banks, have the authority under Michigan law to establish branches anywhere in the State of Michigan, subject to receipt of all required regulatory approvals.
Banks may establish interstate branch networks through acquisitions of other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.
Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Michigan Office of Financial and Insurance Services, Division of Financial Institutions, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) 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 bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan.
Item 2. Properties.
The Bank of Lenawee’s main office is located in Adrian and it serves other communities with branch offices in Hudson, Morenci, Tecumseh and Waldron. The Bank of Washtenaw’s main office is located in Saline and it has a branch office and an administrative office in Ann Arbor. The Banks’ offices are located throughout Lenawee County, in the southeastern portion of Hillsdale County, and the southern portion of Washtenaw County. The area in which the Banks’ offices are located, which is basically southeastern Michigan, has historically been rural in character but now has a growing urban population as residents choose the area to live in while commuting to Ann Arbor, Detroit, and Toledo. The populations of the cities in which the Banks’ offices are located are approximately as follows: Adrian—22,000; Ann Arbor—110,000; Hudson—2,500; Morenci—2,300; Saline—7,600; Tecumseh—8,700; and Waldron—600; The main office of Bank of Lenawee is a three story 40,768 square foot building constructed in 1906. The other offices of the Banks range in size from 1,200 square feet to 4,000 square feet. The majority of the offices of Bank of Lenawee are owned and those of Bank of Washtenaw are leased.
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There is no material legal proceedings against the Company nor either of the Banks except routine litigation incidental to the ordinary conduct of the business of the Banks, none of which would result in a material impact on the Company or the Banks, individually or in the aggregate, in the event of an adverse outcome.
During 1999 an extraordinary large loan loss was recognized stemming from the Bank of Lenawee’s purchase of $3.0 million participation out of a $5.3 million credit package originated by another bank (“Lead Bank”). The Lead Bank retained responsibility for overall credit administration and monitoring and maintained exclusive contact with the borrower after the loan was made. The borrower, a manufacturer located in Big Rapids, Michigan (“Borrower”), unbeknownst to the Bank of Lenawee, began to experience financial difficulties almost immediately and may have provided misleading information to both the Bank of Lenawee and the Lead Bank. The credit is now deemed to be uncollectable as a consequence of the inability of the Borrower to continue as a going concern, and insufficiency of collateral to cover the current amount outstanding and the inability of the individual guarantors to honor their personal guarantee obligations. Over the course of 2000, Bank of Lenawee charged $2.3 million against its allowance for loan losses with respect to this credit. Bank of Lenawee has also instituted legal action against the Lead Bank claiming negligence in its administration of the credit and seeking recovery of the loss incurred as a result of participation in the credit. The litigation is ongoing and may continue for some time, and as in all similar situations, the outcome is uncertain.
Item 4. Submission of Matters to Vote of Security Holders.
No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2001.
The following information concerning executive officers of the Company has been omitted from the Registrant’s proxy statement pursuant to Instruction 3 to Regulation SK, Item 401(b).
Officers of the Company are appointed annually by the Board of Directors of the Company and serve at the pleasure of the Board of Directors. Information concerning these executive officers is given below:
Patrick K. Gill (age 50) is the President and Chief Executive officer of the Company and Bank of Lenawee. He began his career at the Bank of Lenawee in 1992 as Executive Vice President. In July of 1994 Mr. Gill was promoted to President and Chief Operating Officer of Bank of Lenawee and the Company and in January of 1997 he was promoted to President and Chief Executive Officer of Bank of Lenawee and the Company. He also serves as Board Chairman of Bank of Washtenaw
Pamela S. Fisher (age 52) is the Corporate Secretary of the Company and Senior Vice President of Administrative Services of the Bank of Lenawee. Ms. Fisher joined the Bank of Lenawee in 1979 and has served the bank in various capacities. She was elected as Senior Vice President of Bank of Lenawee in 2000 and was elected Secretary of the Company in 1995.
Loren V. Happel (age 46) is the Company’s Treasurer and Senior Vice President and Chief Financial Officer of the Bank of Lenawee. Mr. Happel joined the Company and Bank of Lenawee in December of 1994. At that time he was appointed Treasurer of the Company and First Vice President and Chief Financial Officer of Bank of Lenawee.
Douglas L. Kapnick (age 58) was elected Chairman of the Board of the Company in September of 2000 and has been a director of Bank of Lenawee since 1982 and has been a director of the holding company since it was formed in 1993. Mr. Kapnick is President of Kapnick & Company a full service insurance broker with offices in Adrian and Southfield employing a total of approximately 85 persons.
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The information under the caption “COMMON STOCK INFORMATION” at page 42 of the Company’s 2001 Annual Report to shareholders, is here incorporated by reference to Exhibit 13.
Item 6. Selected Financial Data.
The information under the caption “SELECTED FINANCIAL DATA” at page 2 of the Company’s 2001 Annual Report to shareholders, is here incorporated by reference to Exhibit 13.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The information under the captions “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” at pages 3 through 15 of the Company’s 2001 Annual Report to shareholders, is here incorporated by reference to Exhibit 13.
