1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001 --------------- Commission file number 0-7818 -------- INDEPENDENT BANK CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Michigan 38-2032782 - -------------------------------- ---------------------------------------------- (State or jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) Number) 230 West Main Street, P.O. Box 491, Ionia, Michigan 48846 - -------------------------------------------------------------------------------- (Address of principal executive offices) (616) 527-9450 -------------- (Registrant's telephone number, including area code) NONE - -------------------------------------------------------------------------------- Former name, address and fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --------- --------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at May 11, 2001 - -------------------------------- --------------------------------------------- Common stock, par value $1 11,459,595
2 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES INDEX <TABLE> <CAPTION> Page Number(s) --------- <S> <C> <C> PART I - Financial Information --------------------- Item 1. Consolidated Statements of Financial Condition March 31, 2001 and December 31, 2000 2 Consolidated Statements of Operations Three-month periods ended March 31, 2001 and 2000 3 Consolidated Statements of Cash Flows Three-month periods ended March 31, 2001 and 2000 4 Consolidated Statements of Shareholders' Equity Three-month periods ended March 31, 2001 and 2000 5 Notes to Interim Consolidated Financial Statements Three-month periods ended March 31, 2001 and 2000 6-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-20 Item 3. Quantitative and Qualitative Disclosures about Market Risk 20 PART II - Other Information ----------------- Item 6. Exhibits & Reports on Form 8-K 21 </TABLE>
3 Part I. INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---------------- ---------------- (unaudited) ---------------- ---------------- Assets (in thousands) <S> <C> <C> Cash and due from banks $ 48,871 $ 58,149 Securities available for sale 233,858 217,447 Securities held to maturity (fair value of $20.1 million at December 31, 2000) 20,098 Federal Home Loan Bank stock, at cost 19,612 19,612 Loans held for sale 41,080 20,817 Loans Commercial 404,424 381,066 Real estate mortgage 742,085 772,223 Installment 229,921 226,375 ------------- -------------- Total Loans 1,376,430 1,379,664 Allowance for loan losses (14,322) (13,982) ------------- -------------- Net Loans 1,362,108 1,365,682 Property and equipment, net 34,619 34,757 Accrued income and other assets 48,205 47,229 ------------- -------------- Total Assets $ 1,788,353 $ 1,783,791 ============= ============== Liabilities and Shareholders' Equity Deposits Non-interest bearing $ 135,478 $ 140,945 Savings and NOW 582,898 576,621 Time 635,416 672,334 ------------- -------------- Total Deposits 1,353,792 1,389,900 Federal funds purchased 7,450 27,550 Other borrowings 250,944 196,032 Guaranteed preferred beneficial interests in Company's subordinated debentures 17,250 17,250 Accrued expenses and other liabilities 30,540 24,723 ------------- -------------- Total Liabilities 1,659,976 1,655,455 ------------- -------------- Shareholders' Equity Preferred stock, no par value--200,000 shares authorized; none Outstanding Common stock, $1.00 par value--30,000,000 shares authorized; issued and outstanding: 11,487,876 shares at March 31, 2001 and 11,609,524 shares at December 31, 2000 11,488 11,610 Capital surplus 74,546 77,255 Retained earnings 40,962 37,544 Accumulated other comprehensive income 1,381 1,927 ------------- -------------- Total Shareholders' Equity 128,377 128,336 ------------- -------------- Total Liabilities and Shareholders' Equity $ 1,788,353 $ 1,783,791 ============= ============== </TABLE> See notes to interim consolidated financial statements. 2
4 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations <TABLE> <CAPTION> Three Months Ended March 31, 2001 2000 ----------- ----------- (unaudited) ------------------------- (in thousands, except per share amounts) <S> <C> <C> Interest Income Interest and fees on loans $ 31,188 $ 28,486 Securities available for sale Taxable 2,272 1,670 Tax-exempt 1,403 1,500 Securities held to maturity Taxable 795 Tax-exempt 163 Other investments 389 391 ----------- ----------- Total Interest Income 35,252 33,005 ----------- ----------- Interest Expense Deposits 12,931 11,741 Other borrowings 4,185 4,106 ----------- ----------- Total Interest Expense 17,116 15,847 ----------- ----------- Net Interest Income 18,136 17,158 Provision for loan losses 633 557 ----------- ----------- Net Interest Income After Provision for Loan Losses 17,503 16,601 ----------- ----------- Non-interest Income Service charges on deposit accounts 1,818 1,501 Net gains (losses) on asset sales Real estate mortgage loans 995 380 Securities 35 (16) Other income 2,158 2,279 ----------- ----------- Total Non-interest Income 5,006 4,144 ----------- ----------- Non-interest Expense Salaries and employee benefits 8,622 8,392 Occupancy, net 1,290 1,178 Furniture and fixtures 1,058 1,141 Other expenses 4,153 4,000 ----------- ----------- Total Non-interest Expense 15,123 14,711 ----------- ----------- Income Before Federal Income Tax 7,386 6,034 Federal income tax expense 2,093 1,548 ----------- ----------- Net Income Before Cumulative Effect of Change in Accounting Principle 5,293 4,486 Cumulative effect of change in accounting principle, net of tax (35) ----------- ----------- Net Income $ 5,258 $ 4,486 =========== =========== Net Income Per Share Before Cumulative Effect of Change in Accounting Principle Basic $ .46 $ .38 Diluted .45 .38 Net Income Per Share Basic $ .46 $ .38 Diluted .45 .38 Dividends Per Common Share Declared $ .16 $ .14 Paid .15 .14 </TABLE> See notes to interim consolidated financial statements. 3
