-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FcLv2Z2PKN69CJMik5ex0xIXnDIIQmmlp5B8vBa9KHH2DOgxRVVmEcvrWfmOreqk x1sQWNfESrfNig7758xikw== 0000905729-98-000213.txt : 19981113 0000905729-98-000213.hdr.sgml : 19981113 ACCESSION NUMBER: 0000905729-98-000213 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHEMICAL FINANCIAL CORP CENTRAL INDEX KEY: 0000019612 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 382022454 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-08185 FILM NUMBER: 98745321 BUSINESS ADDRESS: STREET 1: 333 E MAIN ST CITY: MIDLAND STATE: MI ZIP: 48640 BUSINESS PHONE: 5176313310 10-Q 1 =============================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q - ------------------------------------------------------------------------------- (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998, OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ Commission File Number: 0-8185 CHEMICAL FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) MICHIGAN 38-2022454 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 333 EAST MAIN STREET MIDLAND, MICHIGAN 48640 (Address of Principal Executive Offices) (Zip Code) (517) 839-5350 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No _____ The number of shares outstanding of the Registrant's Common Stock, $1 par value, as of October 27, 1998, was 10,794,029 shares. =============================================================================== INDEX CHEMICAL FINANCIAL CORPORATION FORM 10-Q PART I. FINANCIAL INFORMATION PAGE Item 1. Consolidated Financial Statements (unaudited, except Consolidated Statement of Financial Position as of December 31, 1997) Consolidated Statement of Income for the Three and Nine Months Ended September 30, 1998 and September 30, 1997 3 Consolidated Statement of Financial Position as of September 30, 1998, December 31, 1997 and September 30, 1997 4 Consolidated Statement of Cash Flows for the Nine Months Ended September 30, 1998 and September 30, 1997 5 Notes to Consolidated Financial Statements 6-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 PART II. OTHER INFORMATION Item 5. Other Information 21 Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES 22 -2- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Income (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 --------------------- -------------------------- 1998 1997 1998 1997 ------- ------- ------- ------- (In thousands, except per share amounts) INTEREST INCOME Interest and fees on loans . . . . . . . . . . $ 18,807 $ 17,864 $ 55,286 $ 51,857 Interest on investment securities: Taxable . . . . . . . . . . . . . . . . . . . 9,889 10,437 30,573 30,141 Tax-exempt. . . . . . . . . . . . . . . . . . 505 540 1,580 1,622 ------------ ---------- ---------- ----------- TOTAL INTEREST ON SECURITIES . . . . . . 10,394 10,977 32,153 31,763 Interest on federal funds sold . . . . . . . . 1,520 1,290 3,566 3,767 Interest on deposits with unaffiliated banks 55 55 33 ------------ ---------- ---------- ----------- TOTAL INTEREST INCOME. . . . . . . . . . 30,776 30,131 91,060 87,420 INTEREST EXPENSE Interest on deposits . . . . . . . . . . . . . 11,902 12,074 35,709 34,455 Interest on short-term borrowings. . . . . . . 437 357 1,125 991 Interest on long-term debt . . . . . . . . . . 152 152 452 444 ------------ ---------- ---------- ----------- TOTAL INTEREST EXPENSE . . . . . . . . . 12,491 12,583 37,286 35,890 ------------ ---------- ---------- ----------- NET INTEREST INCOME. . . . . . . . . . . 18,285 17,548 53,774 51,530 Provision for possible loan losses . . . . . . 234 219 713 767 ------------ ---------- ---------- ----------- NET INTEREST INCOME after provision for possible loan losses. . . . . . . . . . . . . 18,051 17,329 53,061 50,763 OTHER INCOME Trust department income. . . . . . . . . . . . 834 740 2,607 2,319 Service charges on deposit accounts. . . . . . 1,409 1,332 4,082 3,964 Other charges and fees for customer services 997 790 3,046 2,409 Gains on sales of loans . . . . . . . . . . . 469 81 975 160 Other . . .. . . . . . . . . . . . . . . . . . 238 183 737 818 ------------ ---------- ---------- ----------- TOTAL OTHER INCOME . . . . . . . . . . . 3,947 3,126 11,447 9,670 OPERATING EXPENSES Salaries, wages and employee benefits. . . . . 7,283 6,845 21,931 20,652 -3- Occupancy expense. . . . . . . . . . . . . . . 1,175 1,174 3,525 3,593 Equipment expense. . . . . . . . . . . . . . . 796 872 2,432 2,468 Other . . .. . . . . . . . . . . . . . . . . . 2,950 2,779 9,054 8,371 ------------ ---------- ---------- ----------- TOTAL OPERATING EXPENSES . . . . . . . . 12,204 11,670 36,942 35,084 ------------ ---------- ---------- ----------- INCOME BEFORE INCOME TAXES . . . . . . . . . . 9,794 8,785 27,566 25,349 Federal income taxes . . . . . . . . . . . . . 3,265 2,879 9,079 8,293 ------------ ---------- ---------- ----------- NET INCOME . . . . . . . . . . . . . . . $ 6,529 $ 5,906 $ 18,487 $ 17,056 ============ ========== ========== =========== NET INCOME PER SHARE Basic. . . . . . . . . . . . . . . . . . . . . $ .60 $ .55 $ 1.71 $ 1.59 ============ ========== ========== =========== Diluted . .. . . . . . . . . . . . . . . . . . $ .60 $ .54 $ 1.70 $ 1.57 ============ ========== ========== =========== CASH DIVIDENDS PER SHARE . . . . . . . . . . . $ .24 $ .22 $ .72 $ .62 ============ ========== ========== ===========
See accompanying notes to consolidated financial statements. -4- CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Financial Position
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30 1998 1997 1997 ------------- ------------ ------------- (Unaudited) (Unaudited) (In thousands) ASSETS Cash and demand deposits due from banks $ 78,588 $ 95,794 $ 77,504 Federal funds sold . . . . . . . . . . . . . . 90,650 49,750 62,950 Interest bearing deposits with unaffiliated banks 5,000 Investment securities: Available for sale (at market value) 506,656 494,173 478,981 Held to maturity (market value $222,269 at 9/30/98, $253,459 at 12/31/97, and $262,297 at 9/30/97) 217,935 251,020 260,197 ---------- ----------- ---------- Total investment securities. . . . 724,591 745,193 739,178 Loans: Commercial . . . . . . . . . . . . . . . 136,682 110,554 114,211 Real estate construction . . . . . . . . 32,978 31,143 26,736 Real estate mortgage . . . . . . . . . . 534,682 536,938 533,130 Consumer . . . . . . . . . . . . . . . . 186,864 166,965 165,547 ---------- ----------- ---------- Total loans. . . . . . . . . . . . 891,206 845,600 839,624 Less: Allowance for possible loan losses 17,969 17,359 17,269 ---------- ----------- ---------- Net loans. . . . . . . . . . . . . 873,237 828,241 822,355 Premises and equipment . . . . . . . . . . . . 