The information under the captions “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” at pages 11 through 15 of the Company’s 2001 Annual Report to shareholders, is here incorporated by reference to Exhibit 13.
The financial statements, notes and report of independent auditors included in the Company’s 2001 Annual Report to shareholders, is here incorporated by reference to Exhibit 13.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None
Item 10. Directors and Executive Officers of the Registrant.
Information with respect to the Company’s Executive Officers is included in this report in Part I. The information with respect to Directors of the Company, set forth under the caption “Information About Directors and Nominees” on pages 5 through 11 of the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2002, relating to the April 18, 2002 Annual Meeting of Shareholders, is incorporated herein by reference.
Item 11. Executive Compensation.
The information set forth under the caption “COMPENSATION OF EXECUTIVE OFFICERS” on page 8 through 11 of the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2002, relating to the April 18, 2002 Annual Meeting of Shareholders, is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information set forth under the caption “VOTING SECURITIES AND BENEFICIAL OWNERSHIP OF MANAGEMENT AND OTHERS” on page 4 through 5 of the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2002, relating to the April 18, 2002 Annual Meeting of Shareholders, is incorporated herein by reference.
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The information set forth under the caption “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” on page 11 of the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2002, relating to the April 18, 2002 Annual Meeting of Shareholders, is incorporated herein by reference.
Item 14. Exhibits, Financial Statement Schedules and Report on Form 8-K.
| (a) | 1. |
Financial Statements The following consolidated financial statements of the Company and Report of Crowe Chizek and Company LLP, Independent Auditors, are incorporated by reference under Item 8 “Financial Statements and Supplementary Data” of this document: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Crowe Chizek and Company LLP, Independent Accountants |
| 2. |
Financial Statement Schedules Not applicable |
|
| 3. |
Exhibits (Numbered in accordance with Item 601 of Regulation S-K) The Exhibit Index is located on the final page of this report on Form 10-K. |
|
| (b) | Reports on Form 8-K | |
| No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 2001. | ||
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March __, 2002.
|
LENAWEE BANCORP, INC. /s/ Patrick K. Gill Patrick K. Gill President and Chief Executive officer (Principal Executive Officer) /s/ Loren V. Happel Loren V. Happel Treasurer (Executive Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each director of the Registrant, whose signature appears below, hereby appoints Patrick K. Gill and Loren V. Happel, and each of them severally, as his or her attorney-in-fact, to sign in his or her name and on his or her behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K.
| Signature | |
|
/s/ Allan F. Britain
Allan F. Britain |
March , 2002 |
|
/s/ Fred R. Duncan
Fred R. Duncan |
March , 2002 |
|
/s/ Edward J. Engle, Jr.
Edward J. Engle, Jr. |
March , 2002 |
|
/s/ William R. Gentner
William R. Gentner |
March , 2002 |
|
/s/ Patrick K. Gill
Patrick K. Gill |
March , 2002 |
|
/s/ Douglas L. Kapnick
Douglas L. Kapnick |
March , 2002 |
|
/s/ J. Paul Rupert
J. Paul Rupert |
March , 2002 |
|
/s/ Emory M. Schmidt
Emory M. Schmidt |
March , 2002 |
|
/s/ J. David Stutzman
J. David Stutzman |
March , 2002 |
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The following exhibits are filed herewith, indexed according to the applicable assigned number:
| Exhibit Number |
|
| 13 | Rule 14a-3 Annual Report to Security Holders |
| 21 | Subsidiaries of Registrant |
The following exhibits, indexed according to the applicable assigned number, were previously filed by the Registrant and are incorporated by reference in this Form 10-K Annual Report.
| Exhibit Number |
|
| 3.1 | Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form 10, as amended. |
| 3.2 | Bylaws of the Registrant are incorporated by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form 10, as amended. |
| 4 | Form of Registrant’s Stock Certificate is incorporated by reference to Exhibit 4 of the Registrant’s Registration Statement on Form 10, as amended. |
| 10 | 2001 Stock Option Plan, incorporated by reference to Appendix A to the Registrant’s Definitive Proxy Statement filed with respect to its April 18, 2001 annual meeting of shareholders. |
| 10.1 | 1996 Stock Option Plan, incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement filed on Form 10, as amended. |
| 10.2 | Employment Agreement dated February 22, 1999, and amended February 22, 2000, between Bank of Lenawee and Patrick K. Gill, incorporated by reference to Exhibit 10.2 of the Registrant’s Registration Statement on Form 10, as amended. |
| 10.3 | Supplemental Executive Retirement Agreement dated December 19, 1997, between Bank of Lenawee and Allan W. Brittain, incorporated by reference to the Registrant’s Registration Statement on Form 10, as amended. |
| 10.4 | Consulting Agreement dated January 1, 1998, between Bank of Lenawee and Allan W. Brittain, incorporated by reference to Registrant’s Registration Statement on Form 10, as amended. |
-12-
This 2001 Annual Report contains audited financial statements and a detailed financial review. This is Lenawee Bancorp's 2001 annual report to shareholders. Although attached to our proxy statement, this report is not part of our proxy statement, is not deemed to be soliciting material, and is not deemed to be filed with the Securities and Exchange Commission (the "SEC") except to the extent that it is expressly incorporated by reference in a document filed with the SEC.
