EX-13 6 k68118ex13.txt ANNUAL REPORT INFORMATION EXHIBIT 13 (FORM 10-K) CITIZENS BANKING CORPORATION ANNUAL REPORT INFORMATION TABLE OF CONTENTS I. Financial Review including Management's Discussion and Analysis......................................... 3 Five-Year Summary of Selected Financial Data.............................. 3 Mergers, Acquisitions, Divestitures and Other Initiatives................. 4 Financial Highlights...................................................... 4 Lines of Business Reporting............................................... 5 Net Interest Income....................................................... 6 Provision and Allowance for Loan Losses................................... 9 Noninterest Income ....................................................... 11 Noninterest Expense....................................................... 12 Federal Income Taxes...................................................... 12 Financial Condition....................................................... 12 Liquidity and Debt Capacity and Interest Rate Risk ....................... 18 Interest Rate Sensitivity................................................. 20 Recent Accounting Pronouncements.......................................... 20 Forward-Looking Statements................................................ 20 Selected Quarterly Information............................................ 21 Year Ended December 31, 2000 Compared with 1999...................................................... 22 II. Consolidated Financial Statements.............................................. 23 Consolidated Balance Sheets............................................... 23 Consolidated Statements of Income......................................... 24 Consolidated Statements of Changes in Shareholders' Equity................................................. 25 Consolidated Statements of Cash Flows..................................... 26 III. Notes to Consolidated Financial Statements..................................... 27 IV. Report of Independent Auditors................................................. 46 V. Report of Management........................................................... 47
A-2 MANAGEMENT'S DISCUSSION AND ANALYSIS CITIZENS BANKING CORPORATION AND SUBSIDIARIES
--------------------------------------------------------------------------------------------------------------------------------- TABLE 1. FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA (1) (in thousands, except per share data) 2001 2000 1999 1998 1997 --------------------------------------------------------------------------------------------------------------------------------- FOR THE YEAR Net interest income $ 307,981 $ 314,874 $ 309,642 $ 292,424 $ 274,134 Provision for loan losses 26,407 20,983 24,675 16,528 20,511 Noninterest income before securities gains (losses) 111,286 90,344 85,044 71,413 59,692 Investment securities gains (losses) 6,195 --- (3,052) 475 (572) Noninterest expense before special charges 251,183 242,221 236,778 218,219 208,921 Special charge --- 15,541 40,198 --- 23,734 Income taxes 43,215 35,813 27,989 39,283 25,197 Net income 104,657 90,660 61,994 90,282 54,891 Cash dividends (2) 50,158 48,108 30,035 22,991 19,286 PER COMMON SHARE DATA Net income: Basic $ 2.27 $ 1.92 $ 1.29 $ 1.86 $ 1.17 Diluted 2.25 1.91 1.28 1.84 1.15 Cash dividends (2) 1.085 1.015 0.915 0.82 0.74 Book value, end of year 15.46 14.62 13.32 14.07 12.93 Market value, end of year 32.88 29.06 22.38 33.75 34.50 AT YEAR END Assets $ 7,678,875 $ 8,405,091 $ 7,899,357 $6,930,533 $6,630,974 Loans 5,922,406 6,422,806 5,917,483 5,264,706 5,074,230 Deposits 5,965,126 6,244,141 6,128,998 5,772,792 5,514,313 Long-term debt 629,099 471,117 127,104 226,171 179,191 Shareholders' equity 697,464 679,979 633,669 680,501 610,775 AVERAGE FOR THE YEAR Assets $ 7,935,843 $ 8,073,021 $ 7,342,167 $6,792,829 $6,439,737 Earning assets 7,510,332 7,584,932 6,875,643 6,367,284 6,033,874 Loans 6,109,111 6,202,157 5,528,963 5,159,584 4,843,507 Deposits 6,008,096 6,121,373 5,906,664 5,616,894 5,359,464 Interest-bearing deposits 5,126,928 5,175,252 5,002,135 4,787,143 4,602,093 Repurchase agreements and other short-term borrowings 538,673 920,323 478,920 202,639 259,040 Long-term debt 596,380 303,597 210,289 228,969 144,306 Shareholders' equity 702,381 650,251 672,227 655,034 597,242 FINANCIAL RATIOS Return on average: Shareholders' equity 14.90% 13.94% 9.22% 13.78% 9.19% Earning assets 1.39 1.20 0.90 1.42 0.91 Assets 1.32 1.12 0.84 1.33 0.85 Average shareholders' equity/avg. assets 8.85 8.05 9.16 9.64 9.27 Dividend payout ratio (2) 47.93 53.06 59.13 40.49 61.21 Net interest margin (FTE) 4.32 4.32 4.68 4.78 4.73 Tier I leverage 7.79 7.11 7.21 8.95 8.00 Risk-based Tier I capital ratio 9.87 9.05 9.22 11.01 10.50 Risk-based Total capital ratio 11.12 10.30 10.47 12.26 11.76 ---------------------------------------------------------------------------------------------------------------------------------
(1) Except as indicated, all financial data have been restated for stock splits and pooling of interests transactions. Results of operations for acquisitions accounted for as purchases have been included effective with the respective dates of acquisition. (2) Cash dividends and cash dividends per share are for Citizens Banking Corporation only, not restated for pooling of interests. A-3 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES The following commentary presents Management's discussion and analysis of Citizens Banking Corporations' (Citizens) financial condition and results of operations. All financial data have been restated to give effect to mergers accounted for on a pooling of interests basis and stock splits in previous periods. The results of other acquisitions, accounted for as purchases, have been included effective with the respective dates of acquisition. MERGERS, ACQUISITIONS, DIVESTITURES AND OTHER INITIATIVES