19,384 20,416 20,165 Accrued income . . . . . . . . . . . . . . . . 14,286 14,573 15,039 Other assets . . . . . . . . . . . . . . . . . 9,865 11,133 11,633 ---------- ----------- ---------- TOTAL ASSETS . . . . . . . . . . . $1,815,601 $ 1,765,100 $1,748,824 ========== =========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing. . . . . . . . . . . $ 242,017 $ 237,763 $ 224,618 Interest bearing . . . . . . . . . . . . 1,257,677 1,238,078 1,234,557 ---------- ----------- ---------- Total deposits . . . . . . . . . . 1,499,694 1,475,841 1,459,175 Short-term borrowings: Treasury tax and loan notes payable to the U.S. Treasury 8,127 11,206 11,760 Securities sold under agreements to repurchase 44,913 30,990 .35,290 ---------- ----------- ---------- Total short-term borrowings. . . . 53,040 42,196 47,050 -5- Interest payable and other liabilities 15,905 14,138 14,704 Long-term debt . . . . . . . . . . . . . . . . 9,000 9,000 9,000 ---------- ----------- ---------- Total liabilities. . . . . . . . . 1,577,639 1,541,175 1,529,929 Shareholders' equity: Common stock, $1 par value ($10 par value at 12/31/97 and 9/30/97): Authorized - 18,000,000 shares (15,000,000 at 12/31/97 and 9/30/97) Issued - 10,794,935 shares, 10,753,011 shares, and 10,226,280 shares, respectively 10,795 107,530 102,263 Surplus. . . . . . . . . . . . . . . . . 184,399 87,086 69,500 Retained earnings. . . . . . . . . . . . 38,623 27,904 46,144 Unrealized net gain on securities available for sale 4,145 1,405 988 ---------- ----------- ---------- Total shareholders' equity . . . . 237,962 223,925 218,895 ---------- ----------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY . . . . . . . $1,815,601 $ 1,765,100 $1,748,824 ========== =========== ==========
See accompanying notes to consolidated financial statements. -6- CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statement of Cash Flows (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30 ------------------------- 1998 1997 --------- --------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 18,487 $ 17,056 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 713 767 Origination of loans held for sale (75,278) (21,633) Proceeds from sales of loans 75,877 21,793 Gains on sales of loans (975) (160) Gain on sale of branch office building (256) Provision for depreciation and amortization 2,515 2,382 Net amortization of investment securities 548 1,420 Net (increase) decrease in accrued income and other assets 521 (296) Net increase in interest payable and other liabilities 1,757 525 ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES 24,165 21,598 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Net (increase) decrease in interest-bearing deposits with unaffiliated banks (5,000) 1,134 Proceeds from maturities of securities held to maturity 96,945 109,026 Purchases of securities held to maturity (62,896) (155,848) Proceeds from maturities of securities available for sale 143,569 101,506 Purchases of securities available for sale (153,349) (137,942) Net increase in loans (46,147) (32,504) Proceeds from sale of branch office building 900 Purchases of premises and equipment (1,050) (2,432) ---------- ---------- NET CASH USED FOR INVESTING ACTIVITIES (27,928) (116,160) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand deposits, NOW accounts and savings accounts 11,211 34,091 Net increase (decrease) in certificates of deposit and other time deposits 12,642 (4,831) Net increase in repurchase agreements and other short-term borrowings 10,844 9,717 Principal payments on long-term debt (1,000) -7- Cash dividends paid (7,768) (6,648) Proceeds from stock purchase plan 214 187 Proceeds from exercise of stock options 314 250 Repurchases of common stock (467) ---------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES 27,457 31,299 ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 23,694 (63,263) Cash and cash equivalents at beginning of year 145,544 203,717 ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 169,238 $ 140,454 ========== ========== - -------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Interest paid on deposits, short-term borrowings and long-term debt $ 36,853 $ 35,646 Federal income taxes paid 10,105 8,520 - --------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. -8- CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1998 NOTE A: BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Chemical Financial Corporation (the "Corporation") have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial condition and results of operations of the Corporation for the periods presented. Operating results for the three and nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1997. EARNINGS PER SHARE The Corporation adopted Statement of Financial Accounting Standard No. 128, Earnings Per Share ("SFAS 128"), on December 31, 1997. All earnings per share amounts have been presented, and where appropriate restated, to conform to the SFAS 128 requirements. SFAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes any dilutive effect of stock options. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. Basic earnings per share for the Corporation is computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share for the Corporation is computed by dividing net income by the sum of the weighted average number of common shares outstanding and the dilutive effect of outstanding employee stock options. The following table summarizes the number of shares used in the denominator of the basic and diluted earnings per share computations: -9- THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------ ----------------- 1998 1997 1998 1997 ---- ---- ---- ---- (In thousands) (In thousands) Denominator for basic earnings per share 10,793 10,740 10,785 10,738 ====== ====== ====== ====== Denominator for diluted earnings per share 10,903 10,861 10,907 10,862 ====== ====== ====== ======
COMPREHENSIVE INCOME As of January 1, 1998, the Corporation adopted Statement of Financial Accounting Standard No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components. The adoption of SFAS 130 had no impact on the Corporation's net income or shareholders' equity. SFAS 130 requires unrealized gains or losses on the Corporation's investment securities available for sale to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of SFAS 130. The components of comprehensive income, net of related tax, for the nine-month periods ended September 30, 1998 and 1997 are as follows (in thousands of dollars): NINE MONTHS ENDED SEPTEMBER 30 ----------------- 1998 1997 ------ ------ Net income $ 18,487 $ 17,056 Unrealized net gains on investment securities available for sale 2,740 1,170 -------- -------- Comprehensive income $ 21,227 $ 18,226 ======== ========