5 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ---------------------------- (unaudited) ---------------------------- (in thousands) <S> <C> <C> Net Income $ 5,258 $ 4,486 --------------- ------------- Adjustments to Reconcile Net Income to Net Cash from Operating Activities Proceeds from sales of loans held for sale 67,509 28,155 Disbursements for loans held for sale (86,777) (27,816) Provision for loan losses 633 557 Deferred loan fees 11 122 Depreciation and amortization of premiums and accretion of discounts on securities and loans 1,700 1,605 Net gains on sales of real estate mortgage loans (995) (380) Net (gains) losses on sales of securities (35) 16 Decrease in accrued income and other assets (1,404) (853) Increase in accrued expenses and other liabilities 6,586 3,182 --------------- ------------- Total Adjustments (12,772) 4,588 --------------- ------------- Net Cash from Operating Activities (7,514) 9,074 --------------- ------------- Cash Flow from Investing Activities Proceeds from the sale of securities available for sale 2,163 4,933 Proceeds from the maturity of securities available for sale 5,930 345 Proceeds from the maturity of securities held to maturity 1,010 Principal payments received on securities available for sale 7,411 2,968 Principal payments received on securities held to maturity 4,269 Purchases of securities available for sale (8,503) (19,242) Principal payments on portfolio loans purchased 1,286 905 Portfolio loans made to customers, net of principal payments received 1,644 (22,524) Capital expenditures (1,058) (215) --------------- ------------- Net Cash from Investing Activities 8,873 (27,551) --------------- ------------- Cash Flow from Financing Activities Net increase (decrease) in total deposits (36,108) 38,387 Net decrease in short-term borrowings (25,022) (29,755) Proceeds from Federal Home Loan Bank advances 232,500 147,770 Payments of Federal Home Loan Bank advances (176,350) (148,331) Retirement of long-term debt (500) (500) Dividends paid (1,740) (1,572) Proceeds from issuance of common stock 286 293 Repurchase of common stock (3,703) (806) --------------- ------------- Net Cash from Financing Activities (10,637) 5,486 --------------- ------------- Net Decrease in Cash and Cash Equivalents (9,278) (12,991) Cash and Cash Equivalents at Beginning of Period 58,149 58,646 --------------- ------------- Cash and Cash Equivalents at End of Period $ 48,871 $ 45,655 =============== ============= Cash paid during the period for Interest $ 13,274 $ 16,144 Income taxes 686 Transfer of loans to other real estate 671 1,534 Transfer of securities held to maturity to available for sale 20,098 </TABLE> See notes to interim consolidated financial statements 4
6 INDEPENDENT BANK CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ----------- ------------ (unaudited) ------------------------ (in thousands) <S> <C> <C> Balance at beginning of period $ 128,336 $ 113,746 Net income 5,258 4,486 Cash dividends declared (1,839) (1,684) Issuance of common stock 871 335 Repurchase of common stock (3,703) (806) Net change in accumulated other comprehensive Income (loss), net of related tax effect (note 4) (546) 431 ----------- ------------ Balance at end of period $ 128,377 $ 116,508 =========== ============ </TABLE> See notes to interim consolidated financial statements. 5
7 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. In the opinion of management of the Registrant, the accompanying unaudited consolidated financial statements contain all the adjustments (consisting only of normal recurring accruals) necessary to present fairly the consolidated financial condition of the Registrant as of March 31, 2001 and December 31, 2000, and the results of operations for the three-month periods ended March 31, 2001 and 2000. 2. Management's assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions and other pertinent factors. Loans on non-accrual status, past due more than 90 days, or restructured amounted to $7.6 million at March 31, 2001, and $7.0 million at December 31, 2000. (See Management's Discussion and Analysis of Financial Condition and Results of Operations). 3. The provision for income taxes represents federal income tax expense calculated using annualized rates on taxable income generated during the respective periods. 4. Comprehensive income for the three-month periods ending March 31 follows: <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ----------- ------------ (in thousands) <S> <C> <C> Net income $ 5,258 $ 4,486 Net change in unrealized gain on securities available for sale, net of related tax effect 2,216 431 Net change in unrealized loss on derivative instruments, net of related tax effect (2,762) ----------- ------------ Comprehensive income $ 4,712 $ 4,917 =========== ============ </TABLE> 5. The Registrant's reportable segments are based upon legal entities. The Registrant has five reportable segments: Independent Bank ("IB"), Independent Bank West Michigan ("IBWM"), Independent Bank South Michigan ("IBSM"), Independent Bank East Michigan ("IBEM") and Independent Bank MSB ("IBMSB"). The Registrant evaluates performance based principally on net income of the respective reportable segments. 6
