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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 COMMISSION FILE NO. 0-50078
FRANKLIN BANCORP, INC
(Exact name of bank as specified in its charter)
MICHIGAN 38-2606280
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
24725 WEST TWELVE MILE ROAD
SOUTHFIELD, MICHIGAN 48034
(Address of principal executive offices) (Zip Code)
(248) 358-4710
(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
(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 twelve 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 the Registrant's knowledge, in the 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|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES || NO |X|
As of March 22, 2004 there were issued and outstanding 3,781,024 shares of the
Registrant's Common Stock. The aggregate market value of the voting stock held
by non-affiliates of the Registrant, computed by reference to the price at which
the stock was sold as of June 30, 2003 was $52,176,620.12.
DOCUMENTS INCORPORATED BY REFERENCE: None.
INDEX
PART I
ITEM 1. BUSINESS ..............................................................4
ITEM 2. PROPERTIES............................................................12
ITEM 3. LEGAL PROCEEDINGS.....................................................12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.................13
ITEM 6. SELECTED FINANCIAL DATA...............................................13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION......................................................15
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK...........32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........................32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE .....................................................32
ITEM 9A. CONTROLS AND PROCEDURES.............................................32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...................32
ITEM 11. EXECUTIVE COMPENSATION...............................................35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ...............................40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................42
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES..............................42
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K.......................................................43
SIGNATURES ...................................................................45
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PART I
ITEM 1. BUSINESS
GENERAL
Franklin. Franklin Bancorp, Inc. ("Franklin", the "Company" or the
"Corporation") was incorporated under the Michigan Business Corporation Act on
February 14, 2002. Franklin is a bank holding company registered with, and
subject to, the supervision of the Board of Governors of the Federal Reserve
System under the Bank Holding Company Act of 1956, as amended. Franklin Bank,
National Association ("Franklin Bank" or the "Bank"), a wholly-owned subsidiary
of Franklin, is a national bank, which was incorporated in 1983 as a Michigan
state-chartered savings and loan association and converted its charter to that
of a national bank in 1991. In October 2003, Franklin Bank organized Franklin
Safe Deposit Corporation as its wholly-owned subsidiary, to engage in the safety
deposit box business. Also, in October 2003, Franklin Bank and Franklin Safe
Deposit Corporation formed Franklin Mortgage Services LLC, a Michigan limited
liability company, to act as a mortgage company subsidiary. Franklin Safe
Deposit Corporation is a Michigan corporation which will own and lease
safety-deposit boxes to customers. Franklin Mortgage Services LLC is owned 99%
and 1% by Franklin Bank and Franklin Safe Deposit Corporation, respectively.
Franklin Bank has transferred $146 million of commercial real estate loans to
Franklin Mortgage Services as part of its capital contribution. Franklin
Mortgage Services will be originating first mortgage loans on residential
properties. Franklin became a bank holding company after the close of business
on October 23, 2002 as a result of the reorganization of Franklin Bank involving
an exchange of all the outstanding common stock of Franklin Bank on a
one-for-one basis into common stock of Franklin.
Franklin has corporate power to engage in such activities as permitted to
business corporations under the Michigan Business Corporation Act, subject to
the limitations of the Bank Holding Company Act and regulations of the Federal
Reserve System. In general, the Bank Holding Company Act and regulations
restrict Franklin with respect to its own activities and activities of any
subsidiaries to the business of banking or such other activities, which are
closely related to the business of banking. The principal role of Franklin is to
supervise the activities of Franklin Bank. Franklin derives substantially all of
its income from dividends from Franklin Bank.
Since its conversion to a national banking association charter, Franklin
Bank's business strategy has been focused on low cost deposit gathering and
lending to small and medium-sized businesses, business owners and, to a lesser
extent, individual customers found in Franklin Bank's primary market areas of
Southeast Oakland County and parts of Wayne and Macomb counties, Michigan. While
Franklin Bank offers many standard lending and deposit products, Franklin Bank
promotes its products and services through non-traditional delivery platforms
which emphasize courier deposit pick-up services, lockbox remittance services,
web banking and free ATM services; all of which do not require significant
branch facilities.
Franklin's headquarters are located at 24725 West Twelve Mile Road in
Southfield, Michigan. Franklin Bank maintains its principal office at 24725 West
Twelve Mile Road in Southfield, Michigan "and has" three full service regional
branches located in Southfield, Birmingham and Grosse Pointe Woods, Michigan,
and two Business Center branches in Southfield and Troy, Michigan.
Recent Development. As previously announced, Franklin has entered into a
definitive agreement dated as of November 10, 2003, and as amended on February
3, 2004 (the "merger agreement") to be acquired by First Place Financial
Corporation ("First Place"), a unitary savings and loan holding company. First
Place Bank, a federal savings association and wholly-owned subsidiary of First
Place, is headquartered in Warren, Ohio. Under the agreement, the holding
companies will merge with Franklin merging with and into First Place. After the
holding companies merge, the subsidiaries will merge (the "subsidiary merger"),
with First Place merging with Franklin Bank, and Franklin Bank changing its name
to "First Place Bank" and its main office to Warren, Ohio. In connection with
the merger, on February 9, 2004, Franklin Bank filed an application with the
Office of Thrift Supervision to convert from a national banking association to a
federal savings association. Such conversion is proposed to occur at the same
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time as the merger of the holding companies. First Place and Franklin may agree,
due to business, tax or other considerations, to revise the structure of the
subsidiary merger before the subsidiary merger is completed by amending the
subsidiary merger agreement (e.g., by having Franklin Bank merge with and into
First Place Bank). Completion of the merger depends on satisfying a number of
conditions. There is no certainty as to whether or when the conditions to the
merger will be satisfied, or waived where permissible or that the merger will be
completed.
LENDING ACTIVITIES
Franklin Bank's lending activities focus on originating commercial real
estate loans, other non-real estate commercial loans, residential construction
loans and consumer loans.
Commercial Real Estate Lending. Franklin Bank has historically originated
permanent loans secured by commercial real estate and, to a significantly lesser
extent, land development loans. Essentially all commercial real estate loans
originated by Franklin Bank to date have been secured by real property located
in Michigan.
Franklin Bank's commercial real estate loans generally are for terms of
five to ten years with 25-year amortization periods, generally have
loan-to-value ratios of up to 80% of the appraised value of the secured
property, and are typically secured by full or partial personal guarantees of
the borrowers. At December 31, 2003, approximately 63.2% of Franklin Bank's
commercial real estate loan portfolio had adjustable rates. Of those, 96% are
tied to prime interest rate.
At December 31, 2003, Franklin Bank's largest commercial real estate loan
was a $4.2 million loan secured by a storage facility located in Southfield,
Michigan. Franklin Bank had five other commercial real estate loans in excess of
$2.5 million in accordance with their payment terms.
Commercial real estate lending entails potential risks that are not
inherent in other types of lending. These potential risks include the
concentration of principal in a limited number of loans and borrowers, the
effects of a decline in commercial real estate values on property
collateralizing the loan, and the effects of a decline in general economic
conditions on income producing properties. Furthermore, the repayment of loans
secured by commercial real estate is typically dependent upon the successful
operation of the related real estate project. If the cash flow from the project
is reduced (for example, if leases are not obtained or renewed, or a bankruptcy
court modifies a lease term, or a major tenant is unable to fulfill its lease
obligations), the borrower's ability to repay the loan may be impaired.
Commercial Lending. To a lesser extent, Franklin Bank originates both
secured and unsecured commercial loans to small and medium-sized businesses
located in Southeast Michigan and parts of Wayne and Macomb counties, Michigan.
The loans include term loans, lines of credit, documentary and standby letters
of credit. Loans originated on a secured basis generally have interest rates
tied to the prevailing prime interest rate. Collateral consists of accounts
receivable, inventory, specific equipment and other designated business assets.
All such loans typically are wholly or partially personally guaranteed by the
business owner or related party.
A secured small business line of credit is available to Franklin Bank's
qualified business checking account customers in amounts of up to $50,000. These
loans are structured at higher rates than are charged other types of business
borrowers. Franklin Bank attempts to provide each customer with a 24-hour loan
review and decision process.
Commercial loans involve significant risk and typically are made on the
basis of the borrower's ability to make repayment from the cash flow of the
borrower's business. As a result, the availability of funds for the repayment of
commercial business loans may be substantially dependent on the success of the
business itself. Further, the collateral securing the loans may depreciate over
time, may be difficult to appraise and may fluctuate in value based on the
success of the business.
Residential Construction Lending. Franklin Bank makes construction loans
on single-family residences to individuals who will ultimately be the
owner-occupier of the house. Substantially all of
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Franklin Bank's construction loans have been originated with adjustable rates of
interest and have terms of eighteen months or less.
Franklin Bank's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value upon
completion of the project and the estimated cost (including interest) of the
project. If the estimate of construction costs proves to be inaccurate, Franklin
Bank may be required to advance funds beyond the amount originally committed in
order to permit completion of the project. If the estimate of value proves to be
inaccurate, Franklin Bank may be confronted, at or prior to the maturity of the
loan, with a project having a value insufficient to provide appropriate
collateral value.