The components of accumulated other comprehensive income, net of related tax, at September 30, 1998, December 31, 1997 and September 30, 1997 are as follows (in thousands of dollars): -10- SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30 1998 1997 1997 ------------ ----------- ------------ Unrealized net gains on investment securities available for sale $ 4,145 $ 1,405 $ 988 -------- --------- ------- Accumulated other comprehensive income $ 4,145 $ 1,405 $ 988 ======== ========= =======
OTHER Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), was issued in June 1998. SFAS 133 is effective for all fiscal quarters beginning after June 15, 1999. SFAS 133 standardizes the accounting for derivative instruments embedded in other contracts by requiring the recognition of those items as assets or liabilities in the statement of financial position and measuring them at fair value. SFAS 133 generally provides for matching the timing of gain or loss recognition on the hedging instrument with the recognition of (a) changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, or (b) the earnings effect of the hedged forecasted transaction. The adoption of SFAS 133 is currently expected to have no effect on the financial position, liquidity or results of operations of the Corporation. As of September 30, 1998, the Corporation held no derivative financial instruments. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year financial statement presentation. NOTE B: LOANS AND NONPERFORMING ASSETS The following summarizes loans and nonperforming assets at the dates indicated (in thousands of dollars): SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30 1998 1997 1997 ------------ ----------- ------------ LOANS: Commercial . . . . . . . . . $ 136,682 $ 110,554 $ 114,211 Real estate construction . . 32,978 31,143 26,736 -11- Real estate mortgage . . . . 534,682 536,938 533,130 Consumer . . . . . . . . . . 186,864 166,965 165,547 ------------ --------- ---------- Total Loans. . . . . . . . . $ 891,206 $ 845,600 $ 839,624 ============ ========= ========== NONPERFORMING ASSETS: Nonaccrual loans . . . . . . $ 1,616 $ 1,783 $ 1,870 Loans 90 days or more past due and still accruing interest. 910 1,125 1,691 Restructured loans . . . . . 21 139 6 ------------ --------- ---------- Total nonperforming loans. . 2,547 3,047 3,567 ------------ --------- ---------- Other real estate owned 472 798 817 ------------ --------- ---------- Total nonperforming assets . $ 3,019 $ 3,845 $ 4,384 ============ ========= ========== Other real estate owned includes properties acquired through foreclosure and by acceptance of a deed in lieu of foreclosure, and other property held for sale.
-12- NOTE C: ALLOWANCE FOR POSSIBLE LOAN LOSSES The following summarizes the changes in the allowance for possible loan losses (in thousands of dollars): NINE MONTHS ENDED SEPTEMBER 30 --------------------- 1998 1997 --------- --------- ALLOWANCE FOR POSSIBLE LOAN LOSSES Balance as of January 1. . . . . . . . . . . . . . . $ 17,359 $ 16,607 Provision for possible loan losses . . . . . . . . . 713 767 Gross loans charged-off. . . . . . . . . . . . . . . (346) (394) Gross recoveries of loans previously charged-off . . 243 289 --------- --------- Net loans charged-off . . . . . . . . . . . . . . . (103) (105) --------- --------- Balance at September 30. . . . . . . . . . . . . . . $ 17,969 $ 17,269 ========= ========= -13- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of certain significant factors that have affected the Corporation's financial condition and results of operations during the periods included in the consolidated financial statements included in this filing. FORWARD-LOOKING STATEMENTS This discussion and analysis of financial condition and results of operations, and other sections of this report, contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Corporation itself. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, the statements under the caption "Year 2000 Readiness Disclosure" are forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Future Factors include, but are not limited to, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulations; changes in tax laws; changes in prices, levies and assessments; the impact of technological advances and issues, including Year 2000 issues; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national economy. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. Furthermore, the Corporation undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise. SUMMARY The Corporation's net income was $6,529,000 in the third quarter of 1998, as compared to net income of $5,906,000 during the third quarter of 1997. Earnings per share in the third quarter of 1998 were $.60, compared to earnings per share of $.54 in the third quarter of 1997. -14- The Corporation's net income was $18,487,000 for the first nine months of 1998, compared to net income of $17,056,000 during the first nine months of 1997. Earnings per share for the nine months ended September 30, 1998 were $1.70, compared to earnings per share of $1.57 for the first nine months of 1997. The increases in net income during the three and nine months ended September 30, 1998, as compared to the same periods in the prior year, were principally the result of increases in net interest income and other income. These revenue increases were slightly offset by increased operating expenses. Return on average assets in the third quarter of 1998 was 1.43%, as compared to 1.33% during the third quarter of 1997. Return on average equity for the three months ended September 30, 1998 and September 30, 1997 was 11.2% and 10.8%, respectively. Return on average assets for the nine months ended September 30, 1998 and September 30, 1997 was 1.38% and 1.33%, respectively. Return on average equity for the nine-month periods ended September 30, 1998 and September 30, 1997 was 10.8% and 10.7%, respectively. Total assets were $1.816 billion as of September 30, 1998, up $50.5 million, or 2.9%, from total assets of $1.765 billion as of December 31, 1997, and up $66.8 million, or 3.8%, from total assets of $1.749 billion as of September 30, 1997. Total loans increased $51.6 million, or 6.1%, from September 30, 1997, and $45.6 million, or 5.4%, from December 31, 1997 to $891.2 million as of September 30, 1998. The increase in total loans from both September 30, 1997 and December 31, 1997 to September 30, 1998 was primarily attributable to increases in commercial and consumer loans. Shareholders' equity increased $19.1 million, or 8.7%, from September 30, 1997, to $238.0 million as of September 30, 1998, or $22.04 