The 2000 Summary Annual Report to Shareholders accompanies this proxy statement. That report presents information concerning the business and financial results of Lenawee Bancorp in a format and level of detail that we believe shareholders will find useful and informative. Shareholder who would like to receive even more detailed information than that contained in this 2000 Annual Report are invited to request our Annual Report on Form 10-K.
Lenawee Bancorp, Inc.'s Form 10-K Annual Report to the Securities and Exchange Commission will be provided to any shareholder without charge upon written request. Requests should be addressed to Lenawee Bancorp, Inc., Attention: Pamela S. Fisher, 135 East Maumee Street, Adrian, Michigan 49221.
LENAWEE BANCORP, INC.
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000CONTENTS
| SELECTED FINANCIAL DATA............................................................................................................................ | 2 |
| MANAGEMENT'S DISCUSSION AND ANALYSIS............................................................................................ | 3 |
| MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING......................................................... | 16 |
| REPORT OF INDEPENDENT AUDITORS......................................................................................................... | 17 |
| CONSOLIDATED FINANCIAL STATEMENTS | |
| CONSOLIDATED BALANCE SHEETS.......................................................................................................... | 18 |
| CONSOLIDATED STATEMENTS OF INCOME.......................................................................................... | 19 |
| CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY................................. | 20 |
| CONSOLIDATED STATEMENTS OF CASH FLOWS................................................................................. | 21 |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................................................................... | 22 |
| COMMON STOCK INFORMATION................................................................................................................. | 42 |
SELECTED FINANCIAL DATA
(In thousands, except per share data)
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
For the Year:
Total interest income $ 21,012 $ 20,851 $ 17,923 $ 17,517 $ 16,929
Total interest expense 8,198 8,710 6,312 7,205 7,586
Net interest income 12,814 12,141 11,611 10,312 9,343
Provision for loan losses 388 30 2,560 239 245
Noninterest income 4,151 2,064 2,237 2,850 1,769
Noninterest expense 12,182 9,414 8,994 8,913 7,632
Income before income taxes 4,395 4,761 2,294 4,010 3,235
Net income 3,043 3,205 1,563 2,660 2,132
Per Share Data:
Basic earnings per share $ 3.58 $ 3.75 $ 1.83 $ 3.13 $ 2.51
Diluted earnings per share 3.54 3.71 1.83 3.12 2.51
Cash dividends declared per share .80 .94 .75 .67 .60
Shareholders' equity and net ESOP obligation per share 33.01 29.91 26.72 26.26 23.71
Shareholders' equity per share 27.77 23.90 21.64 21.92 20.24
At Year-End:
Total assets $278,127 $259,747 $239,904 $ 220,414 $ 212,920
Loans receivable 214,749 214,512 197,308 158,487 163,039
Allowance for loan losses 2,200 2,287 4,646 2,182 1,964
Deposits 235,407 224,143 199,206 185,891 174,973
Borrowed funds 7,394 7,936 16,177 10,626 16,346
Shareholders' equity and net ESOP obligations 28,007 25,467 22,775 22,345 20,074
Shareholders' equity 23,563 20,353 18,449 18,648 17,137
Financial:
Net interest income to average earning assets 5.09% 5.26% 5.66% 5.07% 4.72%
Return on average shareholders' equity and
net ESOP obligation 11.58 13.29 6.65 12.46 10.99
Return on average shareholders' equity 14.14 16.59 8.02 14.76 12.84
Return on average assets 1.12 1.28 .70 1.21 1.00
Tier 1 leverage ratio 11.90 9.90 9.90 9.90 9.30
Dividend payout ratio 22.35 25.07 40.98 21.41 23.86
Average shareholders' equity and net ESOP
obligation to average total assets 9.66 9.60 10.52 9.72 9.11
Average shareholders' equity to average total assets 7.91 7.72 8.72 8.21 7.79
All per share data has been adjusted to reflect stock splits and stock dividends.
2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion provides information about the financial condition and results of operations of Lenawee Bancorp, Inc. It should be read in conjunction with the consolidated financial statements included elsewhere in this Annual Report.
BUSINESS OF LENAWEE BANCORP, INC.
Lenawee Bancorp, Inc. (the Company), a bank holding company, was incorporated in Michigan in 1993. On April 15, 1993, the Company acquired all of the stock of the Bank of Lenawee (the Bank), a Michigan banking corporation chartered in 1869. On January 1, 2001 the Bank of Lenawee made the real estate origination component of its business a separate entity named Pavilion Mortgage Company. On January 8, 2001 the Company opened a new bank, the Bank of Washtenaw. The new bank is operating the former Saline Michigan branch of the Bank of Lenawee and has opened a new branch and administrative offices in Ann Arbor, Michigan.