Consumer Lending. Franklin Bank originates directly and through various
dealers a limited number of consumer loans, which are offered at fixed and
adjustable rates of interest. In late 1999, Franklin Bank entered into an
agreement with DTE Energy (formerly MichCon), a large Michigan utility company,
from which Franklin Bank has significantly increased its consumer home
improvement loan portfolio, however, such agreement terminated on December 31,
2003. Under such agreement, DTE's dealer network would refer customers needing
credit for home improvements to Franklin Bank.
Consumer loans generally entail greater risks than loans secured by real
estate, since many consumer loans are typically unsecured or secured by rapidly
depreciating assets such as automobiles and home improvement collateral.
Accordingly, repossessed collateral for defaulted consumer loans may not provide
an adequate source of repayment of the outstanding loan balance. The relatively
small outstanding balance remaining after repossession of collateral often does
not warrant further substantial collection efforts against the borrowers beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans.
LOANS TO ONE BORROWER
Under federal law, the aggregate amount of loans that Franklin Bank is
permitted to make to any one borrower is generally limited to 15% of total risk
based capital. At December 31, 2003, Franklin Bank's loans-to-one-borrower limit
was approximately $7.2 million at the 15% level. At December 31, 2003, Franklin
Bank has no loans to one borrower in excess of its lending limit.
NONPERFORMING ASSETS AND RISK ELEMENTS
When, in the opinion of management, reasonable doubt exists as to the full
and timely collection of interest or principal on Franklin Bank's outstanding
loans, Franklin Bank will place such loans on non-accrual status. Generally,
consumer loans are charged off no later than when they reach 120 days past due
status, or earlier, if deemed uncollectible. Loans, other than consumer loans,
are generally placed on non-accrual status when management determines that
principal or interest may not be fully collectible, but no later than when the
loan is 90 days past due on principal or interest. Interest on loans is
generally accrued daily based on the principal balance outstanding. However,
when a loan is placed on non-accrual status, the accrued interest income is
discontinued and interest previously accrued but not collected on non-accrual
loans is charged against current income.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses reflects management's evaluation of the
adequacy of the allowance for loan losses. The allowance for loan losses
represents management's assessment of probable losses inherent in Franklin
Bank's loan portfolio, including all binding commitments to lend. The allowance
provides for probable losses that have been identified with specific borrowing
customers and for probable losses believed to be inherent but that have not been
specifically identified. Franklin Bank allocates the allowance for loan losses
to each loan category based on a defined methodology that has been used for
several years. Internal risk ratings are assigned to each business loan at the
time of approval and are
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subject to subsequent periodic reviews by Franklin Bank management and Franklin
Bank's loan review consultants. Business loans consist of non-real estate
commercial loans, commercial real estate loans and Franklin Bank lines of
credit. A detailed review of the loan portfolio is performed on a quarterly
basis to assess the credit quality of Franklin Bank's commercial loan portfolio.
A specific portion of the allowance is allocated to such loans based upon this
review. The portion of the allowance allocated to the remaining loans is
determined by applying projected loss ratios to each risk rating based on both
qualitative and quantitative factors. The portion of the allowance allocated to
consumer and mortgage loans is determined by applying projected loss ratios to
various segments of the loan portfolio. Projected loss ratios incorporate
factors such as recent charge-off experience, current economic conditions and
trends, geographic dispersion of borrowers, and trends with respect to past due
and non-accrual amounts.
See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" below relating to the allowance for loan losses, the
loan portfolio composition, loan commitments, loan maturity schedule and
nonperforming assets.
SOURCE OF FUNDS
Franklin Bank's deposits are its primary source of funds for lending and
for other general business purposes. In addition to deposits, Franklin Bank
derives funds from loan repayments, advances from the FHLB ("FHLB") of
Indianapolis and other borrowings. From time to time, Franklin Bank may derive
funds from repurchase agreements and loan and securities sales. Scheduled loan
repayments are a relatively stable source of funds, while loan prepayments and
interest-bearing deposit inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used to
compensate for reductions in normal sources of funds, such as deposit inflows at
less than projected levels, deposit outflows, or to support expanded activities.
Historically, Franklin Bank has borrowed primarily from the FHLB of Indianapolis
and through repurchase agreements.
The ability of Franklin Bank to attract and maintain deposits, and its
cost of funds, have been, and will continue to be, significantly affected by
general economic and business conditions.
See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" below relating to deposits and other sources of
funds.
INVESTMENT ACTIVITIES
Franklin Bank invests in various securities, which are acquired in the
capital markets. These investments may consist of mortgage, government, agency,
municipal and corporate debt securities. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" below relating to
the securities maturity schedule.
COMPETITION
Franklin Bank competes aggressively for its business through a systematic
program of direct calling on both customers and referral sources such as
attorneys, accountants and business people. Franklin Bank's program is enhanced
because of its well-established network of existing relationships, which have
been created over the years in the area's business community and because of the
years of banking experience and community involvement of its senior management
and lending officers. Franklin Bank's programs and services are further enhanced
by its distinctive marketing focus, including its radio advertising campaign,
and by referrals from the growing base of existing business customers.
Generally, Franklin Bank's business strategy focuses on competing in areas
in which it can truly develop niche products and services. Large financial
institutions tend to need very large homogeneous markets in order to support
high levels of automation and systems development. This leaves smaller product
markets and heterogeneous product lines under-served. Large financial
institutions also tend to have rigid structures, which adapt slowly to changing
market environments and, therefore, provide opportunities for smaller
institutions that can react more quickly. Finally, competitive pressures and
other
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regulatory agencies in the past decade have caused a rapid increase in the
merger and acquisition activity among financial institutions. The industry
consolidation has created marketing opportunities for many smaller institutions,
such as Franklin Bank, to service smaller customers in local markets.
SUPERVISION AND REGULATION
Overview - Franklin. Franklin is a Michigan corporation subject to the
Michigan Business Corporation Act. Franklin is a one-bank holding company within
the meaning of the Bank Holding Company Act and is registered as such with, and
subject to, the supervision of the Federal Reserve Board. Franklin is required
to file with the Federal Reserve Board quarterly and annual reports and such
additional information as the Federal Reserve Board may require pursuant to the
Bank Holding Company Act. The Federal Reserve Board regularly conducts
examinations of bank holding companies and their subsidiaries.
As a banking holding company, Franklin is required to obtain the approval
of the Federal Reserve Board:
- before it may acquire all or substantially all of the assets
of any bank, or ownership or control of the voting shares of
any bank if, after giving effect to such acquisition of
shares, Franklin would own or control more than 5% of the
voting shares of such bank; and
- before the merger or consolidation of Franklin and another
bank holding company.
Franklin also is prohibited by the Bank Holding Company Act, except in
certain statutorily prescribed instances, from:
- acquiring direct or indirect ownership or control of more than
5% of the outstanding voting shares of any company that is not
a bank or bank holding company; and
- from engaging, directly or indirectly, in activities other
than those of banking, managing or controlling banks or
furnishing services to its subsidiaries.
However, Franklin may, subject to the prior approval of the Federal
Reserve Board, engage in any, or acquire shares of companies engaged in,
activities that are deemed by the Federal Reserve Board to be so closely related
to banking or managing or controlling banks as to be a proper incident thereto.
Under the Federal Reserve Board's regulations:
- a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and
may not conduct its operations in an unsafe and unsound
manner; and
- in serving as a source of strength to its subsidiary banks, a
bank holding company should stand ready to use available
resources to provide adequate capital funds to its subsidiary
banks during periods of financial stress or adversity and
should maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its
subsidiary banks.
A bank holding company's failure to meet its obligations to serve as a
source of strength to its subsidiary banks will generally be considered by the
Federal Reserve Board to be an unsafe and unsound banking practice or a
violation of the Federal Reserve Board's regulations or both.
Overview - Franklin Bank. Franklin Bank is a federally chartered national
banking association. Accordingly, Franklin Bank is subject to broad federal
regulation and oversight extending to all it operations by the Office of the
Comptroller of the Currency (the "OCC"). Franklin Bank is a member of the FHLB
of Indianapolis and is subject to certain limited regulation by the FDIC.
Franklin Bank is a member
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of the Savings Association Insurance Fund or SAIF and its deposits are insured
by the FDIC. As a result, the FDIC has certain regulatory authority over
Franklin Bank.
Insurance of Accounts and Regulation by the FDIC. Franklin Bank is
currently a member of the SAIF, which is administered by the FDIC. Deposits are
insured up to applicable limits by the FDIC and such insurance is backed by the
full faith and credit of the United States Government. As insurer, the FDIC
imposes deposit insurance premiums and is authorized to conduct examinations of
and to require reporting by FDIC-insured institutions. It also may prohibit any
FDIC-insurance institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the FDIC.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well-capitalized (i.e. those with a core capital ratio of at least 5%, a ratio
of Tier 1 or core capital to risk weighted assets ("Tier 1 risk-based capital")
of at least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than adequately
capitalized (i.e. those with core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. Risk classification of
all insured institutions will be made by the FDIC for each semi-annual
assessment period.
Prompt Corrective Action. The OCC is authorized and, under certain
circumstances required, to take certain actions against national banks that fail
to meet their capital requirements. The OCC is generally required to take action
to restrict the activities of an "undercapitalized association" (generally
defined to be one with less than either a 4% core capital ratio, a 4% Tier I
risked-based capital ratio or an 8% risk-based capital ratio). Any such national
bank must submit a capital restoration plan and, until such plan is approved by
the OCC, may not increase its assets, acquire another institution, establish a
branch or engage in any new activities, and generally may not make capital
distributions. The OCC is authorized to impose the additional restrictions that
are applicable to significantly undercapitalized associations.