per share, representing 13.1% of total assets. The increase was primarily attributable to retained net income. RESULTS OF OPERATIONS NET INTEREST INCOME The Corporation's net interest income for the third quarter of 1998 was $18.28 million, a $.73 million, or 4.2%, increase over the $17.55 million recorded in the third quarter of 1997. The increase in net interest income was due primarily to increases in average earning assets and average loans. Average earning assets increased $53.44 million, or 3.2%, in the third quarter of 1998, compared to the third -15- quarter of 1997, with the increase in noninterest bearing deposits accounting for 45% of the total increase in average earning assets. Average noninterest bearing deposits increased $24.4 million, or 10.7%, in the third quarter of 1998, compared to the third quarter of 1997. Average loans increased $65.2 million, or 7.9%, in the third quarter of 1998, compared to the third quarter of 1997. The Corporation's net interest margin was 4.33% in the third quarter of 1998, compared to 4.29% in the third quarter of September 1997. Net interest income was $53.77 million for the nine months ended September 30, 1998, a $2.24 million, or 4.4%, increase over the $51.53 million recorded for the same period in 1997. The Corporation's net interest margin was 4.35% during both the nine months ended September 30, 1998 and September 30, 1997. OTHER INCOME Other income increased $821,000, or 26.3%, in the third quarter of 1998, compared to the third quarter of 1997, and $1,777,000, or 18.4%, in the first nine months of 1998, compared to the first nine months of 1997. The Corporation realized gains on the sales of residential mortgage loans in the secondary market of $469,000 and $975,000 during the three- and nine-month periods ended September 30, 1998, respectively, compared to $81,000 and $160,000 during these same time periods in 1997, respectively. The continued reduction in residential mortgage loan rates since the latter part of 1997 resulted in the Corporation experiencing an increase in long-term residential mortgage loan volume from both new home purchases and mortgage loan refinancing in the third quarter and first nine months of 1998. The Corporation sold fixed rate residential mortgage loans with terms of fifteen years or greater in the secondary market totaling $24 million and $75 million during the three- and nine-month periods ended September 30, 1998, respectively, compared to $10 million and $22 million during the three- and nine-month periods ended September 30, 1997, respectively. The Corporation's trust department income increased $94,000, or 12.7%, in the third quarter and $288,000, or 12.4%, in the first nine months of 1998, compared to comparable periods in 1997, due to a combination of increased fees and new business. Service charges on deposit accounts increased $77,000, or 5.8%, in the third quarter of 1998 and $118,000, or 3.0%, in the first nine months of 1998, compared to comparable periods in 1997. Other charges and fees for customer services increased $207,000, or 26.2%, in the third quarter of 1998, compared to the third quarter of 1997, and $637,000, or 26.4%, during the first nine months of 1998, compared to the first nine months of 1997. The majority of the increases in other charges and fees during 1998 was attributable to increased ATM fees. -16- PROVISION FOR POSSIBLE LOAN LOSSES The provision for possible loan losses reflects management's judgment of changing economic conditions, as well as increases and other changes in the subsidiary banks' loan portfolios. It is management's policy to control loan quality through a carefully structured review of loan requests. In assessing the adequacy of the allowance for possible loan losses (the "Allowance"), management believes that its historical experience confirms, in principle, its judgment in what is essentially a subjective decision. Based upon historical experience and a constant evaluation of present and potential risks in the loan portfolios, management believes that the Allowance is adequate. During the three and nine months ended September 30, 1998, the Corporation added $234,000 and $713,000, respectively, to the Allowance through the provision for possible loan losses, compared to $219,000 and $767,000, respectively, during the comparable periods in 1997. Net loan charge-offs during the three- and nine-month periods ended September 30, 1998 were $41,000 and $103,000, respectively, compared to net loan charge-offs of $31,000 and $105,000, respectively, during the comparable periods in 1997. OPERATING EXPENSES Total operating expenses increased $534,000, or 4.6%, in the third quarter of 1998, compared to the third quarter of 1997, and $1,858,000, or 5.3%, in the first nine months of 1998, compared to the first nine months of 1997. Salaries, wages and employee benefits increased $438,000, or 6.4%, in the third quarter of 1998 over the third quarter of 1997 and $1,279,000, or 6.2%, in the first nine months of 1998 over the first nine months of 1997. Occupancy expense and equipment expense, combined, decreased $75,000, or 3.7%, and $104,000, or 1.7%, during the third quarter and first nine months of 1998, compared to the third quarter and first nine months of 1997, respectively. Other operating expenses increased $171,000, or 6.2%, in the third quarter of 1998, compared to the third quarter of 1997, and $683,000, or 8.2%, during the first nine months of 1998, compared to the first nine months of 1997. Other operating expenses have increased in 1998, at a slightly higher percentage than the Corporation's other categories of operating expenses, due to increased expenses incurred in conjunction with the Corporation's computer software conversion, which occurred during the first quarter of 1998, and higher advertising expenses incurred in conjunction with consumer loan promotions. -17- INCOME TAX EXPENSE The Corporation's effective federal income tax rate was 33.3% and 32.9%, respectively, during the three and nine months ended September 30, 1998, compared to 32.8% and 32.7%, respectively, during these same periods in 1997. The effective federal income tax rate is a function of the proportion of the Corporation's interest income exempt from federal taxation, nondeductible interest expense and other nondeductible expenses. BALANCE SHEET CHANGES ASSET AND DEPOSIT CHANGES Total assets increased $50.5 million, or 2.9%, from December 31, 1997 and increased $66.8 million, or 3.8%, from September 30, 1997 to $1.816 billion as of September 30, 1998. Total deposits increased $23.9 million, or 1.6%, from December 31, 1997 and increased $40.5 million, or 2.8%, from September 30, 1997 to $1.5 billion as of