Business is concentrated primarily in a single industry segment - commercial banking. Each bank provides a full range of banking services to individuals, commercial businesses and industries located in its service area. Each bank maintains diversified loan portfolios, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. Each bank offers a variety of deposit products, including checking, savings, money market, individual retirement accounts and certificates of deposit.
The principal markets for financial services are the mid-Michigan communities in which the banks are located and the areas immediately surrounding these communities. The banks serve these markets through 11 locations in or near their communities. The banks do not have any material foreign assets or income.
Our principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 77% of our total revenue in 2001 compared to 84% in 2000. The significant reductions in interest rates during 2001 resulted in a significant increase in the volume of loan sale activity and gains on sales of mortgage loans. These gains accounted for 11% of our total revenue in 2001 as compared to 3% in 2000.
2001 HIGHLIGHTS
The major highlights of 2001 for the Company were the formation of Pavilion Mortgage Company and the Bank of Washtenaw. We believe these new subsidiaries will help us expand our market and provide the products and services our customers need. We made significant investments in these new subsidiaries and the impact is reflected in the 2001 financial statements, particularly in the areas of staffing and occupancy costs.
Our net income for the year ended December 31, 2001 was $3,043,072, which was a 5.3% decrease from our 2000 net income of $3,204,933. As a result, our basic earnings per share decreased to $3.58 in 2001 from $3.75 in 2000. Diluted earnings per share decreased from $3.71 in 2000 to $3.54 in 2001. Our return on average equity including net ESOP obligation declined to 11.58% in 2001 from 13.29% in 2000.
Our total assets grew to $278.1 million in 2001 from $259.7 million in 2000. This growth reflects the investments made in our new subsidiaries. As a result of the significant refinancing activity that occurred during 2001, our net loan balances stayed relatively unchanged at $212 million.
3.
NET INTEREST INCOME
As discussed earlier, the largest component of our operating income is net interest income. Net interest income is the difference between the interest and fees we earn on our earning assets and the interest we pay on deposits and other borrowings. A number of factors influence net interest income. These factors include: changes in volume and mix of interest-earning assets and interest-bearing liabilities, government monetary and fiscal policies, national and local market interest rates and customer preference.
Our net interest income was $12.8 million in 2001, an increase of $673,000 over 2000. The 2001 increase in net interest income was primarily the result of decreased funding costs. The table below shows the yields earned on our interest-earning assets and our costs of interest-bearing liabilities. The table also reflects our net interest margin for the years ended December 31, 2001, 2000 and 1999.
Average Balance Sheet and Analysis of Net Interest Income
Years ended December 31,
-------------2001------------ ------------2000-------------- -----------1999--------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
(Dollars in thousands)
Interest-earning assets:
Loans receivable $ 217,424 $ 19,284 8.87% $ 203,698 $ 19,268 9.46% $ 171,276 $16,025 9.36%
Securities available for sale (1) 24,038 1,253 5.21 21,264 1,168 5.49 28,456 1,555 5.46
Federal funds sold 6,783 255 3.76 2,708 167 6.17 2,319 118 5.09
Federal Home Loan Bank Stock 2,504 181 7.23 2,504 200 7.99 2,504 200 7.99
Interest-bearing balances with
other financial institutions 867 40 4.61 782 48 6.14 517 25 4.84
--------- ------- -------- ------- -------- -------
Total interest-earning assets 251,616 21,013 8.35 230,956 20,851 9.03 205,072 17,923 8.74
Noninterest-earning assets:
Cash and due from financial
institutions 10,316 8,369 7,807
Premises and equipment, net 6,526 6,333 6,556
Other assets 3,424 5,466 3,893
--------- -------- --------
Total assets $ 271,882 $ 251,124 $ 223,328
========= ========= ========
Interest-bearing liabilities:
Interest-bearing demand deposits $ 56,113 $ 1,207 2.15 $ 53,156 $ 1,821 3.43% $ 48,636 $1,337 2.75%
Savings deposits 24,389 340 1.39 23,756 358 1.51 24,293 379 1.56
Time deposits 115,060 6,233 5.42 97,827 5,675 5.80 79,088 3,977 5.03
Repurchase agreements and other
borrowings 3,083 86 2.79 3,955 191 4.83 3,942 155 3.93
FHLB advances 5,519 333 6.03 10,637 665 6.25 7,812 464 5.94
--------- ------- -------- ------- -------- -------
Total interest-bearing 204,164 8,199 4.02 189,331 8,710 4.60 163,771 6,312 3.85
liabilities
Noninterest-bearing liabilities:
Demand deposits 39,198 35,839 34,634
Other liabilities 2,251 1,846 1,430
--------- -------- --------
Total liabilities 245,613 227,016 199,835
Common stock subject to
repurchase obligation in ESOP 4,756 4,720 4,012
Shareholders' equity 21,513 19,388 19,481
--------- -------- --------
Total liabilities and
shareholders' equity $ 271,882 $ 251,124 $ 223,328
========= ========= =========
Net interest income/interest rate
spread $ 12,814 4.33% $12,141 4.43% $11,611 4.89%
========= ===== ======= ===== ======= =====
Net interest margin (2) 5.09% 5.26% 5.66%
===== ===== =====
Average interest-earning assets to
average interest-bearing liabilities 123.24% 121.99% 125.22%
======= ======= =======
| (1) | Interest income on tax-exempt securities has not been adjusted to a taxable equivalent basis. |
| (2) | Net interest earnings divided by average interest-earning assets. |
4.