Any national bank that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier I risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of it operations and include a forced
merger or acquisition of the bank. Any national bank that becomes "critically
undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to
further mandatory restrictions on its activities in addition to those applicable
to significantly undercapitalized associations. In addition, the OCC must
appoint a receiver (or conservator with the concurrence of the FDIC) for a
national bank, with certain limited exceptions, within 90 days after it becomes
critically undercapitalized. Any undercapitalized association is also subject to
the general enforcement authority of the OCC, including the appointment of a
conservator or a receiver.
The OCC is also generally authorized to reclassify an association into a
lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
See the discussion under "Regulatory Capital" in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" below.
Limitations on Dividends and Other Capital Distributions. Most of
Franklin's revenues are received by it in the form of dividends paid by Franklin
Bank. Under Michigan law, dividends to shareholders cannot be made if, after
giving them effect, the corporation would not be able to pay its debts as the
debts become due in the usual course of business, or the corporation's total
assets would be less than its total liabilities. As a national bank, Franklin
Bank's ability to pay dividends is governed by the National Bank Act and OCC
regulations. Under such statute and regulations, all dividends by a national
bank must be paid out of current or retained net profits, after deducting
reserves for losses and bad debts. The National Bank Act further restricts the
payment of dividends out of net profits by prohibiting a national bank from
declaring a dividend on its shares of common stock until the surplus fund equals
the amount of capital stock or, if the surplus fund does not equal the amount of
capital stock, until one-tenth of the national bank's net profits for (i) the
preceding four quarters in the case of annual dividends; or (ii) the preceding
two quarters in the case of quarterly or semi-annual dividends, are transferred
to the surplus
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fund. In addition, the prior approval of the OCC is required for the payment of
a dividend if the total of all dividends declared by a national bank in any
calendar year would exceed the total of its net profits for the year combined
with its net profits for the two preceding years, less any required transfers to
surplus or a fund for the retirement of any preferred stock.
The OCC has the authority to prohibit the payment of dividends by a
national bank when it determines such payment to be an unsafe and unsound
banking practice. In addition, Franklin Bank would be prohibited by federal
statute and the OCC's prompt corrective action regulations from making any
capital distribution if, after giving effect to the distribution, it would be
classified as "undercapitalized" under the OCC's regulations.
Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"),
every FDIC-insured institution, including national banks, has a continuing and
affirmative obligation, consistent with safe and sound banking practices, to
help meet the credit needs of its entire community, including low and moderate
income neighborhoods. The CRA does not establish specific lending requirements
or programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OCC, in connection with the examination of Franklin Bank, to assess
Franklin Bank's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications, such as a
merger or the establishment of a branch, by Franklin Bank. An unsatisfactory
rating may be used as the basis for the denial of an application by the OCC.
Due to the heightened attention being given to the CRA in the past few
years, Franklin Bank may be required to devote additional funds for investment
and lending in its local community. Franklin Bank was examined for CRA
compliance in 2003 and received a satisfactory rating.
Federal Reserve System. As a national bank, Franklin Bank is required to
become a member of the Federal Reserve System and subscribe for stock in the
Federal Reserve Bank ("FRB") of Chicago in an amount equal to 6% of its paid in
capital and surplus (payment for one-half is initially required with the
remainder subject to call by the FRB).
The FRB requires all depository institutions to maintain non-interest
bearing reserves at specified levels against their transaction accounts
(primarily checking, NOW and Super NOW checking accounts).
Federal Home Loan Bank System. Franklin Bank is currently a member of the
FHLB of Indianapolis, which is one of 12 regional FHLB's that administer the
home financing credit function of savings associations. Each FHLB serves as a
reserve or central bank for its member within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidation obligations of
the FHLB System. It makes loans to members (i.e. advances) in accordance with
policies and procedures, established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB. In addition, all loan advances are required to
provide funds for residential home financing.
As a member, Franklin Bank is required to purchase and maintain stock in
the FHLB of Indianapolis. At December 31, 2003, Franklin Bank had $5.9 million
in FHLB stock, which was in compliance with this requirement. In past years,
Franklin Bank has received substantial dividends on its FHLB stock although
there can be no assurance such dividends will continue to be paid in the future.
RECENT LEGISLATION
USA Patriot Act. On October 26, 2001, President Bush signed into law, the
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act"). The USA
Patriot Act is intended to allow the federal government to address terrorist
threats through enhanced domestic security measures, expanded surveillance
powers, increased information sharing and broadened anti-money laundering
requirements. Title III of the USA Patriot Act takes measures intended to
encourage information sharing among bank regulatory agencies and law enforcement
bodies. Certain provisions of Title III impose affirmative obligations on a
broad range
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of financial institutions, including banks, thrifts, brokers, dealers, credit
unions, money transfer agents and parties registered under the Commodity
Exchange Act.
Among its provisions, the USA Patriot Act requires each financial
institution: (i) to establish an anti-money laundering program, (ii) to
establish due diligence policies, procedures and controls with respect to its
private banking accounts and corresponding banking accounts involving foreign
individuals and certain foreign banks and (iii) to avoid establishing,
maintaining, administering, or managing correspondent accounts in the United
States for, or on behalf of, a foreign bank that does not have a physical
presence in any country. In addition, the USA Patriot Act contains a provision
encouraging cooperation among financial institutions, regulatory authorities and
law enforcement authorities with respect to individuals, entities and
organizations engaged in, or reasonably suspected of engaging in, terrorist
acts, or money laundering activities. The federal banking agencies have become
proposing and implementing regulations in interpreting the USA Patriot Act. It
is not anticipated that the USA Patriot Act will have a significant impact on
the financial condition or results of operations of Franklin.
Sarbanes-Oxley Act. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") which is intended to
address systemic and structural weaknesses of the capital markets in the United
States that were perceived to have contributed to recent corporate scandals. The
Sarbanes-Oxley Act creates the Public Company Accounting Oversight Board to
oversee the conduct of audits of public companies. Such Board will be funded
from assessments on public companies. In addition, the Sarbanes-Oxley Act
attempts to strengthen the independence of public company auditors and to
increase the responsibility of corporate management. Franklin does not expect
that such compliance will have a material impact on Franklin's financial
condition or results of operations.
EMPLOYEES
At December 31, 2003, the Bank had a total of 163 full-time equivalent
employees, none of whom were employed pursuant to collective bargaining
agreements. The Bank considers its relations with its employees to be
satisfactory.
SELECTED STATISTICAL AND OTHER INFORMATION
Certain statistical and other information referenced below is included in
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations" and in "Notes to Consolidated Financial Statements" below on the
pages referenced.
Page
----
I. Distribution of Assets, Liabilities and Stockholders' Equity;
Interest Rates and Interest Differential
A. Average Balance Sheets ................................................... 19
B. Net Interest Earnings..................................................... 19
C. Net Interest Income Volume/Rate........................................... 18
II. Investment Portfolio
A. Book Value of Investments................................................. 25
B. Due Date of Investments................................................... 25
III. Loan Portfolio
A. Types of Loans............................................................ 24
B. Maturities and Sensitivities of Loans to Changes in Interest Rates........ 25
C. Risk Elements ............................................................ 25
D. Other Interest Bearing Assets............................................. 25
IV. Summary of Loan and Lease Loss Experiences
A. Allowance For Loan Losses................................................. 20
B. Allocation of Allowance For Loan Losses................................... 21
V. Deposit Portfolio
A. Average Deposits.......................................................... 19
B. Maturity Distribution of Time Deposits.................................... 27
VI. Return on Equity and Assets........................................................ 16
VII. Short Term Borrowings.............................................................. 27
11
ITEM 2. PROPERTIES
The Bank leases space for its executive offices located at 24725 West
Twelve Mile Road, Southfield, Michigan 48034. The term of the lease was extended
as of January 1, 2003 and now expires on January 1, 2010. The Bank has an option
to extend the lease for an additional three years.
The Bank also leases its Southfield branch office located at 26336 West
Twelve Mile Road, Southfield, Michigan 48034. This lease expires on March 31,
2008. The Bank has four options to extend the lease for a period of five years
each.
The Bank owns the approximately 2,200 square-foot Grosse Pointe Woods
branch office located at 20247 Mack Avenue. This property had a net book value
of $484,146 at December 31, 2003.
The Bank leases its Birmingham branch office located at 479 Old South
Woodward Avenue. The building's lease expires May 1, 2007, but carries an option
to renew the lease for an additional 20-year term.
The Bank leases its Troy branch located at 755 West Big Beaver Road, Suite
101, Troy, MI 48084. This lease expires on November 1, 2010. The Bank has two
options to extend the lease for a period of five years each.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is a party to routine legal proceedings
arising out of its general lending activities and other operations. However,
there are no material pending legal proceedings to which the Company or its
subsidiary are a party, or to which any of their property is subject, which, if
determined adversely to the Company or its subsidiary, would individually or in
the aggregate have a material adverse effect on its consolidated financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders of the
Company during the fourth quarter of 2003.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Franklin common stock is traded on the Nasdaq National Market under the
symbol "FBCP."