September 30, 1998. LOANS The Corporation's subsidiary banks are generally located in rural communities, where the demand for commercial loans which meet the Corporation's credit standards historically has not been high. The Corporation's philosophy is such that it will neither compromise on loan quality nor make loans outside its banking markets to increase its loan portfolio. The Corporation does not generally purchase participation loans, which is a method utilized by many financial institutions to increase the size of their loan portfolios. Total loans as of September 30, 1998 were $891.2 million, compared to $839.6 million as of September 30, 1997 and $845.6 million as of December 31, 1997. The increase in total loans from September 30, 1997 and December 31, 1997 to September 30, 1998 of $51.6 million, or 6.1%, and $45.6 million, or 5.4%, respectively, was primarily attributable to increases in commercial and consumer loans. Commercial loans increased $22.5 million, or 19.7%, from September 30, 1997, and $26.1 million, or 23.6%, from December 31, 1997 to $136.7 million as of September 30, 1998. The growth in commercial loans was achieved through an increased sales effort by the Corporation to increase commercial loans as a percentage of total loans. Commercial loans represented 15.3%, 13.1% and 13.6% of the Corporation's loan portfolio as of September 30, 1998, December 31, 1997 and September 30, 1997, respectively. -18- Real estate construction and mortgage loans increased $7.8 million, or 1.4%, from September 30, 1997, and decreased $.4 million, or .1%, from December 31, 1997 to $567.7 million as of September 30, 1998. The decrease in these loans from December 31, 1997 and only slight increase from September 30, 1997 resulted from an increase in the proportion of residential mortgage loans originated being sold in the secondary market. As residential mortgage loan interest rates have continued to decline since the latter part of 1997, the Corporation continues to experience the refinancing of real estate mortgages and consumers converting balloon mortgage loans to long-term fixed rate loans at the lower interest rates. The Corporation keeps balloon mortgage loans in its own portfolio and generally sells the long-term fixed rate residential mortgage loans it originates in the secondary market. The Corporation sold $75 million of fixed rate residential mortgage loans, with terms of fifteen years or greater, in the secondary mortgage market in the first nine months of 1998, compared to $22 million of similar type loans sold during the first nine months of 1997. Real estate construction and mortgage loans represented 63.7%, 67.2% and 66.7% of the Corporation's loan portfolio as of September 30, 1998, December 31, 1997 and September 30, 1997, respectively. Consumer loans increased $21.3 million, or 12.9%, from September 30, 1997, and $19.9 million, or 11.9%, from December 31, 1997 to $186.9 million as of September 30, 1998. The increases from December 31, 1997 and September 30, 1997 were the result of several consumer loan promotions, which offered lower interest rates on certain types of consumer loans during the twelve month period ended September 30, 1998. These various consumer loan promotions offered loans with annual percentage rates ranging from 7.40% to 7.99% and maximum terms varying from 48 to 60 months. The Corporation has utilized similar special promotions to increase consumer loans during the past eight years. Consumer loans represented 21.0%, 19.7% and 19.7% of total loans as of September 30, 1998, December 31, 1997 and September 30, 1997, respectively. The Corporation's total loan to deposit ratio as of September 30, 1998, December 31, 1997 and September 30, 1997 was 59.4%, 57.3% and 57.5%, respectively. The Corporation traditionally has had a conservative loan underwriting policy. This is evidenced by its historically low loan losses and low ratio of nonperforming loans to total loans. During the three and nine months ended September 30, 1998, the Corporation experienced net loan charge-offs of $41,000 and $103,000, respectively. The Corporation had net loan charge-offs of $31,000 and $105,000, respectively, during the comparable periods in 1997. -19- Nonperforming loans consist of loans which are past due for principal or interest payments by 90 days or more and are still accruing interest, loans for which the accrual of interest has been discontinued, and other loans which have been renegotiated to less than market terms due to a serious weakening of the borrower's financial condition. Nonperforming loans were $2.5 million as of September 30, 1998, $3.0 million as of December 31, 1997 and $3.6 million as of September 30, 1997, and represented .29%, .36% and .42% of total loans as of those dates, respectively. The allowance for possible loan losses at September 30, 1998 was $17,969,000 and represented 2.02% of total loans, compared to $17,359,000, or 2.05% of total loans at December 31, 1997 and $17,269,000, or 2.06% of total loans at September 30, 1997. LIQUIDITY The maintenance of an adequate level of liquidity is necessary to ensure that sufficient funds are available to meet customers' loan demands and deposit withdrawals. The banking subsidiaries' primary liquidity sources consist of investment securities, those maturing within one year and those classified as available for sale, maturing loans and federal funds sold. As of September 30, 1998, the Corporation's investment securities portfolio had an average life of less than two years. In addition, at September 30, 1998, the Corporation held only $2.2 million in mortgage-backed securities, which represented less than one percent of the investment securities portfolio, and had no other derivatives. CAPITAL RESOURCES As of September 30, 1998, shareholders' equity was $238 million, compared to $223.9 million as of December 31, 1997 and $218.9 million as of September 30, 1997, resulting in an increase of $14.1 million, or 6.3%, from December 31, 1997 and $19.1 million, or 8.7%, from September 30, 1997. Shareholders' equity as a percentage of total assets was 13.1% as of September 30, 1998, 12.7% at December 31, 1997 and 12.5% as of September 30, 1997. Total equity included an after- tax unrealized net gain of $4.1 million as of September 30, 1998, $1.4 million as of December 31, 1997 and $1 million as of September 30, 1997, on investment securities available for sale in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." A statement of changes in shareholders' equity covering the nine-month periods ended September 30, 1998 and September 30, 1997 follows (in thousands of dollars): -20-