8 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) A summary of selected financial information for the Registrant's reportable segments for the three-month periods ended March 31, follows: <TABLE> <CAPTION> Three months ended March 31, IB IBWM IBSM IBEM IBMSB OTHER(1) TOTAL -------------------------------------------------------------------------------------------- (in thousands) <S> <C> <C> <C> <C> <C> <C> <C> 2001 Total assets $ 455,587 $ 353,835 $ 218,301 $ 307,312 $ 448,960 $ 4,358 $ 1,788,353 Interest income 9,053 7,731 4,425 5,936 8,101 6 35,252 Net interest income 5,223 4,564 2,483 3,401 3,044 (579) 18,136 Provision for loan losses 150 150 90 150 93 633 Income (loss) before Income tax 2,459 2,408 1,117 1,350 1,063 (1,011) 7,386 Net income (loss) before change in accounting principle 1,727 1,636 828 1,044 798 (740) 5,293 Net income (loss) 1,720 1,564 828 1,087 799 (740) 5,258 2000 Total assets $ 421,335 $ 329,536 $ 201,223 $ 306,848 $ 471,525 $ 8,545 $ 1,739,012 Interest income 8,091 7,037 3,934 5,601 8,340 2 33,005 Net interest income 4,725 4,159 2,224 3,276 3,395 (621) 17,158 Provision for loan losses 150 135 60 120 92 557 Income (loss) before Income tax 1,978 1,663 884 1,169 1,476 (1,136) 6,034 Net income (loss) 1,415 1,157 683 920 1,106 (795) 4,486 </TABLE> (1) Includes items relating to the Registrant and certain insignificant operations. 7
9 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) 6. A reconciliation of basic and diluted earnings per share for the three-month month periods ending March 31 follows: <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ------------ ----------- (in thousands, except per share amounts) <S> <C> <C> Net income before cumulative effect of change in accounting principle $ 5,293 $ 4,486 ============ =========== Net income $ 5,258 $ 4,486 ============ =========== Shares outstanding (Basic) (1) 11,548 11,751 Effect of dilutive securities - stock options 138 85 ------------ ----------- Shares outstanding (Diluted) 11,686 11,836 ============ =========== Net income per share before cumulative effect of change in accounting principle Basic $ .46 $ .38 Diluted .45 .38 Net income per share Basic $ .46 $ .38 Diluted .45 .38 </TABLE> (1) Shares outstanding have been adjusted for a 5% stock dividend in 2000. 7. The Registrant adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS #133") on January 1, 2001. SFAS #133, which was subsequently amended by SFAS #137 and SFAS #138, requires companies to record derivatives on the balance sheet as assets and liabilities measured at fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives will qualify for hedge accounting. The Registrant's derivative financial instruments according to the type of hedge in which they are designated under SFAS #133 follows: <TABLE> <CAPTION> March 31, 2001 Notional WAM Fair Amount (yrs) Value -------------------------------------- (dollars in thousands) <S> <C> <C> <C> FAIR VALUE HEDGE - pay variable interest-rate swap agreements $62,000 6.6 $(1,594) ====================================== CASH FLOW HEDGE Pay fixed interest-rate swap agreements $166,000 2.6 $(3,916) Interest-rate collar agreements 10,000 2.6 (282) -------------------------------------- Total $176,000 2.6 $(4,198) ====================================== NO HEDGE DESIGNATION Pay variable interest-rate swap agreements $ 75,000 0.2 $ 299 Pay fixed interest-rate swap agreements 42,000 0.6 (318) Interest-rate cap agreements 47,000 1.2 1 Interest-rate floor agreements 13,000 1.2 0 Rate-lock real estate mortgage loan commitments 39,000 .1 (112) Mandatory commitments to sell real estate mortgage loans 72,000 .1 60 -------------------------------------- Total $288,000 0.4 $ (70) ====================================== </TABLE> 8
10 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) Risk Management Objectives and Strategies The Banks have established interest-rate risk parameters for maximum fluctuations in net interest income and market value of portfolio equity. Management continually monitors the Banks' interest rate risk position via simulation modeling reports (See "Asset/liability management"). The goal of the Banks' asset/liability management efforts is to maintain profitable financial leverage within established risk parameters. Cash Flow Hedges The Banks use variable rate and short-term (less than 12 months) debt obligations to fund a portion of their balance sheets, which expose the Banks to variability in interest rates. To meet its objective, the Banks may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates ("Cash Flow Hedges"). Cash Flow Hedges include pay-fixed interest-rate swaps and interest-rate collars. Pay-fixed interest-rate swaps convert the variable-rate cash flows on variable rate and short-term debt obligations to fixed-rates. Under interest-rate collars, the Banks will receive cash if interest rates rise above a predetermined level while the Banks will make cash payments if interest rates fall below a predetermined level. The Banks effectively have variable rate debt with an established maximum and minimum rate. Upon adoption of SFAS #133, the Banks recorded the fair value of Cash Flow Hedges in accrued expenses and other liabilities. On an ongoing basis, the banks will adjust their balance sheets to reflect the then current fair value of Cash Flow Hedges. The related gains or losses are reported in other comprehensive income and are subsequently reclassified into earnings, as a yield adjustment in the same period in which the related interest on the debt obligations affect earnings. It is anticipated that approximately $1.2 million, net of tax, of unrealized losses