As of March 22, 2004, there were 3,781,024 shares of Franklin common stock
outstanding, which were held by approximately 409 holders of record. Such
numbers do not reflect the number of individuals or institutional investors
holding stock in nominee name through brokerage firms and others.
The following table sets forth during the periods indicated the high and
low sales prices of the Franklin common stock as reported on the Nasdaq National
Market and the dividends declared per share of Franklin common stock for the
periods included.
CALENDAR PERIOD MARKET PRICE Dividends
----------------------- Declared Per
High Low Share
-------- -------- ------------
2003
Quarter ended December 31 $21.55 $18.30 $0.08
Quarter ended September 30 18.69 17.30 0.08
Quarter ended June 30 18.01 16.12 0.08
Quarter ended March 31 18.59 15.75 0.08
2002
Quarter ended December 31 $18.28 $17.58 $0.08
Quarter ended September 30 19.01 17.75 0.08
Quarter ended June 30 19.35 17.65 0.08
Quarter ended March 31 18.35 16.96 0.08
ITEM 6. SELECTED FINANCIAL DATA
The information with respect to selected financial data is included in the table
below entitled "Five Year Summary of Selected Consolidated Financial Data."
13
FIVE YEAR SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(Dollar amounts in thousands, except for per share data)
For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Income and Expense Items
Total interest income $ 27,433 $ 33,557 $ 38,809 $ 40,789 $ 36,651
Total interest expense 6,046 7,911 10,537 12,697 10,493
Net interest income 21,387 25,646 28,272 28,093 26,158
Provision for loan losses 2,903 3,810 1,859 3,693 1,226
Non-interest income 5,414 7,027 5,714 4,089 4,154
Non-interest expense 22,525 22,644 20,127 26,715 23,121
Net income before preferred stock dividends 1,078 5,616 8,641 1,918 4,757
Net income applicable to common shares 1,078 3,815 6,840 117 2,956
December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance Sheet Items
Total assets $ 518,963 $ 542,478 $ 532,559 $ 527,971 $ 516,646
Total average assets 530,530 553,878 527,830 527,247 512,643
Loans 355,124 333,346 325,325 316,124 275,621
Deposits 406,380 429,130 389,358 387,919 400,365
Borrowings 65,000 65,000 79,606 82,326 62,521
Common shareholders' equity 45,737 45,642 42,179 35,288 33,066
Total shareholders' equity 45,737 45,642 42,179 35,288 33,066
Shares outstanding 3,753,667 3,647,593 3,607,542 3,552,550 3,509,537
At or For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Per Share
Book value $ 12.18 $ 12.51 $ 11.69 $ 9.93 $ 9.42
Basic earnings 0.29 1.05 1.92 0.03 0.84
Diluted earnings 0.28 1.01 1.86 0.03 0.83
Cash dividends declared - Common Stock 0.32 0.32 0.28 0.28 0.28
Payout ratio - Common Stock, in percent 109.6% 29.5% 14.6% 842.1% 33.2%
Market price:
End of year $ 21.55 $ 18.25 $ 17.60 $ 11.63 $ 9.56
52 week high 21.55 19.50 17.60 11.63 11.50
52 week low 15.75 16.96 11.03 7.00 7.13
At or For the Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Asset Quality
Non-performing assets to total assets 0.46% 1.35% 0.68% 0.71% 1.06%
Net charge-offs to average loans 1.22 0.80 0.29 1.12 0.78
Key Ratios
Net interest margin 4.41 5.12% 5.76% 5.62% 5.58%
Net interest spread 3.72 4.15 4.31 3.72 3.94
Operating expenses to average assets 4.25 4.09 3.81 5.07 4.51
Return on average assets 0.20 0.69 1.30 0.02 0.58
Return on average common shareholders' equity 2.39 8.38 17.36 0.35 8.76
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
CRITICAL ACCOUNTING POLICIES
Franklin's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industry in which it operates. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the consolidated financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the consolidated financial
statements; accordingly, as this information changes, the consolidated financial
statements could reflect different estimates, assumptions, and judgments.
Certain policies inherently have a greater reliance on the use of estimates,
assumptions, and judgments and as such have a greater possibility of producing
results that cold be materially different than originally reported. Estimates,
assumptions, and judgments are primarily necessary when assets and liabilities
are required to be recorded at fair value, when a decline in the value of an
asset not carried on the financial statements at fair value warrants an
impairment write-down or valuation reserve to be established, or when an asset
or liability needs to be recorded contingent on a future event. Carrying assets
and liabilities at fair value inherently results in more financial statement
volatility. The fair values and the information used to record valuation
adjustments for certain assets and liabilities are based either on quoted market
prices or are provided by third-party sources, when available. When third-party
information is not available, valuation adjustments are estimated in good faith
by management primarily through the use of internal cash flow modeling
techniques. The most significant accounting policies followed by Bancorp are
presented in Note 1 to the consolidated financial statements. These policies,
along with disclosures presented in the other financial statement notes and in
this financial review, provide information on how significant assets and
liabilities are valued in the consolidated financial statements and how those
values are determined. Based on the valuation techniques used and the
sensitivity of financial statements amounts to the methods, assumptions, and
estimates underlying those amounts, management has identified the determination
of the allowance for loan losses and the valuation of repossessed assets to be
the accounting areas that require the most subjective or complex judgments, and
as such could be most subject to revision as new information becomes available.
Any material effects on the consolidated financial statements during the twelve
months at 2003 related to these critical accounting areas are discussed in
management's discussion and analysis of financial condition and results of
operations. In addition, the sensitivities of valuations to adverse changes in
the factors and assumptions used in estimating certain fair values are discussed
in the notes to the consolidated financial statements. The remainder of
management's discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes presented in Part II, Item
8, Financial Statements and Supplementary Data.
15
FINANCIAL SUMMARY
The Corporation reported net income of $1.1 million, or $0.28 per diluted share,
in 2003 compared to $3.8 million, or $1.01 per diluted share, in 2002 and $6.8
million, or $1.86 per diluted share, in 2001. The return on average assets was
0.20 % in 2003, down from 0.69 % in 2002 and 1.30 % in 2001. The return on
average common shareholders' equity was 2.39 % in 2003 compared to 8.38 % in
2002 and 17.36 % in 2001.
FINANCIAL HIGHLIGHTS
(Dollar amounts in thousands; except per share data)
Percent
2003 2002 Change
---- ---- ------
For the year ended December 31,
Net income $ 1,078 $ 3,815 (71.7)%
Net interest income 21,387 25,646 (16.6)
Non-interest income 5,414 7,027 (23.0)
Return on average common shareholders' equity 2.39 8.38 (23.2)
Return on average assets 0.20 0.69 (71.0)
Per share
Diluted earnings $ 0.28 $ 1.01 (72.3)
Cash dividend paid - common 0.32 0.32 --
At December 31,
Assets $ 518,963 $ 542,478 (4.2)
Loans 355,124 333,346 6.5
Deposits 406,380 429,130 (5.3)
Total shareholders' equity 45,737 45,642 0.2
Book value per share $ 12.18 $ 12.51 (2.6)
Market price per share 21.55 18.25 18.1
Total shares outstanding 3,753,667 3,647,593 2.9
SIGNIFICANT EVENTS
On November 10, 2003, the Corporation entered into an agreement as amended on
February 3, 2004, pursuant to which Franklin will be merged with and into First
Place Financial Corp. Franklin shareholders will vote on the merger at a special
meeting on April 5, 2004.
A new management team was formed during 2003.
- On November 10, 2003, Craig L. Johnson was appointed President
and Chief Executive Officer of Franklin and Franklin Bank,
succeeding David L. Shelp who had announced his retirement.
Mr. Johnson joined Franklin Bank on June 16, 2003 as Executive
Vice President and Chief Lending Officer.
- On June 16, 2003, in addition to the appointment of Mr.
Johnson, (see above), Leonard B. Carleton was appointed Chief
Financial Officer and Treasurer of Franklin and Franklin Bank.
- Effective April 14, 2003, Michael A. King was appointed Senior
Vice President of Retail Banking. In addition, on such date,
Ronald J. Carr was promoted from Vice President of Human
Resources to Senior Vice President and Director of Human
Resources.
Market interest rates declined during the first half of 2003 and remained at low
levels during the second half of the year. The cost of variable rate deposits
and the rates offered on new fixed rate deposits were generally lower during the
second half of the year.
In the third and fourth quarters of 2003, the Bank purchased whole loan pools of
first lien residential mortgages totaling $53.3 million.
16
NET INTEREST INCOME
Net interest income is interest earned on loans and investments less interest
paid for deposits and other borrowed funds. That net result, plus the impact of
net non-interest-bearing funds, expressed as a percentage of average
interest-earning assets, is the Bank's net interest margin.
Net interest income and net interest margin are influenced by increases or
decreases in the volume of earning assets or interest paying liabilities, and
the change in the average rate of interest earned on earning assets or paid for
deposits or other borrowed funds.
Net interest income for 2003, 2002 and 2001 was $21.4 million, $25.6 million and
$28.3 million, respectively. This represents a decrease in net interest income
of 16.61% when comparing 2003 to 2002 and a decrease of 9.29% when comparing
2002 to 2001. Net interest margin for those same periods was 4.42%, 5.12% and
5.76%, respectively.