NINE MONTHS ENDED SEPTEMBER 30 ------------------------------ 1998 1997 ------------ ------------ Total shareholders' equity as of January 1 $ 223,925 $ 207,269 Net income 18,487 17,056 Dividends (7,768) (6,648) Shares issued upon exercise of employee stock options 314 250 Shares issued from director stock purchase plan 264 265 Repurchases of common stock (467) Change in unrealized net gains and losses on securities available for sale 2,740 1,170 ------------ ------------ Total shareholders' equity as of end of period $ 237,962 $ 218,895 ============ ============
The following table represents the Corporation's regulatory capital ratios as of September 30, 1998: TIER 1 TOTAL RISK-BASED RISK-BASED LEVERAGE CAPITAL CAPITAL -------- ---------- ---------- Chemical Financial Corporation - actual ratio 12.7% 28.2% 29.5% Regulatory Minimum Ratio 3.0 4.0 8.0 Ratio considered "well capitalized" by regulatory agencies 5.0 6.0 10.0
The Corporation's Tier 1 and Total capital ratios under the risk-based capital measure at September 30, 1998 are high due to the Corporation holding $521 million in investment securities and other assets which are assigned a 0% risk rating, $336 million in assets which are assigned a 20% risk rating and $466 million in residential real estate mortgages and other assets which are assigned a 50% risk rating. These three risk ratings (0%, 20% and 50%) represent 71% of the Corporation's total risk-based assets (including off-balance sheet items) as of September 30, 1998. OTHER The Corporation paid a 5% stock dividend on December 30, 1997. All per share amounts have been adjusted for this stock dividend. -21- Except as discussed below relating to the Year 2000 issue, there are currently no known trends, events or uncertainties that management believes may be reasonably expected to have a material effect on the Corporation's liquidity, capital resources or financial performance. YEAR 2000 READINESS DISCLOSURE During the third quarter of 1996, the Corporation formed a Year 2000 project team and began developing its plan to prepare for the Year 2000. The project began with a process to identify information technology and non-information technology systems that required modification for the Year 2000. A Year 2000 Plan was developed with goals and target dates. This plan includes communicating with third party vendors and suppliers, and obtaining certifications of compliance from third party software and service providers. During the early planning process, the Corporation was notified by the vendor of its core operating system that the core operating system used by the Corporation was not Year 2000 compliant and that it would not be modified to become Year 2000 compliant. The Corporation performed an extensive evaluation of replacement operating systems and, in July 1997, chose to convert its core operating system to a new system ("Dimension") offered by its existing vendor. The vendor of the new core operating system has certified to the Corporation that its Dimension system is Year 2000 compliant. The Corporation converted to the new operating system during the first quarter of 1998. The cost of converting to the new operating system was approximately $300,000. In conjunction with the conversion to the new core operating system, the Corporation purchased a new mainframe computer in 1997 at a cost of approximately $1 million, which was capitalized. The previous mainframe computer and core operating system software were fully depreciated prior to 1997. The Corporation continued to assess the impact of the Year 2000 issue on the remainder of its computer-based systems and applications and non-information technology systems throughout the first nine months of 1998. As of September 30, 1998, it is the Corporation's opinion that it is substantially complete with the assessment phase of its Year 2000 Plan. As of September 30, 1998, the Corporation had begun testing of its internal mission critical systems, including the new Dimension core operating system and other software programs. Management believes that, as of September 30, 1998 (i) the conversion to the new core operating system software has been completed, but that additional testing is necessary; (ii) the core operating system represents approximately 85% of the Corporation's "mission critical" systems; and (iii) all "mission critical" systems and software are on schedule to be renovated by December 31, 1998. -22- The Corporation spent a total of $112,000 to replace computer hardware and software that was not Year 2000 compliant in the third quarter of 1998, which was capitalized. The Corporation expects to spend approximately $425,000 during the fourth quarter of 1998, primarily to replace desk-top computers and related equipment, that are not currently Year 2000 compliant. These costs will be capitalized. The Corporation currently anticipates that remaining Year 2000 costs for hardware and software purchases, associated reprogramming, and remedial actions for both information technology and non-information technology will not exceed $250,000 in 1999. The impact of the Year 2000 issues on the Corporation will depend not only on corrective actions that the Corporation takes, but also on the way in which Year 2000 issues are addressed by governmental agencies, businesses and other third parties that provide services or data to, or receive services or data from, the Corporation, or whose financial condition or operational capability is important to the Corporation. To reduce this exposure, the Corporation has initiated formal communications with its significant suppliers and large customers to determine the extent to which the Corporation's interface systems are vulnerable to those third parties' failures to resolve their own Year 2000 issues. The Corporation has received communications from the majority of its third party vendors and suppliers either confirming that the third parties' software systems are Year 2000 compliant or providing the Corporation with a time line of an expected compliance date by mid 1999. The testing of mission critical third party software systems has begun. The Corporation is on schedule to have all testing of third party software systems completed by June 30, 1999. The Corporation is continuing to seek assurances that the systems of other companies on which the Corporation's systems rely will be timely converted or modified. If such modifications and conversions are not completed timely, their inability to correctly recognize the Year 2000 could have an adverse impact on the results of operations and financial condition of the Corporation. The Corporation's credit risk associated with borrowers may increase to the extent borrowers fail to adequately address Year 2000 issues. As a result, all