on Cash Flow Hedges at March 31, 2001 will become realized over the next twelve months. To the extent that the change in value of the Cash Flow Hedges do not perfectly offset the change in the value of the debt obligations, the ineffective portion of the Cash Flow Hedges are immediately recognized as interest expense. The maximum term of any Cash Flow Hedge is 8.3 years. Fair Value Hedges The Banks use long-term, fixed-rate brokered CDs to fund a portion of their balance sheets. These instruments expose the Banks to variability in fair value due to changes in interest rates. To meet their asset/liability management objectives, the Banks may enter into pay-variable interest-rate swaps to mitigate fluctuations in fair values of such fixed-rate debt instruments ("Fair Value Hedges"). Upon adoption of SFAS #133, the Banks recorded Fair Value Hedges at fair value in accrued expenses and other liabilities. The hedged instruments were also recorded at fair value, which offsets the adjustment to Fair Value Hedges. On an ongoing basis, the Banks will adjust its balance sheets to reflect the then current fair value. To the extent that the change in value of the Fair Value Hedges does not perfectly offset the change in the value of the hedged instruments, the ineffective portion is immediately recognized as interest expense. 9
11 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) No Hedge Designation Certain financial derivative instruments, discussed in the following paragraphs, were not designated as hedges. The fair value of these derivative instruments have been recorded on the Banks' balance sheets and will be adjusted on an ongoing basis to reflect their then current fair value. The changes in the fair value of interest rate swap agreements and option contracts are recognized currently as interest expense. The changes in the fair value of Rate Lock Commitments and Mandatory Commitments are recognized currently in gains on the sale of real estate mortgage loans. Interest expense and net gains on the sale of mortgage loans, as well as net income may be more volatile as a result of derivative instruments, which are not designated as hedges. Interest rate caps are used to help manage fluctuations in cash flows resulting from interest rate risk on certain short-term debt obligations. Under these agreements, the Banks will receive cash if interest rates rise above a predetermined level. Pay-fixed interest-rate swaps are also used to manage fluctuations in cash flows resulting from changes in interest rates on certain short term debt obligations. Certain pay-variable swaps are also used to synthetically create sub-LIBOR debt. These swaps convert fixed rate brokered CDs with an original term of 1 year to 3 month LIBOR by entering into receive fixed, pay-variable interest-rate swaps. In the ordinary course of business, the Banks enter into rate-lock real estate mortgage loan commitments with customers ("Rate Lock Commitments"). These commitments expose the Banks to interest rate risk. The Banks also enter into mandatory commitments to sell real estate mortgage loans ("Mandatory Commitments") to hedge price fluctuations of mortgage loans held for sale and Rate Lock Commitments. Mandatory Commitments help protect the Banks' loan sale profit margin from fluctuations in interest rates. 10
12 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued) (unaudited) Implementation Effect The impact of adopting SFAS #133 on net income and other comprehensive income is as follows: <TABLE> <CAPTION> Income (Expense) Other Comprehensive Net Income Income Total ------------------ ------------------- ------------------- (in thousands) <S> <C> <C> <C> CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE Fair value adjustments of Option contracts not designated as hedges $ (215) $ (215) Interest rate swap agreements not designated as hedges 310 310 Fair value hedges (39) (39) Cash flow hedges (110) $ (1,107) (1,217) ------------------ ------------------- ------------------- Total (54) (1,107) (1,161) Federal income tax (19) (376) (395) ------------------ ------------------- ------------------- Net $ (35) $ (731) $ (766) ================== =================== =================== CHANGE IN FAIR VALUE DURING THE QUARTER Option contracts not designated as hedges $ (27) $ (27) Interest rate swap agreements not designated as hedges (329) (329) Rate Lock Commitments (112) (112) Mandatory Commitments 60 60 Fair value hedges (4) (4) Ineffectiveness of cash flow hedges 4 4 Cash flow hedges 33 $ (3,034) (3,001) Reclassification adjustment (43) (43) ------------------------------------------------------------- Total (375) (3,077) (3,452) Federal income tax (131) (1,046) (1,177) ------------------ ------------------- ------------------- Net $ (244) $ (2,031) $ (2,275) ================== =================== =================== </TABLE> The Banks transferred securities held to maturity with book values and market values of $20.1 million to available for sale upon adoption of SFAS #133. 8. The results of operations for the three-month period ended March 31, 2001, are not necessarily indicative of the results to be expected for the full year. 11