The decrease in net interest income in 2003 as compared to 2002 was principally
caused by a decline in average earning assets of $24.6 million, a greater
decline in the yield on earning assets compared to the reduction in cost of
interest-bearing sources of funds (93 basis points versus 51 basis points,
respectively), and a shift in the mix of earning assets to lower yielding,
short-term investments. Interest earned on loans in 2003 amounted to $22.0
million compared to $25.1 million in 2002 and $28.7 million in 2001. The yield
on loans declined to 6.89% in 2003 from 7.77% in 2002 and 8.87% in 2001.
As management determined that longer term investments were not attractive at the
market rates, funds were invested in interest-bearing deposits with banks until
other opportunities became available. In the third and fourth quarters, whole
mortgage loans were purchased in the amount of $53.3 million. These loans have
yields significantly higher than the interest-bearing deposits and contribute to
improving the quality of the loan portfolio at the same time.
Factors that contributed to the Bank's decrease in net interest income during
the year 2002 include relatively flat average earning balances in the loan
portfolio coupled with a decline in the average rate earned on earning assets.
During the same period the average amount invested in other earning assets, such
as U.S. Treasury and mortgage-backed securities and interest-earning deposits,
increased by $12.3 million with a decrease in the average rate earned on these
investments of 1.37%.
The interest-bearing deposit average balance and the average cost of these
deposits declined in 2003 compared to 2002. As shown in table 2, money market
and NOW checking average balances increased while the other categories of
interest-bearing deposits declined. Interest expense on deposits declined by
$1.9 million in 2003 compared to 2002 and by $2.3 million in 2002 compared to
2001. In December, 2003 the Bank offered a special 20th anniversary CD with a
20-month term and a rate of 2.75%. Approximately $10 million of these CD
accounts were opened.
The FHLB advances have maturities of $10 million in 2004 and $55 million is
2011. The FHLB may elect to convert the advances to floating rates and may do so
if the index exceeds the fixed rate. The cost of the FHLB advances remained
stable because of the fixed rate during the period.
Business and personal checking accounts continue to supply funds without
interest costs. Non-interest bearing sources of funds contributed 0.69 basis
points to the net interest margin in 2003 compared to 0.97 basis points in 2002
and 1.45 basis points in 2001.
17
NET INTEREST INCOME VOLUME/RATE ANALYSIS - TABLE 1
(Dollars in Thousands) 2003/2002 2002/2001
INCREASE/(DECREASE)*IN INCREASE/(DECREASE)*IN
VOLUME RATE/YIELD NET VOLUME RATE/YIELD NET
------ ---------- --- ------ ---------- ---
INTEREST INCOME
LOANS $ (568) $(2,570) $(3,138) $ 48 $(3,566) $(3,518)
INVESTMENT SECURITIES:
U.S. TREASURIES AND MORTGAGE-BACKED
SECURITIES (3,552) (923) (4,475) (240) (1,786) (2,026)
INTEREST BEARING DEPOSITS WITH BANKS 251 (547) (296) 387 (23) 364
OTHER 2,863 (1,078) 1,785 8 (80) (72)
------- ------- ------- ------- ------- -------
TOTAL INTEREST INCOME (1,006) (5,118) (6,124) 203 (5,455) (5,252)
INTEREST EXPENSE
DEPOSITS (437) (1,365) (1,802) 516 (2,802) (2,286)
FHLB ADVANCES (9) 3 (6) 616 (168) 448
OTHER BORROWINGS (57) -- (57) (439) (349) (788)
------- ------- ------- ------- ------- -------
TOTAL INTEREST EXPENSE (503) (1,362) (1,865) 693 (3,319) (2,626)
------- ------- ------- ------- ------- -------
NET INTEREST INCOME (503) (3,756) (4,259) (490) (2,136) (2,626)
======= ======= ======= ======= ======= =======
* THE CHANGE IN INTEREST DUE TO BOTH VOLUME AND RATE HAS BEEN ALLOCATED BETWEEN
THE FACTORS IN PROPORTION TO THE RELATIONSHIP OF THE ABSOLUTE DOLLAR AMOUNTS OF
THE CHANGE IN EACH.
18
NET INTEREST INCOME ANALYSIS - TABLE 2
(Dollars in Thousands) YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- -----------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
--------- --------- ------- --------- --------- ------- --------- --------- ------
Assets
Loans:
Commercial $ 253,896 $ 18,069 7.12% $ 250,424 $ 18,763 7.49% $ 236,086 $ 20,527 8.69%
Residential 44,660 1,999 4.48% 48,178 3,253 6.75% 61,977 5,083 8.20
Consumer 20,826 1,908 9.16% 24,799 3,022 12.19% 22,520 2,747 12.20
Lease Financing 7 34 485.71% 305 109 35.86% 2,581 307 11.94
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Loans 319,389 22,010 6.89% 323,706 25,147 7.77% 323,164 28,664 8.87%
U.S. Treasuries and
Mortgage-Backed
Securities 68,733 2,476 3.60% 140,568 6,951 4.94% 149,049 9,227 6.19
Tax-Exempt Municipal
Securities (1) 11,202 623 8.43% 8,767 365 6.31% 2,502 115 6.96
Interest-Bearing Deposits
With Banks 33,426 350 1.05% 24,077 646 2.68% 9,715 282 2.90
Other 47,147 2,185 4.63% 7,401 448 6.05% 7,283 520 7.14
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Earning Assets/Interest
Income 479,897 27,644 5.76% 504,519 33,557 6.69% 491,713 38,809 7.90%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Cash and Due from Banks 21,813 21,564 22,353
All Other Assets 34,041 32,487 18,324
Allowance for Possible
Credit Losses (5,221) (4,692) (4,560)
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Assets $ 530,530 $ 553,878 $ 527,830
========= ========= ======= ========= ========= ======= ========= ========= ======
Liabilities:
Money Markets 163,985 1,657 1.01% 159,786 2,762 1.73% 150,566 4,335 2.88%
Savings Accounts 151 1 0.57% 281 3 1.00% 276 5 1.73
NOW Checking 21,476 72 0.33% 19,437 131 0.67% 16,667 95 0.57
Certificates 29,997 1,021 3.40% 35,877 1,303 3.63% 25,870 1,303 5.04
Jumbo Certificates 16,146 399 2.47% 27,354 753 2.75% 32,179 1,500 4.66
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Interest-Bearing
Deposits 231,755 3,150 1.36% 242,735 4,952 2.04% 225,558 7,238 3.21
FHLB Advances 65,316 2,896 4.43% 65,528 2,902 4.43% 51,806 2,454 4.74
Other 3,133 57 1.82% 16,492 845 5.13
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Interest-Bearing
Liabilities/Expense 297,071 6,046 2.04% 311,396 7,911 2.54% 293,856 10,537 3.59%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Business/Personal Checking 186,258 177,448 172,621
Preferred Stock 0 17,875 19,500
Other Liabilities 2,168 1,605 2,443
Shareholders' Equity 45,033 45,554 39,410
--------- --------- ------- --------- --------- ------- --------- --------- ------
Total Liabilities and
Shareholders' Equity $ 530,530 $ 553,878 $ 527,830
========= ========= ======= ========= ========= ======= ========= ========= ======
Net Interest Income (FTE) $ 21,598 $ 25,646 $ 28,272
--------- --------- ------- --------- --------- ------- --------- --------- ------
Net Interest Spread 3.72% 4.15% 4.31%
--------- --------- ------- --------- --------- ------- --------- --------- ------
Impact of Net Non-Interest
Bearing Source of Funds
And Equity 0.69% 0.97% 1.45%
========= ========= ======= ========= ========= ======= ========= ========= ======
Net Interest Margin 4.41% 5.12% 5.76%
========= ========= ======= ========= ========= ======= ========= ========= ======
(1) Interest rates are calculated on a federal tax equivalent basis.
Interest and principal balances pertaining to non-accrual loans are not included
for this analysis
ALLOWANCE FOR LOAN AND LEASE LOSSES ("ALLL")
The provision for loan and lease losses reflects management's evaluation of the
adequacy of the allowance for loan and lease losses. The allowance for loan and
lease losses represents management's assessment of probable losses inherent in
the Bank's loan portfolio, including all binding commitments to lend. The
allowance provides for probable losses that have been identified with specific
borrowing customers and for probable losses believed to be inherent but that
have not been specifically identified. Internal risk ratings are assigned to
each business loan at the time of approval and are subject to subsequent
periodic reviews by Bank management and the Bank's loan review consultants.
Business loans consist of non-real estate commercial loans, commercial mortgages
and Franklin lines of credit. A detailed review of the loan portfolio is
performed on a quarterly basis to assess the credit quality of the Bank's
commercial loan portfolio. A specific portion of the allowance is allocated to
such loans based upon this review. The portion of the allowance allocated to the
remaining business loans is determined by applying projected loss ratios to each
risk rating based on both qualitative and quantitative factors. The portion of
the allowance allocated to consumer and mortgage loans is determined by applying
projected loss ratios to various segments of the loan portfolio. Projected loss
ratios incorporate factors such as recent charge-off experience, current
economic conditions and trends, geographic dispersion of borrowers, and trends
with respect to past due and non-accrual amounts.