of the Corporation's subsidiary banks have identified their material borrowers and have assessed these borrowers' Year 2000 preparedness. The material borrowers' Year 2000 readiness will be monitored periodically, based on the level of risk that the Year 2000 has been estimated to potentially impact the business of each borrower. The Corporation is preparing general contingency plans to address unforeseen Year 2000 issues, including plans in the event that mission critical systems experience difficulties or other significant third parties fail to adequately address year 2000 issues. Such plans -23- principally involve the operation of systems in an off-line "limited computerized" environment. This would be accomplished by the manual and desktop computer update of financial records until problems or difficulties are remedied. The Corporation has determined that it must rely primarily on its software vendors to remedy any unforeseen situations of its mission critical systems in a timely manner. Internal remediation plans are being developed in the remaining information and non information technology areas. The Corporation is also enhancing its existing business resumption plans to reflect Year 2000 issues. It is developing plans, designed to coordinate the efforts of its personnel and resources, in addressing any Year 2000 difficulties that become evident after December 31, 1999. There can be no assurance that any plans will fully mitigate any such difficulties. Furthermore, there may be certain mission critical third parties, such as utilities or telecommunication companies, where alternative arrangements or other sources are limited or unavailable. The Corporation believes that with modifications to existing software, new hardware and software purchases, and the conversion of the Corporation's core operating system, the Year 2000 issue will not pose significant operational problems for its computer systems and that the additional costs to be incurred are not expected to be material to the Corporation's results of operations, liquidity or capital resources. The costs of the project and the date on which the Corporation projects it will complete the Year 2000 modifications were based on management's best estimates. There can be no guarantee that these estimates will be achieved and actual results could differ from those anticipated. Specific factors that might cause differences include, without limitation, the ability of other companies on which the Corporation's systems rely to modify or convert their systems to be Year 2000 compliant, the ability to locate and correct all relevant computer codes, and similar uncertainties. -24- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information concerning quantitative and qualitative disclosures about market risk contained under the caption "Liquidity and Interest Sensitivity" on pages 37 through 41 (inclusive) of the Corporation's Annual Report to Shareholders for the year ended December 31, 1997 is here incorporated by reference. Such Annual Report was previously filed as Exhibit 13 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1997. The Corporation does not believe that there has been a material change in the nature or categories of the Corporation' primary market risk exposures, or the particular markets that present the primary risk of loss to the Corporation. As of the date of this report, the Corporation does not know of or expect there to be any material change in the general nature of its primary market risk exposure in the near term. The methods by which the Corporation manages its primary market risk exposures, as described in the sections of its Annual Report to Shareholders incorporated by reference in response to this item, have not changed materially during the current year. As of the date of this report, the Corporation does not expect to make material changes in those methods in the near term. The Corporation may change those methods in the future to adapt to changes in circumstances or to implement new techniques. The Corporation's market risk exposure is mainly comprised of its vulnerability to interest rate risk. Prevailing interest rates and interest rate relationships are primarily determined by market factors which are beyond the Corporation's control. All information provided in response to this item consists of forward-looking statements. Reference is made to the section captioned "Forward-Looking Statements" in Item 2 of this report for a discussion of the limitations on the Corporation's responsibility for such statements. In this discussion, "near term" means a period of one year following the date of the most recent statement of financial position contained in this report. -25- PART II. OTHER INFORMATION ITEM 5. OTHER INFORMATION All information with respect to Year 2000 issues provided by the Corporation in this Quarterly Report and in other reports and materials previously filed with the Securities and Exchange Commission, as set forth on Exhibit 99.1 to this Quarterly Report, are "Year 2000 Readiness Disclosures" under the Year 2000 Information and Readiness Disclosure Act. The Bylaws of the Corporation provide that no matter submitted by a shareholder may be presented for shareholder action at an annual or special meeting of shareholders unless written notice of the matter is delivered to the Corporation before a designated deadline prior to the applicable meeting of shareholders. The deadline for submitting shareholder proposals for consideration at the next annual meeting of shareholders was November 6, 1998. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS. The following documents are filed as exhibits to this report on Form 10-Q: EXHIBIT NUMBER DOCUMENT 3.1 RESTATED ARTICLES OF INCORPORATION. Previously filed as Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. Here incorporated by reference. 3.2 BYLAWS. Previously filed as Exhibit 4(b) to the Registrant's Form S-8 Registration Statement No. 33- 47356 filed with the Commission on April 28, 1992. Here incorporated by reference. 27 FINANCIAL DATA SCHEDULE. 99.1 PRIOR YEAR 2000 READINESS DISCLOSURES. (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the quarter covered by this Report on Form 10-Q. -26- 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. CHEMICAL FINANCIAL CORPORATION Date: November 11, 1998 By /S/ ALOYSIUS J. OLIVER Aloysius J. Oliver Chief Executive Officer and President (Principal Executive Officer) Date: November 11, 1998 By /S/ LORI A. GWIZDALA Lori A. Gwizdala Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) -27- EXHIBIT INDEX EXHIBIT NUMBER DOCUMENT 3.1 RESTATED ARTICLES OF INCORPORATION. Previously filed as Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. Here incorporated by reference. 3.2 BYLAWS. Previously filed as Exhibit 4(b) to the Registrant's S-8 Registration Statement No. 33-47356 filed with the Commission on April 28, 1992. Here incorporated by reference. 27 FINANCIAL DATA SCHEDULE. 99.1 PRIOR YEAR 2000 READINESS DISCLOSURES. EX-27 2 ART. 9 FDS FOR 1998 3RD QUARTER FORM 10-Q