13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis of financial condition and results of operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in such forward-looking statements. The following section presents additional information that may be necessary to assess the financial condition and results of operations of the Registrant and its subsidiary banks (the "Banks"). This section should be read in conjunction with the consolidated financial statements contained elsewhere in this report as well as the Registrant's 2001 Annual Report on Form 10-K. FINANCIAL CONDITION SUMMARY Loans, excluding loans held for sale ("Portfolio Loans"), totaled $1.376 billion at March 31, 2001, and were largely unchanged from December 31, 2000, as a decline in real estate mortgage loans offset increases in commercial and installment loans. Commercial loans totaled $404.4 million at March 31, 2001, compared to $381.1 million at December 31, 2000. At those same dates, real estate mortgage loans totaled $742.1 million and $772.2 million, respectively. (See "Portfolio loans and asset quality.") Deposits totaled $1.354 billion at March 31, 2001, compared to $1.390 billion at December 31, 2001. The $36.1 million decline in total deposits during the period principally reflects a decline in brokered certificates of deposits ("Brokered CDs") and a corresponding increase in advances from the Federal Home Loan Bank ("FHLB Advances"). SECURITIES The Banks maintain diversified securities portfolios, which include obligations of the U.S. Treasury and government-sponsored agencies as well as securities issued by states and political subdivisions, corporate securities and mortgage-backed securities. Management continually evaluates the Banks' asset/liability management needs and attempts to maintain a portfolio structure that provides sufficient liquidity and cash flow. (See "Asset/liability management.") SECURITIES <TABLE> <CAPTION> Unrealized ---------------------------- Amortized Fair Cost Gains Losses Value ------------- ------------- ------------- ------------- (in thousands) <S> <C> <C> <C> <C> Securities available for sale March 31, 2001 $227,485 $ 6,627 $254 $233,858 December 31, 2000 214,526 3,486 565 217,447 Securities held to maturity December 31, 2000 $20,098 $ 200 $187 $20,111 </TABLE> 12
14 As permitted by Statement of Financial Accounting Standards, No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS #133") securities that were previously designated as held to maturity were reclassified to available for sale as of January 1, 2001. (See note #7 to interim consolidated financial statements.) The purchase or sale of securities is dependent upon Management's assessment of investment and funding opportunities as well as the Banks' asset/liability management needs. The Banks sold securities designated as available for sale with an aggregate market value of $2.1 million during the three months ended March 31, 2001. The Banks sold securities with a market value of $4.9 million during the corresponding period of 2000. SALES OF SECURITIES AVAILABLE FOR SALE <TABLE> <CAPTION> Three months ended March 31, 2001 2000 -------------- ------------- (in thousands) <S> <C> <C> Proceeds $2,163 $4,933 ============== ============= Gross gains $35 $ 7 Gross losses (23) -------------- ------------- Net Gains $35 $(16) ============== ============= </TABLE> PORTFOLIO LOANS AND ASSET QUALITY Management believes that the Registrant's decentralized structure provides important advantages in serving the credit needs of the Banks' principal lending markets. In addition to the communities served by the Banks' branch networks, principal lending markets include nearby communities and metropolitan areas. Subject to established underwriting criteria, the Banks also participate in commercial lending transactions with certain non-affiliated banks and may also purchase real estate mortgage loans from third-party originators. Although the Management and Board of Directors of each Bank retain authority and responsibility for credit decisions, each of the Banks has adopted uniform underwriting standards. Further, the Registrant's loan committee as well as the centralization of commercial loan credit services and loan review functions promote compliance with such established underwriting standards. The centralization of retail loan services also provides for consistent service quality and facilitates compliance with consumer protection laws and regulations. The Banks generally retain loans that may be profitably funded within established risk parameters. (See "Liquidity and capital resources.") As a result, the Banks often retain adjustable-rate and balloon real estate mortgage loans, while 15- and 30-year, fixed-rate obligations are sold to mitigate exposure to changes in interest rates. (See "Asset/liability management.") The $30.1 million decrease in real estate mortgage loans during the three months ended March 31, 2001, reflects an increase in prepayments, which has accompanied the recent decrease in interest rates. The $23.4 million increase in commercial loans during the three months ended March 31, 2001, principally reflects Management's emphasis on lending opportunities within the Lansing and Grand Rapids markets. Loans secured by real estate comprise the majority of new commercial 13