Net interest margin is net interest income divided by average earning assets. Our net interest margin declined to 5.09% from 5.26% in 2000 and 5.66% in 1999. During 2001, the Federal Reserve decreased the discount rate by 475 basis points from 6.0% to 1.25%. As a result, our prime lending rate decreased from 9.5% at December 31, 2000 to 4.75% at December 31, 2001. With such a drastic change in interest rates, we experienced a short-term decline in revenues from this decrease in the prime lending rate. A large portion of our variable rate business and consumer loan portfolios is tied directly to the prime lending rate. Offsetting the impact of this reduction in interest income on our loan products was the decrease in our costs of local deposit funding. Our primary source of funding is from the local markets we serve and our costs of funds decreased from 4.60% in 2000 to 4.02% in 2001.
The following table analyzes the effect of volume and rate changes on interest income and expense for the periods indicated.
---------2001 Compared to 2000------- --------2000 Compared to 1999---------
Amount Amount Net Amount Amount Net
Due to Due to Increase Due to Due to Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(In thousands)
Interest income
Loans receivable $ 1,256 $ (1,240) $ 16 $ 3,065 $ 178 $ 3,243
Securities available for sale 147 (62) 85 (395) 8 (387)
Federal funds sold 173 (85) 88 22 27 49
Federal Home Loan Bank Stock - (19) (19) - - -
Interest-bearing balances with
financial institutions 5 (13) (8) 15 8 23
Total interest income 1,581 (1,419) 162 2,707 221 2,928
Interest expense
Interest-bearing deposits
Demand 96 (712) (616) 133 351 484
Savings 9 (27) (18) (8) (13) (21)
Time 952 (394) 558 1,030 668 1,698
Repurchase agreements and
other borrowings (36) (69) (105) 1 35 36
FHLB advances (310) (22) (332) 175 26 201
Total interest expense 711 (1,224) (513) 1,331 1,067 2,398
Net interest income $ 870 $ (197) $ 673 $ 1,376 $ (846) $ 530
5.
PROVISION FOR LOAN LOSSES
The provision for loan losses is the amount added to the allowance for loan losses to absorb losses that have been incurred. The loan loss provision is based on historical loss experience and such other factors, which, in our judgment, deserve current recognition in maintaining an adequate allowance for loan loss balance.
The provision for loan losses was $388,000 in 2001 and $30,000 in 2000. This increase in provision for loan losses is representative of the increased risk arising from the deteriorating economy in 2001. We determined the additional provision was necessary in 2001 as a result of the current economic conditions as well as signs of deterioration of credit quality as shown in key indicators such as nonperforming loans. Our total nonperforming loans more than doubled from $636,000 at December 31, 2000 to $1,276,000 at December 31, 2001.
In 1999 the provision for loan losses was $2,560,000 due to a large anticipated loan loss stemming from the Bank of Lenawee’s purchase of a $3.0 million participation out of a $5.3 million credit package originated by another bank (“Lead Bank”). The Lead Bank retained responsibility for overall credit administration and monitoring and maintained exclusive contact with the borrower after the loan was made. The borrower, a manufacturer located in Big Rapids, Michigan (“Borrower”), unbeknownst to the Bank of Lenawee, began to experience financial difficulties almost immediately and may have provided misleading information to both the Bank of Lenawee and the Lead Bank. Over the course of 2000, we charged $2.3 million against the allowance for loan losses with respect to this credit. We have also instituted legal action against the Lead Bank claiming negligence in its administration of the credit and seeking recovery of the loss incurred as a result of participation in the credit. That litigation has continued for some time, and as in all similar situations, the outcome remains uncertain.
Noninterest income was $4.2 million in 2001 as compared to $2.1 million in 2000. This represents a 101% increase from 2000. This increase in noninterest income is attributable to increased service charges and fees and a significant increase in the mortgage banking activity and resulting increase in gains on loan sales.
The largest contributing factor to our 2001 noninterest income was a $2.1 million increase in net gains on mortgage loan sales. The decline in interest rates during 2001 substantially increased the mortgage refinancing business. During 2001, we sold $158.3 million of loans in the secondary market, resulting in net gains of $2.7 million. In 2000, we sold $45.0 million of loans resulting in net gains of $652,000. In 1999, we sold $49.5 million of loans resulting in net gains of $1.0 million.