At year-end 2003 the allowance for loan losses was $4.9 million compared to $5.9
million at year-end 2002. In 2003, provisions for loan losses decreased by $0.9
million compared to 2002, which were $1.9 million higher than the provision in
2001. Recoveries were $2.8 million, $1.6 million, and $1.4 million for 2003,
2002, and 2001, respectively. Net charge offs increased by
19
42.2 % in 2003 compared to 2002 and 190 % when comparing year ended 2002 to
2001. During calendar year 2003, management of the Bank continued its aggressive
approach towards reducing troubled assets. The effects of the economic slowdown
resulted in the increase in charge-offs for the Bank's consumer and small
business lines of credit portfolio in 2002. In both 2003 and 2002, the
continuing weak economy resulted in a deterioration of certain Bank loan
relationships and prompted the Bank to take credit actions designed to promptly
charge off troubled loans and increase its loan loss provision. The majority of
the non-performing asset balance at December 31, 2003 consists of ten loans
totaling $2.1 million including four commercial loans, five commercial real
estate loans and one residential property in redemption.
ALLOWANCE FOR LOAN LOSSES - TABLE 3
Year Ended December 31,
-------------------------------------------------------------
2003 2,002 2001 2000
---------- ---------- ---------- ----------
Balance at Beginning of Period $5,926,813 $4,863,948 $3,951,552 $3,584,301
Provision for Losses 2,902,612 3,809,760 1,858,500 3,693,371
Charge-offs
Commercial 1,904,545 2,210,026 1,143,857 2,327,440
Commercial Mortgage 2,687,166 0 0 0
Construction 0 0 0 0
Residential 432,971 268,794 51,815 265,868
Overdraft 74,911 104,424 124,043 142,506
Consumer 1,633,984 1,650,631 847,638 667,646
Lease Financing 0 68,334 175,917 1,055,030
---------- ---------- ---------- ----------
Total Charge-Offs 6,733,577 4,302,209 2,343,270 4,458,490
Recoveries
Commercial 923,859 225,928 303,232 99,587
Commercial Mortgage 537,038 0 0 0
Construction 0 0 0 0
Residential 13,500 0 148 39,980
Overdraft 55,071 35,259 118,548 42,570
Consumer 1,214,172 1,053,712 558,100 114,464
Lease Financing 83,981 240,415 417,138 835,769
---------- ---------- ---------- ----------
Total Recoveries 2,827,621 1,555,314 1,397,166 1,132,370
---------- ---------- ---------- ----------
Net Charge-offs 3,905,956 2,746,895 946,104 3,326,120
---------- ---------- ---------- ----------
Balance at End of Period $4,923,469 $5,926,813 $4,863,948 $3,951,552
========== ========== ========== ==========
Allowance as a Percentage of :
Loans 1.39% 1.78% 1.50% 1.25%
Non-performing assets 205.16 80.93 134.06 106.14
Net Charge-offs 126.05 215.76 514.10 118.80
Net Charge-offs to:
Average Loans Outstanding 1.22 0.85 0.29 1.12
20
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES - TABLE 4
(Dollar amounts in thousands)
December 31,
---------------------------------------------------------------------------------
2003 2002
----------------------------------------- -----------------------------------
Percentage Percentage
Allocated Allocated
Reserve to Percent of Reserve to Percent of
Total Allocated Total Allocated
Loans Reserve to Loans Reserve to
Amount Outstanding Total Reserve Amount Outstanding Total Reserve
------ ----------- ------------- ------ ----------- -------------
Commercial Real Estate Loans $1,009 0.55% 20.50% $2,758 0.83% 46.53%
Commercial Non-Real Estate Loans 2,574 3.19 52.28% 1,599 0.48 26.98
Residential Loans 331 0.47 6.72% 129 0.04 2.18
Consumer Loans 427 2.15 8.67% 747 0.22 12.60
Unallocated 582 0.16 11.83% 694 0.21 11.71
------ ------
Total $4,923 1.39% 100% $5,927 1.78% 100%
December 31,
----------------------------------------------------------------------------------
2001 2000
----------------------------------------- ------------------------------------
Amount Outstanding Total Reserve Amount Outstanding Total Reserve
------ ----------- ------------- ------ ----------- -------------
Commercial Real Estate Loans $1,423 0.44% 29.26% $2,481 0.78% 62.78%
Commercial Non-Real Estate Loans 1,878 0.58 38.61 257 0.08 6.5
Residential Loans 403 0.12 8.28 250 0.08 6.33
Consumer Loans 542 0.17 11.15 278 0.09 7.03
Unallocated 618 0.19 12.7 686 0.22 17.36
------ ------
Total $4,864 1.5% 100% $3,952 1.25% 100%
December 31,
-----------------------------------------
1999
-----------------------------------------
Amount Outstanding Total Reserve
------ ----------- -------------
Commercial Real Estate Loans $2,796 1.02% 78.01%
Commercial Non-Real Estate Loans 29 0.01 0.81
Residential Loans 69 0.02 1.93
Consumer Loans 114 0.01 3.18
Unallocated 576 0.21 16.07
------
Total $3,584 1.27% 100%
21
NON-INTEREST INCOME
Total non-interest income in 2003 amounted to $5.4 million compared to $7.0
million in 2002 and $5.7 million in 2001. Deposit service charges are the
largest recurring component of non-interest income and amounted to $3.1 million
in 2003 down $136 thousand or 4.2 % from 2002. In 2003, non-sufficient funds
("NSF") fees were down by $293 thousand and statement charges were up $186
thousand compared to 2002, in addition miscellaneous fees and returned item
charges were down $27 thousand in 2003. The changes in deposit service charges
in 2002 compared to 2001 were a result of a $175 thousand decrease in NSF fees
and a $165 thousand decrease in statement fees. The gains on sales of other
assets were $270 thousand in 2003 versus a loss of $192 thousand in 2003 for an
increase in non-interest income of $462 thousand when comparing year-to-year
changes.
In 2002 the proceeds from life insurance were $2.3 million, primarily as a
result of the untimely death of an insured officer. In 2003 the increase in the
cash surrender value of life insurance was $515 thousand. This accounts for $1.8
million in the reduction of non-interest income in 2003 compared to 2002.
Net gain on sale of securities was $412 thousand in 2003 compared to $648
thousand in 2002 and $1.1 million in 2002.
NON-INTEREST INCOME ANALYSIS - TABLE 5
(Dollars in Thousands) Year Ended December 31, Percent Change
---------------------------------- --------------------
2003 2002 2001 2003-02 2002-01
------- ------- ------- ------- -------
Deposit Service Charges $ 3,086 $ 3,222 $ 3,595 -4.22% -10.38%
Loan Fees 661 537 325 23.09% 65.23%
Gain on Sale of Securities 412 648 1,144 -36.42% -43.36%
Gain/(Loss) on Sale of Other Assets 270 (192) (59) NM 225.42%
Increase in Cash Value and Proceeds
from Life Insurance 515 2,332 18 -77.92% NM1
Other 470 480 691 -2.08% -30.54%
------- ------- ------- ------- --------
Total Non-Interest Income $ 5,414 $ 7,027 $ 5,714 -22.95% 22.98%
======= ======= ======= ======= ========
22
NON-INTEREST EXPENSE
Total non-interest expenses were $22.3 million in 2003 compared to $22.6 million
in 2002 and $20.1 million in 2001. Included in non-interest expenses were
severance compensation of $3.1 million in 2003, $2.5 million in 2002 and $708
thousand in 2001. Officers with higher value severance packages exercised their
agreements in 2003, including the retirement payment to David Shelp. Merger
related expenses were $304 thousand in 2003, zero in 2002 and $67 thousand in
2001. 2002 expenses included non-recurring expenses relating to a previously
reported investigation conducted by a special committee of independent directors
and the expenses incurred in the creation of the bank holding company of $665
thousand and $181 thousand, respectively.
Compensation, excluding severance compensation, declined for the second year in
a row to $9.4 million in 2003 from $9.6 million in 2002 and $9.8 million in
2001. The full time equivalent staff at December 31, 2003 was 163 compared to
189.5 and 195.5 at December 31, 2002 and 2001, respectively.
The Troy office was opened in January, 2003.
NON-INTEREST EXPENSE ANALYSIS - TABLE 6
(Dollars in Thousands) YEAR ENDED DECEMBER 31, PERCENT CHANGE
--------------------------------- ----------------------
2003 2002 2001 2003-02 2002-01
------- ------- ------- --------- ----------
Salaries $ 7,118 $ 7,460 $ 7,883 -4.6% -5.4%
Employee Benefits 2,257 2,124 1,891 6.3 12.3%
------- ------- ------- ------- -------
Total Compensation Expense 9,375 9,584 9,774 (2.2) -1.9%
Occupancy and Equipment 3,250 3,217 3,332 1.0 -3.5%
Advertising 551 610 799 (9.7) -23.7%
Outside Services 2,651 2,913 2,199 (9.0) 32.5%
Federal Insurance 65 69 186 4.3 -62.9%
Communication Expense 565 594 585 (4.9) 1.5%
Defaulted Loan Expense 791 778 401 11.8 94.0%
Other 1,896 2,389 2,076 (20.6) 15.0%
------- ------- ------- ------- -------
Total Non-Interest Expense Before Merger
and Severance Expenses 19,144 20,154 19,352 (5.8%) 4.1%
Severance Compensation 3,077 2,490 708 23.6% 251.7%
Merger Expenses 304 0 67 -100.0%
------- ------- ------- ------- -------
Total Non-Interest Expense $22,525 $22,644 $20,127 (1.2%) 12.5%
INCOME TAXES
The provision for federal income taxes for 2003, 2002 and 2001 were $296
thousand, $603 thousand and $3.4 million, respectively. The differences reflect
the fluctuations in pre-tax earnings along with the effect of tax-exempt
interest income, non-taxable life insurance gains and low income housing
credits, which reduced the effective tax rate to 21.5 %, 13.65 % and 32.94 % in
2003, 2002 and 2001, respectively.