15 loans. Continued growth within this segment of Portfolio Loans is dependent upon a number of competitive and economic factors. NON-PERFORMING ASSETS <TABLE> <CAPTION> March 31, December 31, 2001 2000 ----------------- ----------------- (dollars in thousands) <S> <C> <C> Non-accrual loans $5,416 $5,200 Loans 90 days or more past due and still accruing interest 1,901 1,571 Restructured loans 251 260 ----------------- ----------------- Total non-performing loans 7,568 7,031 Other real estate 2,425 2,174 ----------------- ----------------- Total non-performing assets $9,993 $9,205 ================= ================= As a percent of Portfolio Loans Non-performing loans 0.55 % 0.51 % Non-performing assets 0.73 0.67 Allowance for loan losses 1.04 1.01 Allowance for loan losses as a percent of non-performing loans 189 199 </TABLE> Impaired loans totaled approximately $4.1 million at March 31, 2001. At that same date, certain impaired loans with a balance of approximately $500,000, had specific allocations of the allowance for loan losses, which totaled approximately $200,000. The Banks' average investment in impaired loans was approximately $3.9 million for the three-month period ended March 31, 2001. Cash receipts on impaired loans on non-accrual status are generally applied to the principal balance. Interest recognized on impaired loans during that three-month period was approximately $40,000. ALLOWANCE FOR LOAN LOSSES <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ------------- ------------ (in thousands) <S> <C> <C> Balance at beginning of period $13,982 $12,985 Additions (deduction) Provision charged to operating expense 633 557 Recoveries credited to allowance 156 160 Loans charged against the allowance (449) (425) ------------- ------------ Balance at end of period $14,322 $13,277 ============= ============ Net loans charged against the allowance to average Portfolio Loans (annualized) 0.08% 0.08% </TABLE> In determining the allowance and the related provision for loan losses, Management considers four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allowances 14
16 based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios. In its recent assessment of subjective factors, Management considered national and local economic trends as well as the recent performance of the major stock indices and changes in consumer spending which may indicate a slow down in the economy. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---------------------------------------- <S> <C> <C> Specific allocations $ 100,000 $ 100,000 Other adversely rated loans 3,318,000 3,166,000 Historical loss allocations 4,636,000 4,717,000 Additional allocations based on subjective factors 6,268,000 5,999,000 ---------------------------------------- $14,322,000 $13,982,000 ======================================== </TABLE> Loans charged against the allowance for loan losses, net of recoveries, were equal to .08% of average loans during the three months ended March 31, 2001 and 2000. (See "Provision for loan losses.") DEPOSITS AND BORROWINGS The Banks' competitive position within many of the markets served by the branch networks limits the ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits. Accordingly, the Banks compete on the basis of convenience and personal service, while employing pricing tactics that are intended to enhance the value of core deposits. The Banks have implemented funding strategies that incorporate other borrowings and Brokered CDs to finance a portion of the Portfolio Loans. The use of such alternate sources of funds supplements the Banks' core deposits and is also an integral part of the Banks' asset/liability management efforts. The decline in Brokered CDs during the three months ended March 31, 2001 principally reflects the competitive cost of FHLB Advances. (See "Liquidity and capital resources.") <TABLE> <CAPTION> March 31, 2001 December 31, 2000 -------------------------------- ---------------------------------- Average Average Amount Maturity Rate Amount Maturity Rate -------------------------------- ---------------------------------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Brokered CDs $164,787 2.6 years 6.41% $212,010 3.5 years 6.73% Fixed rate FHLB advances 135,238 4.3 years 5.70 68,743 7.9 years 6.33 Variable rate FHLB advances 104,000 0.4 years 5.46 114,345 0.2 years 6.69 Federal funds purchased 7,450 1 day 5.62 27,550 1 day 6.85 -------------------------------- ---------------------------------- Total $411,475 2.6 years 5.92 $422,648 3.1 years 6.67 ================================ ================================== </TABLE> Derivative financial instruments are employed to manage the Banks' exposure to changes in interest rates. (See "Asset/liability management".) At March 31, 2001, the Company employed interest-rate caps, floors and collars with an aggregate notional amount of $71.0 million. The Banks also employed interest-rate swaps with an aggregate notional amount of $345.0 million. (See note #7 to interim consolidated financial statements.) LIQUIDITY AND CAPITAL RESOURCES Effective management of capital resources is critical to Management's mission to create value for the Registrant's shareholders. The cost of capital is an 15
17 important factor in creating shareholder value and, accordingly, the Registrant's capital structure includes unsecured debt and Preferred Securities. Management believes that diversified portfolios of quality commercial and consumer loans will provide superior risk-adjusted returns. Accordingly, the Banks have implemented balance sheet management strategies that combine efforts to originate Portfolio Loans with disciplined funding strategies. Acquisitions have also been integral components of Management's capital management strategies. To supplement its balance sheet management activities, the Company adopted a share repurchase plan on September 19, 2000, which authorizes open market purchases of up to 500,000 shares of common stock through September 30, 2001. The Company purchased 349,000 shares at an average price of $18.83 since adoption of the plan and purchased 182,000 shares at an average price of $20.35 per share during the three months ended March 31, 2001. CAPITALIZATION <TABLE> <CAPTION> March 31, December 31, 2001 2000 ------------------- ------------------ (in thousands) <S> <C> <C> Unsecured debt $11,000 $11,500 Preferred Securities 17,250 17,250 Shareholders' Equity Preferred stock, no par value Common Stock, par value $1.00 per share 11,488 11,610 Capital surplus 74,546 77,255 Retained earnings 40,962 37,544 Accumulated other comprehensive income 1,381 1,927 -------- -------- Total shareholders' equity 128,377 128,336 -------- -------- Total capitalization $156,627 $157,086 ======== ======== </TABLE> Total shareholders' equity at March 31, 2001 was largely unchanged from December 31, 2000, as the retention of earnings was offset by open market purchases of common stock and a decline in accumulated other comprehensive income. Shareholders' equity totaled $128.4 million, equal to 7.18% of total assets at March 31, 2001. At December 31, 2000, shareholders' equity totaled $128.3 million, which was equal to 7.19% of assets. CAPITAL RATIOS <TABLE> <CAPTION> March 31, 2001 December 31, 2000 ----------------------- ---------------------- <S> <C> <C> Equity capital 7.18% 7.19% Average shareholders equity to average assets(1) 7.35 6.92 Tier 1 leverage (tangible equity capital) 7.39 7.26 Tier 1 risk-based capital 9.67 9.68 Total risk-based capital 10.74 10.74 </TABLE> (1) Based on year to date average balances for the respective periods ASSET/LIABILITY MANAGEMENT Interest-rate risk is created by differences in the pricing characteristics of the Banks' assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers' rights to prepay fixed-rate loans also create interest-rate risk. 16
18 The asset/liability management efforts of the Registrant and the Banks are intended to identify sources of interest-rate risk and to evaluate opportunities to structure the balance sheet in a manner that is consistent with Management's mission to maintain profitable financial leverage. The marginal cost of funds is a principal consideration in the implementation of the Banks' balance sheet management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. Management employs simulation analyses to monitor the Banks' interest-rate risk profiles and evaluate potential changes in the Banks' net interest income and market value of portfolio equity that result from changes in interest rates. RESULTS OF OPERATIONS SUMMARY Net income totaled $5.3 million during the three months ended March 31, 2001, compared to $4.5 million during the comparable period in 2000. The increase in net income reflects increases in net interest income and non-interest income, which were partially offset by increases in non-interest expense and the provision for loan losses. The Company implemented SFAS #133 on January 1, 2001. Pursuant to SFAS #133, the Company recorded certain charges, which are the result of accounting for derivatives at fair value. These net charges reduced the Company's net interest income and its net gains on the sale of real estate mortgage loans by approximately $300,000 and $50,000 respectively. An additional $35,000, net of taxes, has been recorded as a cumulative effect of change in accounting principle. (See note #7 to interim consolidated financial statements.) KEY PERFORMANCE RATIOS <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ---------------------------- <S> <C> <C> Net income to Average assets 1.21% 1.05% Average equity 16.45 15.74 Earnings per common share Basic $0.46 $.38 Diluted 0.45 .38 </TABLE> NET INTEREST INCOME Tax equivalent net interest income totaled $19.0 million during the three months ended March 31, 2001. The increase from $18.1 million during the comparable period of 2000 principally reflects an increase in average earning assets. Increases in loans as a percent of average earning assets also contributed to the increase in tax equivalent net interest income. Pursuant to SFAS #133, the Company recorded certain charges, which reduced tax equivalent net interest income by approximately $300,000. Average earning assets totaled $1.659 billion during the three-month period in 2001. The $56.6 million increase from $1.603 billion during the comparable period in 2000 reflects an increase in Portfolio Loans. 17
19 Tax equivalent net interest income as a percent of average earning assets ("Net Yield") was equal to 4.60% of average earning assets during the three months ended March 31, 2001, compared to 4.52% during the corresponding period of 2000. A portion of the 8 basis point increase in Net Yield may be attributed to an increase in Portfolio Loans as a percent of average earning assets. Portfolio Loans were equal to 84.7% and 81.8% of average earning assets for the three months ended March 31, 2001 and 2000, respectively. The scheduled maturity of certain low-yielding assets and high-cost liabilities at the former Mutual Savings Bank, which was acquired in 1999, also contributed to the increase in Net Yield. NET INTEREST INCOME AND SELECTED RATIOS <TABLE> <CAPTION> Three months ended March 31, 2001 2000 --------------- ------------ <S> <C> <C> Average earning assets (in thousands) $1,659,363 $1,602,804 Tax equivalent net interest income 19,040 18,111 As a percent of average earning assets Tax equivalent interest income 8.78 % 8.50 % Interest expense 4.18 3.98 Tax equivalent net interest income 4.60 4.52 Average earning assets as a percent of average assets 94.05 % 93.48 % Free-funds ratio 10.52 % 8.58 % </TABLE> PROVISION FOR LOAN LOSSES The provision for loan losses was $633,000 during the three months ended March 31, 2001, compared to $557,000 during the three-month period in 2000. The increase in the provision reflects Management's assessment of the allowance for loan losses. (See "Asset quality.") NON-INTEREST INCOME Non-interest income, including net gains on the sale of real estate mortgage loans, grew to $5.0 million during the three months ended March 31, 2001. The $862,000 increase from $4.1 million during the comparable period of 2000 principally reflects a $615,000 increase in net gains on the sale of real estate mortgage loans. A $317,000 increase in service charges on deposit accounts also contributed to the increase in non-interest income. 18