Contributing further to noninterest income were increases in our service charges and fees which grew to $1.4 million in 2001 from $1.0 million in 2000 and $779,000 in 1999. These increases are primarily attributable to the growth of our deposit base.
Noninterest expense of $12.2 million in 2001 is an increase of $2.8 million or 29% compared to the noninterest expense of $9.4 million in 2000. The majority of the increase is the result of start up costs, staffing and occupancy expenses associated with opening the Bank of Washtenaw. We added two facilities and increased our staff from 127 full time equivalents at December 31, 2000 to 150 full time equivalents at December 31, 2001. This resulted in an increase in our efficiency ratio from 66.26% in 2000 to 71.81% in 2001.
6.
Our income tax expense was $1.4 million in 2001 compared to $1.6 million in 2000 and $731,000 in 1999. The decrease from 2000 to 2001 was directly attributable to the increased level of noninterest expense.
The statutory federal tax rate during 2001, 2000 and 1999 was 34%. Our effective tax rate was lower than the statutory rate in all three years, primarily due to our tax-exempt interest income. Our effective tax rate was 31% in 2001, 33% in 2000, and 32% in 1999.
The following table shows securities by classification as of December 31, 2001 and the amounts and weighted-average yields by maturity period. Securities that are not due at a single maturity date, primarily mortgage-backed securities, are not shown.
--------------------------------------------MATURING----------------------------------------------
Within After One But After Five But After
One Within Five Within Ten Ten
Year Years Years Years Total
(Dollars in thousands)
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Available For Sale
U.S. Treasuries
and government
agencies $ 5,398 5.14% $ 12,666 5.57% $ - -% $ - -% $ 18,064 5.44%
State and municipal (1) 349 5.94% 3,358 4.81% 661 6.50% 765 6.50% 5,133 5.36%
Total $ 5,747 $ 16,024 $ 661 $ 765 $ 23,197
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent basis.
Our Asset/Liability Management Committee (Committee) is responsible for developing investment guidelines and strategies. The Committee relies on the expertise of an investment advisor to select appropriate investments for the portfolio. Decisions to purchase securities and the maturity date selected are coordinated with an overall plan to manage liquidity and interest rate exposure.
We do not invest in derivative securities. We held no impaired securities at December 31, 2001. As of December 31, 2001, the aggregate amortized cost of securities we held which were issued by the State of Michigan and its political subdivisions totaled $4.6 million with an aggregate market value of $4.7 million.
The U.S. government agency securities identified as available for sale are laddered to mature over five years with a three year average life. The goal is to reduce the volatility of the securities portfolio yield and still provide a predictable source of liquidity.
We had no held to maturity securities as of December 31, 2001, 2000 and 1999. The book value of securities available for sale, as of the dates indicated, are summarized as follows:
-----------December 31,-------------
2001 2000 1999
---- ---- ----
(In thousands)
U.S. Treasuries and government agencies $ 18,064 $ 7,283 $ 7,169
State and municipal 5,133 6,911 9,376
Other securities 2,772 5,127 6,479
--------- -------- --------
$ 25,969 $ 19,321 $ 23,024
========= ======== ========
7.
Our lending efforts are concentrated primarily in the Michigan communities in which our banks’ branches are located. The banks have no foreign loans.
Our loan growth during 2001 was limited as a result of the significant refinancing activity experienced during 2001. Our total loans increased $200,000 from year-end 2000 to 2001. We did experience growth in our commercial loan portfolio, growing from $116.1 million at December 31, 2000 to $123.3 million at December 31, 2001.
The following table presents the gross amount of loans outstanding by loan type:
--------------------------December 31,-------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(In thousands)
Commercial, financial and agricultural $ 155,071 $ 149,058 $ 135,324 $ 112,451 $ 106,494
Real estate - construction 7,318 13,383 9,934 - -
Real estate - mortgage 17,409 14,225 17,203 17,010 27,835
Consumer 34,951 37,846 34,847 29,026 28,710
---------- ---------- ---------- --------- ----------
$ 214,749 $ 214,512 $ 197,308 $ 158,487 $ 163,039
========== ========== ========== ========= ==========
The following table shows the maturity of loans outstanding (in thousands) at December 31, 2001. Also provided are the amounts due after one year, classified according to their sensitivity to changes in interest rates.
Due
Due After One Due
Within But Within After
One Year Five Years Five Years Total
-------- ---------- ---------- -----
Commercial, financial and agricultural $ 49,494 $ 90,407 $ 15,170 $ 155,071
Real estate-construction 7,318 - - 7,318
Real estate-mortgage 3,152 7,150 7,107 17,409
Consumer 12,899 15,845 6,207 34,951
----------- ---------- ----------- -----------
$ 72,863 $ 113,402 $ 28,484 $ 214,749
=========== =========== =========== ===========
Loans due after one year:
Fixed rate $ 84,012
Floating or adjustable rate 57,874
-----------
$ 141,886
===========
8.