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS OF CHEMICAL FINANCIAL CORPORATION AND SUBSIDIARIES FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 78,588 5,000 90,650 0 506,656 217,935 222,269 891,206 17,969 1,815,601 1,499,694 53,040 15,905 9,000 10,795 0 0 227,167 1,815,601 55,286 32,153 3,621 91,060 35,709 37,286 53,774 713 0 36,942 27,566 27,566 0 0 18,487 1.71 1.70 4.35 1,616 910 21 2,547 17,359 346 243 17,969 17,969 0 0
EX-99 3 Exhibit 99.1 PRIOR YEAR 2000 READINESS DISCLOSURES Each of the following statements previously made by the Corporation is being designated as a "Year 2000 Readiness Disclosure" under the Year 2000 Information and Readiness Disclosure Act. These prior Year 2000 Readiness Disclosures were based in part upon and repeated information provided by the Corporation's customers, suppliers and other third parties without independent verification by the Corporation. These prior Year 2000 Readiness Disclosures are superseded by the Year 2000 Readiness Disclosure in the Quarterly Report on Form 10-Q for the period ended September 30, 1998. QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 1998 YEAR 2000 COMPLIANCE The Corporation has completed an analysis of its hardware and software systems to determine whether those systems will properly recognize and account for the year 2000. As described in greater detail in the Corporation's 1997 Annual Report to Shareholders, the Corporation has now completed the conversion of its core operating system to a new system that has been certified by the vendor to be year 2000 compliant. The Corporation also purchased a new mainframe computer in 1997, which was capitalized. Management currently anticipates that the remaining costs of analysis, conversion, hardware and software purchases, associated reprogramming and other remedial actions will not exceed $750,000 for the remaining eighteen-month period ending December 31, 1999, and that a majority of these costs will relate to hardware purchases and will be capitalized. Management believes that, as of June 30, 1998 (i) the conversion of the core operating system software had been completed, but that additional testing will be required; (ii) the core operating system represents approximately 85% of the Corporation's "mission critical" systems; and (iii) all "mission critical" systems and software are scheduled to be renovated by December 31, 1998. ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 The Corporation is currently in the process of addressing an issue that is facing all users of automated information systems. The issue is that many computer systems that process transactions based on two digits representing the year of the transaction may recognize a date using "00" as the year 1900 rather than the Year 2000. The inability to correctly recognize "00" as the Year 2000 could affect a wide variety of automated information systems, such as mainframe applications, personal computers and communication systems, in the form of software failure, errors or miscalculations. The Corporation began developing its plan to prepare for the Year 2000 in 1996. This plan began with the performance of an inventory of software applications, communicating with third party vendors and suppliers, and obtaining certifications of compliance from third party providers. During the early planning process, the Corporation was notified by the vendor of its core operating system that the core operating system used by the Corporation was not Year 2000 Compliant and that it would not be modified to become Year 2000 Compliant. The Corporation performed an extensive evaluation of replacement operating systems and in July 1997 chose to convert its core operating system to a new system offered by its existing vendor. The vendor of the core operating system has certified to the Corporation that its system is Year 2000 Compliant. The Corporation is scheduled to convert to the new operating system during the first quarter of 1998. The Corporation's conversion to the new core operating system is anticipated to enhance customer service and operating efficiencies. The cost of converting to the new operating system is approximately $300,000. In conjunction with the conversion to the new operating system, the Corporation purchased a new mainframe computer in 1997 at a cost of approximately $1 million, which was capitalized. The existing mainframe computer and core operating system software were fully depreciated prior to 1997. The Corporation will continue to assess the impact of the Year 2000 issue on the remainder of its computer-based systems and applications throughout 1998. The Corporation's goal is to perform tests of its systems and applications during 1998 and to have all systems and applications compliant with the century change by December 31, 1998. In addition to reviewing its own computer operating systems and applications, the Corporation has initiated formal communications with its significant suppliers and large customers to determine the extent to which the Corporation's interface systems are vulnerable to those third parties' failures to resolve their own Year 2000 issues. The Corporation is continuing to seek assurances that the systems of other companies on which the Corporation's systems rely will be timely converted or modified. If such modifications and conversions are not completed timely, their inability to correctly recognize the Year 2000 could have an adverse impact on the operations of the Corporation. The Corporation believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems and that additional costs to be incurred are not expected to be material to the Corporation's results of operations, liquidity or capital resources. The costs of the project and the date on which the Corporation projects it will complete the Year 2000 modifications were based on management's best estimates. There can be no guarantee that these estimates will be achieved -2- and actual results could differ from those anticipated. Specific factors that might cause differences include, but are not limited to, the ability of other companies on which the Corporation's systems rely to modify or convert their systems to be Year 2000 Compliant, the ability to locate and correct all relevant computer codes, and similar uncertainties. -3- -----END PRIVACY-ENHANCED MESSAGE-----