20 NON-INTEREST INCOME <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ------------ ------------- (in thousands) <S> <C> <C> Service charges on deposit accounts $1,818 $1,501 Net gains on asset sales Real estate mortgage loans 995 380 Securities 35 (16) Manufactured home loan origination 353 508 fees and commissions Title insurance fees 286 160 Real estate mortgage loan servicing fees 391 376 Mutual fund and annuity commissions 172 405 Other 956 830 ------------ ------------- Total non-interest income $5,006 $4,144 ============ ============= </TABLE> The increase in net gains on the sale of real estate mortgage loans principally reflects an increase in the volume of loans sold. An increase in the sale of servicing rights also contributed to the increase in net gains. Pursuant to SFAS #133, the Company recorded certain charges, which reduced net gains on the sale of real estate mortgage loans by approximately $50,000. <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ------------- ---------- (in thousands) <S> <C> <C> Real estate mortgage loans originated $115,971 $66,954 Real estate mortgage loan sales 66,514 27,775 Real estate mortgage loan servicing rights sold 57,919 2,642 Net gains on the sale of real estate mortgage loans 995 380 Net gains as a percent of real estate mortgage loans sold 1.50% 1.37% </TABLE> The volume of loans sold is dependent upon the Banks' ability to originate real estate mortgage loans as well as the demand for fixed-rate obligations and other loans that the Banks cannot profitably fund within established interest-rate risk parameters. (See "Portfolio loans and asset quality.") Net gains on real estate mortgage loans are also dependent upon economic and competitive factors as well as the Banks' ability to effectively manage exposure to changes in interest rates. The Banks capitalized approximately $70,000 and $200,000 of related servicing rights during the three-month periods ended March 31, 2001 and 2000, respectively. Amortization of capitalized servicing rights for those periods was $271,000 and $267,000, respectively. The book value of capitalized mortgage servicing rights was $4.4 million at March 31, 2001. The fair value of capitalized servicing rights, which relate to approximately $770 million of loans sold and 19
21 serviced, approximated $5.5 million at that same date, and therefore, no valuation allowance was considered necessary. Service charges on deposit accounts increased by 21% to $1.8 million during the three months ended March 31, 2001, from $1.5 million during the comparable period in 2000. The increase in service charges principally relate to certain deposit account promotions, which include direct mail solicitations, at each of the Banks. Mutual fund and annuity commissions declined by $233,000 to $172,000 during the three months ended March 31, 2001, from $405,000 during the comparable period in 2000. The decline in such commissions reflects an industry-wide reduction in sales activity as well as the resignation of certain commission sales personnel. Fees associated with the origination of manufactured home loans totaled $353,000 during the three months ended March 31, 2001. The $155,000 decline from $508,000 during the comparable period of 2000 principally reflects a decline in loan volumes. NON-INTEREST EXPENSE Non-interest expense totaled $15.1 million during the three months ended March 31, 2001. Increases in salaries and employee benefits accounted for $230,000 of the $412,000 increase in non-interest expense from $14.7 million during the comparable period in 2000. NON-INTEREST EXPENSE <TABLE> <CAPTION> Three months ended March 31, 2001 2000 ------------ ------------ (in thousands) <S> <C> <C> Salaries $ 6,180 $ 5,824 Performance-based compensation and benefits 1,085 1,201 Other benefits 1,357 1,367 ------------ ------------ Salaries and benefits 8,622 8,392 Occupancy, net 1,290 1,178 Furniture and fixtures 1,058 1,141 Communications 588 565 Data processing 554 693 Advertising 501 457 Loan and collection 465 307 Amortization of intangible assets 427 432 Supplies 423 395 Other 1,195 1,151 ------------ ------------ Total non-interest expense $15,123 $14,711 ============ ============ </TABLE> Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. No material changes in the market risk faced by the Registrant has occurred since December 31, 2000. 20
22 Item 6. Exhibits & Reports on Form 8-K (a) Exhibit Number & Description 11. Computation of Earnings Per Share (b) Reports on Form 8-K During the quarter ended March 31, 2001, there were no reports filed on Form 8-K. 21
23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date May 11, 2001 By s/William R. Kohls -------------------------- ---------------------------------------- William R. Kohls, Principal Financial Officer Date May 11, 2001 By s/James J. Twarozynski -------------------------- ---------------------------------------- James J. Twarozynski, Principal Accounting Officer 22
24 Exhibit Index Exhibit No. Description - ----------- ----------- 11 Computation of Earnings Per Share