EARNING ASSETS
At year-end 2003, total earning assets totaled $454.4 million compared to $503.2
million at December 31, 2002. Average earning assets amounted to $479.9 million
in 2003, $504.5 million in 2002 and $491.7 million in 2001.
Loans are the largest component of earning assets with an average balance of
$319.4 million in 2003 compared to average balances of $323.7 million and $323.2
million in 2002 and 2001, respectively. Commercial loans, including commercial
real estate, grew $3.5 million in 2003 compared to 2002 and $14.3 million in
2002 compared to 2001. Both residential and consumer loans had lower average
23
balances in 2003 than in 2002, while consumer loans averaged $2.3 million higher
in 2002 than in 2001. The consumer loans were primarily related to the four-year
lending program in conjunction with DTE Energy that ended at the end of 2003.
Residential loans reduced during 2003 through principal reduction and
refinancing with other lenders. In the third and fourth quarters of 2003, the
Bank acquired whole loan mortgage pools to replenish the portfolio.
Asset or liability sensitivity along with interest rate risk arises in the
normal course of the Bank's business due to differences in the re-pricing and
maturity characteristics of interest rate sensitive assets and liabilities.
Sensitivity of earnings to interest rate changes arises when yields on assets
change differently from the interest costs on liabilities. Asset or liability
sensitivity is determined by the difference between interest-earning assets and
interest-bearing liabilities re-pricing within a specific time period and the
magnitude by which interest rates change on the various types of earning assets
and interest-bearing liabilities. The management of interest rate sensitivity
includes monitoring the maturities and re-pricing opportunities of
interest-earning assets and interest-bearing liabilities.
At year-end 2003, the Bank's investment portfolio had a balance of $91.6 million
compared to $149.8 million at year-end 2002. Compared to the broad array of
investment opportunities generally accepted as suitable bank investments, the
Bank's investment portfolio remained conservative and consisted primarily of
mortgage-backed securities and U.S. government agency securities. At December
31, 2003, the Bank's investment securities portfolio had a weighted average
maturity of 11.2 years and a weighted average yield of 3.12 %.
There were no investments in securities of any one issuer, which exceeded 10% of
stockholders' equity except for holdings of U.S. Government Agency Securities
($59.0 million), CIT Group Inc. Corporate Bonds ($5.0 million), and Goldman
Sachs Group Inc. Corporate bonds ($5.2 million) at December 31, 2003. The
majority of the U.S. Government Agency Securities are pledged to secure
borrowing arrangements for Federal Home Loan Bank borrowings and securities sold
under agreements to repurchase or for other purposes as required or permitted by
law.
LOAN AND LEASE FINANCING PORTFOLIO ANALYSIS - TABLE 7
(Dollars in Thousands)
At December 31,
--------------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
Commercial $ 74,440 22.7% $ 77,856 23.4% $ 70,613 21.7%
Commercial Mortgage 185,132 52.1 188,121 56.4 169,865 52.2
Residential Mortgage and Home Equity 64,034 19.6 16,753 5 24,627 7.6
Real Estate Construction 10,677 0.0 26,071 7.8 31,858 9.8
Consumer 20,843 5.6 24,512 7.4 27,378 8.4
Lease Financing -- 0.0 33 0.0 984 0.3
-------- ------ -------- ------ -------- ------
Loans $355,124 100% $333,346 100% $325,325 100%
======== ====== ======== ====== ======== ======
The Bank has no foreign loans and there were no concentrations greater than 10%
of total loans that are not disclosed as a separate category.
24
LOAN COMMITMENTS - TABLE 8
(Dollars in Thousands) At December 31,
-------------------------------------
2003 2002 2001
------ ------ ------
Outstanding Loan Commitments 10,278 21,000 21,500
Unused Commercial Line of Credit Commitments 54,740 70,400 53,500
Unused Home Equity Commitments 6,276 4,600 5,200
Undisbursed Construction Loans 7,940 5,900 7,900
LOAN MATURITY ANALYSIS - TABLE 9
(Dollars in Thousands) At December 31,
----------------------------------------------------------------
With One To After
One Year Five Years Five Years Total
----------- ------------ ----------- ------------
Commercial $39,957,729 $ 24,246,011 $10,236,269 $ 74,440,009
Commercial Mortgage 13,099,704 153,271,048 18,760,873 185,131,625
Residential Mortgage and Home Equity 2,362,263 4,871,788 56,801,052 64,035,103
Real Estate Construction 7,133,313 3,543,856 10,677,169
Consumer 1,704,191 19,128,965 7,177 20,840,333
Lease Financing
Lease Financing - Held for Sale
----------- ------------ ----------- ------------
Loans 64,257,200 $205,061,668 $85,805,371 355,124,239
----------- ------------ ----------- ------------
Total Loans Above
=========== ============ =========== ============
Fixed Rates $10,870,303 $131,026,853 $47,006,343 $188,903,499
Floating Rates 53,386,897 74,034,815 38,799,028 166,220,740
----------- ------------ ----------- ------------
Loans $64,257,200 $205,061,668 $85,805,371 $355,124,239
=========== ============ =========== ============
SECURITIES MATURITY ANALYSIS - TABLE 10
(Dollar amounts in thousands)
At December 31, 2003
-------------------------------------------------------------------------------------
Within 1 Year 1 - 5 Years 5 - 10 Years Over 10 Years
----------------- ---------------- ------------------- ----------------
Cost Yield Cost Yield Cost Yield Cost Yield
------- ----- ------- ----- ------- ------- ------- ------
Mortgage-backed securities $ -- $ -- $ 2,561 5.33% $26,315 4.07%
U.S. Government and agency securities 8,526 4.18% 20,040 2.22% 954 6.63%
Tax-exempt municipal securities 2,592 3.44% 762 4.30% 6,594 4.61%
Taxable municipal securities 1,356 1.19%
Corporate bonds 6,496 6.51% 4,999 6.50% 5,165 6.29% 3,000 4.82%
------- ------- ------- -------
Total $15,022 $28,987 $ 9,442 $35,909
At December 31, 2003
-----------------------------------
Maturing
-----------------------------------
Weighted
Average
Amortized Fair Maturity
Cost Value (Years)
--------- ------- --------
Mortgage-backed securities $28,876 $29,250 24.3
U.S. Government and agency securities 29,520 29,750 2.4
Tax-exempt municipal securities 9,949 10,461 9.7
Taxable municipal securities 1,356 1,356 1.4
Corporate bonds 19,659 20,754 6.6
------- -------
Total $89,360 $91,571 11.2
25
OTHER EARNING ASSETS
The Bank's other earning assets are comprised of Federal Home Loan Bank ("FHLB")
stock, Federal Reserve Bank ("FRB") stock, interest-bearing deposits with other
banks and bank owned life insurance. Total other earning assets at year-end
totaled $18.9 million and $29.8 million at December 31, 2003 and 2002.
Interest-bearing deposits with banks averaged $33.4 million in 2003 compared to
$24.1 million in 2002 and $9.7 million in 2001. Liquid funds were temporarily
maintained in these interest-bearing deposits while seeking higher yielding,
high quality alternative investments. Management viewed the available investment
securities as an unattractive alternative during this period of the interest
rate cycle.
As a member of both the FHLB and the FRB, stock ownership is required. At
year-end 2003 and 2002, the Bank's FHLB stock position remained at $5.9 million.
FRB stock held at year-end 2003 was $0.9 million compared to $1.5 million at
December 31, 2002. These investments carried a weighted average yield of 5.26%
during 2003 and 6.05% during 2002.
During December of 2001, the Bank invested $10 million in cash value life
insurance, commonly known as "BOLI". "BOLI" is a tax-free investment vehicle
that provides a stable return which is typically at or above market rates. The
"BOLI" investment is held indefinitely by the Bank. In the event of death of a
member of the insured group, the proceeds from the life insurance claim are
included in the Bank's other income. During 2002, the Bank recognized $2.3
million in proceeds from this product, of which $1.7 million was recognized
during the fourth quarter of 2002 due to the untimely death of the Bank's Senior
Vice President and Chief Credit Officer. The Bank invested $830 thousand in
additional "BOLI" during 2003.
DEPOSITS AND OTHER BORROWED FUNDS
Providing a stable source of low-cost funding, core deposits include
non-interest-bearing business checking deposits, money market savings, personal
checking and savings and retail certificates. Average core deposits were $401.9
million in 2003 compared to $392.3 million in 2002. Average business- and
personal-checking balances were $186.3 million in 2003 compared to $177.4
million in 2002. Average money market savings were $164.0 million in 2003
compared to $159.8 million in 2002 and $150.6 million in 2001. Average retail
certificate of deposits were $30.0 million in 2003 compared to $35.9 million in
2002 and $25.9 million for 2001. The Bank's largest core deposit source
continues to be business and personal checking account balances. The average
balance of those accounts increased during 2003 by $8.8 million.