Management believes that a conservative credit culture is critical to successful performance. Through Officer and Director Loan Committees, management reviews and monitors the quality of the various loan portfolios. Internal and external loan review personnel also review our loan performance and underwriting regularly. The stable regional economy over recent years has created a stable lending environment. The recent change in the momentum of the economy to static has begun to show signs of impacting some of our loan customers as shown in the nonperforming assets table below.
Loans are placed on non-accrual status when principal or interest is past due 90 days or more, the loan is not well-secured, and is in the process of collection or when reasonable doubt exists concerning collectibility of interest or principal. Any interest previously accrued in the current period but not collected is reversed and charged against current earnings.
At December 31, 2001, the Banks had no loans for which payments were presently current, but the borrowers were experiencing serious financial difficulties. As of December 31, 2001 there were no concentrations of loans exceeding 10% of total loans.
The following table summarizes non-accrual and past due loans and other real estate owned:
--------------------------December 31,-------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(In thousands)
Non-accruing loans past due $ 230 $ 113 $ 3,071 $ 121 $ 78
Loans past due 90 days or more 1,046 523 275 275 367
--------- --------- -------- -------- ---------
Total nonperforming loans 1,276 636 3,346 396 445
Other real estate 879 294 255 341 232
--------- --------- -------- -------- ---------
Total nonperforming assets $ 2,155 $ 930 $ 3,601 $ 737 $ 677
========= ========= ======== ======== =========
Nonperforming loans as a percent of
total loans .59% .30% 1.73% .25% .27%
Nonperforming assets as a percent of
total loans 1.00% .43% 1.87% .47% .42%
Nonperforming loans as a percent of the
loan loss reserve 58.00% 27.81% 77.50% 18.15% 22.66%
9.
The following table summarizes changes in the allowance for loan losses.
--------------------Years ended December 31,-------------------
(in thousands)
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Loans:
Average daily balance of loans for the year, net $ 217,424 $ 203,698 $171,276 $163,916 $ 158,603
Amount of loans outstanding at end of year, net $ 212,589 $ 212,317 $192,721 $156,272 $ 161,102
Allowance for loan losses:
Balance at beginning of year $ 2,287 $ 4,646 $ 2,182 $ 1,964 $ 1,761
Loans charged off:
Real estate - mortgage - - 34 13 -
Real estate - construction - 18 - - -
Commercial and agricultural 314 2,339 28 14 15
Consumer 265 120 96 26 61
--------- --------- -------- -------- ---------
579 2,477 158 53 76
--------- --------- -------- -------- ---------
Recoveries of loans previously charged-off:
Real estate-mortgage - 2 15 - -
Commercial and agricultural 81 36 6 10 14
Consumer 23 50 41 22 20
--------- --------- -------- -------- ---------
104 88 62 32 34
--------- --------- -------- -------- ---------
Net loans charged-off (recoveries) 475 2,389 96 21 42
Additions to allowance charged to operations 388 30 2,560 239 245
--------- --------- -------- -------- ---------
Balance at end of year $ 2,200 $ 2,287 $ 4,646 $ 2,182 $ 1,964
========= ========= ======== ======== =========
Ratios:
Net loans charged off to average net loans
outstanding .22% 1.17% .06% .01% .03%
Allowance for loan losses to net loans
outstanding 1.03% 1.08% 2.41% 1.40% 1.22%
The allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the probability of losses being incurred as follows:
------------------------------------------------December 31,----------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
to Total to Total to Total to Total to Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
-----------------------------------------------------------------------------------------------------
(In thousands)
Commercial, financial
and agricultural $1,900 72.20% $ 1,774 69.49% $ 4,010 68.59% $ 1,680 70.95% $ 1,556 65.32%
Real estate - mortgage 5 8.11 1 6.63 33 8.72 18 10.73 2 17.07
Real estate - construction 23 3.41 134 6.23 99 5.03 74 - 49 -
Consumer 148 16.28 119 17.65 135 17.66 130 18.32 27 17.61
Unallocated 124 - 259 - 369 - 280 - 330 -
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
$2,200 100.00% $ 2,287 100.00% $ 4,646 100.00% $ 2,182 100.00% $ 1,964 100.00%
====== ======= ======= ======= =======
10.
Liquidity is generally defined as the ability to meet cash flow needs of customers for loans and deposit withdrawals. To meet cash flow requirements, sufficient sources of liquid funds must be available. These sources include short-term investments, repayments of loans, maturing and called securities, sales of assets, growth in deposits and other liabilities and profits.
At December 31, 2001, we had $8.3 million in federal funds sold. We also had $25.0 million of additional borrowing capacity at the Federal Home Loan Bank and $4.0 million of borrowing capacity with correspondent banks.
During 2001, we also generated $5.8 million in cash from operating activities. All of these sources are available to meet cash flow needs of loan and deposit customers.
We also need cash to pay dividends to our shareholders. Our primary source of cash is the dividends paid to the parent by our banks. We believe that cash from operations is sufficient to supply the cash needed to continue paying a reasonable dividend.
At December 31, 2001, equity capital totaled $23.6 million. Management monitors the capital levels of the Company and the banks to provide for current and future business opportunities and to meet regulatory guidelines for “well capitalized” institutions. “Well capitalized” institutions are eligible for reduced FDIC premiums, and also enjoy other reduced regulatory restrictions.
At December 31, 2001, the Company and the banks exceeded all regulatory minimum capital requirements and are considered to be “well capitalized.”
Asset liability management involves developing, implementing and monitoring strategies to maintain sufficient liquidity, maximize net interest income and minimize the impact that significant fluctuations in market interest rates would have on earnings. Our banks’ Asset/Liability Committees are responsible for managing this process.
Quantitative and Qualitative Disclosures about Market Risk
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. Our
banks’ transactions are denominated in U.S. dollars with no specific
foreign exchange exposure. Also, the banks have a limited exposure to commodity
prices related to agricultural loans. Any impacts that changes in foreign
exchange rate and commodity prices would have on interest rates are assumed to
be insignificant.
Interest rate risk (IRR) is the exposure of a banking organization’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value; however, excessive levels of IRR could pose a significant threat to earnings and capital. Accordingly, effective risk management that maintains IRR at prudent levels is essential to our safety and soundness.
11.
Evaluating exposure to changes in interest rates includes assessing both the adequacy of management’s process used to control IRR and the organization’s quantitative level of exposure. When assessing the IRR management process, we seek to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires the assessment of existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity, and, where appropriate, asset quality.
The Federal Reserve Board, together with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency Policy Statement on IRR effective June 26, 1996. The policy statement provides guidance to examiners and bankers on sound practices for managing IRR, which will form the basis for ongoing evaluation of the adequacy of IRR management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing IRR. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk management process that effectively identifies, measures and controls IRR.
We derive the majority of income from the excess of interest collected over interest paid. The rates of interest earned on its assets and owed on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profit margins (or losses) if we cannot adapt to interest rate changes. For example, assume that an institution’s assets carry intermediate or long-term fixed rates and that those assets are funded with short-term liabilities. If market interest rates rise by the time the short-term liabilities must be refinanced, the increase in the institution’s interest expense on its liabilities may not be sufficiently offset if assets continue to earn at the long-term fixed rates. Accordingly, an institution’s profits could decrease because the institution will either have lower net interest income or possibly, net interest expense. Similar risks exist when assets are subject to contractual interest rate ceilings, or rate sensitive assets are funded by longer-term, fixed-rate liabilities in a decreasing rate environment.
Various techniques might be used by an institution to minimize IRR. We periodically analyze assets and liabilities and make future financing and investment decisions based on payment streams, interest rates, contractual maturities, and estimated sensitivity to actual or potential changes in market interest rates. Such activities fall under the broad definition of asset/liability management.
Several ways an institution can manage IRR include: selling existing assets or repaying certain liabilities; matching repricing periods for new assets and liabilities, for example, by shortening terms of new loans or investments and hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change IRR. Interest rate swaps, futures contracts, options on futures, and other such derivative financial instruments are often used for this purpose. Because these instruments are sensitive to interest rate changes, they require management’s expertise to be effective. We have not purchased derivative financial instruments in the past and do not presently intend to purchase such instruments.
We are also subject to repayment risk when interest rates fall. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refinance their obligations at new, lower rates. Prepayments of assets carrying higher rates reduces interest income and overall asset yields.
Certain portions of an institution’s liabilities may be short-term or due on demand, while most of its assets may be invested in long-term loans or investments. Accordingly, we seek to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits or selling assets. Also, Federal Home Loan Bank advances and short-term borrowings provide additional sources of liquidity.
12.
The following table provides information about our financial instruments that are sensitive to changes in interest rates as of December 31, 2001. We had no derivative financial instruments, or trading portfolio, as of that date. The expected maturity date values for loans receivable, mortgage-backed securities and investment securities were calculated without adjusting the instrument’s contractual maturity date for expectations of prepayments. Expected maturity date values for interest-bearing core deposits were not based upon estimates of the period over which the deposits would be outstanding, but rather the opportunity for repricing.
Principal/notional amount as of December 31, 2001 maturing in:
Fair
2002 2003 2004 2005 2006 Thereafter Total Value
---- ---- ---- ---- ---- --------- ----- -----
(In thousands)
Rate Sensitive Assets
Federal funds sold $ 8,290 $ - $ - $ - $ - $ - $ 8,290 $ 8,290
Average interest rate 1.50% - - - - - -
Fixed interest rate securities 5,786 - 4,143 2,128 8,142 421 20,620 20,836
Average interest rate 5.14% - 5.24% 5.12% 5.85% 5.52% 5.44%
Tax-exempt fixed rate securities 316 1,056 697 757 716 1,426 4,968 5,133
Average interest rate 5.94% 4.45% 5.24% 4.43% 5.32% 6.50% 5.37%
FHLB stock 2,504 -