At December 31, 2003, total deposits were $406.4 million compared to $429.1
million at the end of 2002. Total deposits for any given day can fluctuate
primarily as business checking customer's balances changes as collections and
payments cause their balances to change. There is an indication that business
checking balances tend to be lower around the year end and rise to a higher
level around the middle of each year.
Comparing year end 2002 to 2001, total deposits increased $39.8 million or
10.2%. This significant increase is deposits has not only contributed to funding
loans, but has also allowed the Bank to decrease its other borrowed funds $14.6
million and to redeem the $20.7 million of preferred stock of the Bank's
subsidiary Franklin Finance Corporation which was paying a dividend of 8.70%.
Borrowed funds in the form of advances from the FHLB and repurchase agreements
provided a limited amount of the funding to support loan growth in the year 2002
while providing a source of liquidity which mirrors the estimated duration of
the Bank's deposit portfolio. The average balance in these forms of borrowed
funds was $65.0 million for FHLB advances and $0.3 million for repurchase
agreements in 2003, as compared to $65.3 million for FHLB advances and $3.1
million in repurchase agreements in 2002 and $51.8 million for FHLB advances and
$16.5 million in repurchase agreements, in 2001. In 2004, $10 million of the
FHLB advances mature.
26
SOURCE OF FUNDS - TABLE 11
(Dollars in thousands)
December 31,
----------------------------------------------------------------------------------
2003 2002 2001
---- ---- ----
Business checking $185,159 39.28%% $180,011 36.43% $159,450 34.00%
Money market savings 147,697 31.33% 165,365 33.47 147,231 31.40
Personal checking and savings 25,076 5.32% 25,567 5.17 23,661 5.05
Jumbo certificates 19,736 4.19% 20,967 4.24 33,460 7.13
Retail certificates 28,712 6.09% 37,220 7.53 25,556 5.45
-------- -------- -------- -------- -------- --------
Total deposits 406,380 86.21% 429,130 86.85 389,358 83.03
Borrowings 65,000 13.79% 65000 13.15 79,606 16.97
-------- -------- -------- -------- -------- --------
Total source of funds 471,380 100% $494,130 100% $468,964 100%
MATURITY DISTRIBUTION OF TIME DEPOSITS ANALYSIS - TABLE 12
(In thousands of dollars)
December 31, 2003
-----------------
(less than) $100,000 (greater than) $100,000
-------- --------
Three months or less $ 4,404 $ 5,001
Over three months to six months 6,023 4,462
Over six months to twelve months 15,943 8,905
Over twelve months 2,342 1,368
-------- --------
Total $ 28,712 $ 19,736
======== ========
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual obligations
and commercial commitments, which require future cash payments. The following
table presents the aggregated annual maturities of contractual obligations
(based on final maturity dates) at December 31, 2003 (in thousands).
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year years years 5 years
(In thousands of dollars) ----- ------ ----- ----- -------
Deposits without stated maturities $357,932 $ -- $ -- $ -- $357,932
Certificates of deposit 48,448 19,890 24,848 3,447 263
Long-term debt obligations 65,000 10,000 -- -- 55,000
Capital lease obligations -- -- -- -- --
Operating lease obligations 6,614 1,097 2,282 2,065 1,170
Purchase obligations -- -- -- -- --
Other long-term liabilities -- -- -- -- --
-------- ------- ------- ------ --------
Total $477,994 $30,987 $27,130 $5,512 $414,365
27
REGULATORY CAPITAL
The adequacy of the Corporation's capital is reviewed regularly to ensure that
sufficient capital is available to meet current and future funding needs and
comply with regulatory requirements.
Shareholders' equity, excluding the net unrealized gain on securities available
for sale, increased by $1.1 million at year end 2003, or 2.46 %, compared to
December 31, 2002 and represents 8.52 % of total assets. At December 31, 2002,
the similar ratio of shareholders' equity to assets was 7.97%. The increase was
primarily the result of net income of $1.1 million and exercise of common stock
options of $1.2 million, offset by $1.2 million of cash dividends. Dividends
declared per common share remained $0.32 per share in 2003 as in 2002.
Management believes the Corporation has an adequate capital position to meet its
needs in 2004.
The Corporation is subject to risk-based capital adequacy guidelines that
measure capital relative to risk-weighted assets and off-balance sheet financial
instruments. Capital adequacy guidelines issued by the Federal Reserve Board
require bank holding companies to have a minimum total risk-based capital ratio
of 8.00%, with at least half of total capital in the form of Tier 1, or core
capital. The Corporation's total risk-based capital ratio was 13.15% at December
31, 2003. For further information regarding regulatory capital requirements, see
Note 6 to the consolidated financial statements.
The Bank has consistently exceeded the capital levels established by The Office
of the Comptroller of the Currency ("OCC"). During 2003, the Bank's capital
levels remained above the "well capitalized" OCC classification. It is the
Corporation's objective to maintain this highest classification level, which
both ensures compliance with regulatory requirements and allows for greater
potential growth.
The OCC measures regulatory capital three ways: 1) Tier 1 capital to average
assets (the "Tier 1 leverage" ratio), 2) Tier 2 capital to risk weighted assets
and 3) Total capital to risk weighted assets. Minimum accepted ratios for these
three levels are 4.00%, 4.00% and 8.00%, respectively. "Well capitalized"
institutions must meet OCC established minimums of 5.00%, 6.00% and 10.00% for
the three tiers, respectively.
CAPITAL ANALYSIS - TABLE 13
(In thousands)
Tier 1 Tier 1 Total
Leverage Risk-based Risk-based
---------- ---------- ----------
Regulatory capital balances at December 31, 2003 $ 44,279 $ 44,279 $ 49,202
Required regulatory capital (well capitalized) 26,594 25,444 42,090
---------- ---------- ----------
Capital in excess of well capitalized $ 17,685 $ 18,325 $ 7,112
========== ========== ==========
Capital ratios at December 31, 2003 8.32% 10.24% 11.37%
Capital ratios at December 31, 2002 7.55 10.63 11.89
Regulatory capital ratios--"well capitalized" definition 5.00 6.00 10.00
NON-PERFORMING ASSETS
The Bank's policies regarding non-accrual and impaired loans reflect the
importance of early identification of troubled loans. Consumer loans are charged
off no later than 120 days past due, or earlier if deemed uncollectible. Loans
other than consumer loans are generally placed on non-accrual status when
management determines that principal or interest may not be fully collectible,
but generally no later than when the loan is 90 days past due on principal or
interest. Loan amounts in excess of probable future cash collections are charged
off at the time the loan is placed on non-accrual status, to an amount that
represents management's assessment of the ultimate collectibility of the loan.
Interest previously accrued but not collected on non-accrual loans is charged
against current income. Income on such loans is then recognized only to the
extent that cash is received and where the future collection of principal is
probable. When the future collection of principal is not probable, cash received
is applied to the carrying value of the loan.
28
Total non-performing assets at year-end 2003 were $2.4 million compared to $7.3
million and $3.6 million at year-end 2002 and 2001, respectively. The $4.9
million decrease in 2003 reflects sales of other real estate owned and
collection on previously non-performing loans. Non-accrual loans totaled $1.7
million at the end of 2003 compared to $4.8 million at year end 2002, which was
a decrease of $3.1 million; there were no accruing loans past due 90 days at
year-end 2003, 2002 or 2001. Real estate owned or in redemption decreased from
$2.5 million at December 31, 2002 to $0.7 million at December 31, 2003. As a
percentage of total assets, non-performing assets were 0.46 %, 1.35 % and 0.68 %
at year-end 2003, 2002 and 2001, respectively. At December 31, 2003, loans 30 or
more days past due was 0.81 % of total loans outstanding compared to 0.66 % at
December 31, 2002. At December 31, 2001 total non-performing assets were $3.6
million of which $564 thousand was real estate owned or in redemption. At year
end 2001 loans 30 days or more past due were 0.72 percent of total loans.
At December 31, 2003, management was not aware of any potential problem loans
that would have a material effect on loan delinquency or loan charge-offs.
Management continues to actively manage the loan portfolio, seeking to identify
and resolve problem assets at an early stage. Management believes that the Bank
is adequately reserved.
NON-PERFORMING ASSETS - TABLE 14
December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Non-accrual loans
Commercial $ 344,963 $ 338,547 $ 284,955 $ 640,936 $ 63,393
Commercial mortgage 1,231,987 3,104,793 2,188,869 1,542,632 807,713
Residential mortgage -- 1,313,654 376,969 216,000 --
Consumer 126,430 75,993 201,745 -- --
Lease financing -- -- 11,360 -- --
---------- ---------- ---------- ---------- ----------
Total non-accrual loans 1,703,380 4,832,987 3,063,898 2,399,568 871,106
Accruing loans past due 90 days or more
Commercial -- -- -- -- 141,029
Commercial mortgage -- -- -- -- --
Residential mortgage -- -- -- 18,867 469,080
Consumer -- -- -- 81,299 257,868
Lease financing -- -- -- 104,617 357,639
---------- ---------- ---------- ---------- ----------
Total -- -- -- 204,783 1,225,616
---------- ---------- ---------- ---------- ----------
Total non-performing loans 1,703,380 4,832,987 3,063,898 2,604,351 2,096,722
Real estate owned
Commercial mortgage 57,250 540,326 77,500 542,182 891,000
R