MERGERS, ACQUISITIONS AND DIVESTITURES In November 2001, Citizens sold F&M Bank-Minnesota with assets of $27 million. The bank was Citizens' sole location in Minnesota. On May 12, 2000, Citizens purchased three Jackson, Michigan offices of Great Lakes National Bank. The purchase added approximately $31 million in deposits for which Citizens paid a premium of $3.9 million. On October 8, 1999, Citizens completed the acquisition of seventeen former Bank One offices located in the northern section of Michigan's Lower Peninsula. The purchase added approximately $88 million in loans and $442 million in deposits. Citizens paid a premium of $36.1 million or 10.13% of certain core deposits. These transactions were accounted for as purchases. On November 1, 1999, Citizens merged with F&M Bancorporation, Inc. (F&M), a $2.7 billion bank holding company headquartered in Kaukauna, Wisconsin. As part of the merger, Citizens issued 21.0 million shares of its common stock, based on a fixed exchange ratio of 1.303, for all of the outstanding shares of F&M. This transaction was accounted for as a pooling of interests. SPECIAL CHARGES AND OTHER ONE-TIME COSTS During 2000, conversion and integration efforts resulting from the merger with F&M were completed. Net costs of $12.3 million ($7.4 million after-tax) incurred to complete these efforts (including system conversions, business unit integration, branch closures and other items) were recorded in noninterest expense as the "Special Charge". The net costs included reversals of prior year business restructuring reserves of $6.2 million, pre-tax, due to successful settlement of a contract with a former vendor of F&M and favorable experience in employee separations. In the fourth quarter of 2000, Citizens recorded an additional pre-tax charge of $3.2 million ($2.1 million after-tax) consisting of restructuring costs of $2.0 million and asset impairment and other charges of $1.2 million associated with corporate and organizational re-engineering initiatives. The restructuring plans include reorganization of Citizens' trust and investment management business into one nationally chartered trust bank, streamlining of Citizens' community bank organizational structure, consolidation of its direct and indirect lending operations, and exiting of certain unprofitable indirect lending dealer relationships. These initiatives were completed by year-end 2001. In 1999, the Special Charge included a fourth quarter pre-tax charge of $40.2 million consisting of $36.3 million ($25.9 million after-tax) in merger-related integration costs and $3.9 million ($2.5 million after-tax) of restructuring and other costs related to separate strategic initiatives and impairment write-offs. Merger-related integration costs included employee termination benefits of $7.1 million, transaction costs of $5.6 million, contract termination and other conversion costs (primarily recognition of obligations under existing contractual agreements related to system conversions) of $13.6 million, asset-related write-downs of $1.5 million, a $2.1 million write-down of impaired goodwill at an F&M bank, a $2.5 million contribution to Citizens' Charitable Trust for the acquired entities and other transaction related costs of $3.9 million. Restructuring plans related to the strategic initiatives, approved in the fourth quarter of 1999, included realignment of Citizens' branch network, including closure of selected branches in Michigan and Illinois, and transfer of certain financial and credit audit functions to a third party. Also, in the fourth quarter of 1999, Citizens recorded $6.8 million ($4.4 million after-tax) of additional provision for loan losses and $3.6 million ($2.4 million after-tax) of securities losses related to the F&M merger. The additional loan loss provision was provided to conform F&M's allowance to that which results from applying Citizens' allowance methodology and credit risk standards to F&M's loan portfolio. The security losses resulted from the sale of $122.8 million of securities to reposition the portfolios of Citizens and F&M after the merger to normalize investment exposure and reduce overall interest rate risk. At year-end 2001 Citizens' Special Charge reserve was fully utilized. Total deductions to the Special Charge reserve were $3.3 million in 2001, and $16.0 million in 2000 and $22.8 million in 1999. Included in these deductions were cash payments of $3.3 million, $9.7 million and $15.4 million in 2001, 2000 and 1999, respectively. See Note 3 to the Consolidated Financial Statements for additional information regarding the Special Charges in 2000 and 1999. FINANCIAL HIGHLIGHTS Citizens reported net income of $104.7 million, or $2.25 per diluted share in 2001, compared with $90.7 million, or $1.91 per diluted share in 2000. Net income increased 15.4% over the prior year while net income per diluted share increased 17.8%. The corresponding returns on average assets and equity were 1.32% and 14.90%, respectively, in 2001, as compared with 1.12% and 13.94% in 2000. Net income for 2001 included after tax gains of $13.5 million or $0.29 per share from sales of securitized mortgage loans, sale of NYCE stock, sale of credit card assets and the sale of F&M Bank-Minnesota. Net income for 2000 included after-tax merger, restructuring and other charges of $9.5 million, or $0.20 per diluted share. A-4 The improvement in net income reflects increased noninterest income partially offset by lower net interest income, a higher loan loss provision and higher noninterest expenses. Net interest income decreased 2.2% in 2001 from 2000. The decline in net interest income in 2001 was primarily due to a decline in earning assets as a result of balance sheet restructuring. Noninterest income, before nonrecurring gains of $19.8 million in 2001 (see Noninterest Income table on page 11), reflects increases in mortgage fees, title insurance fees, deposit account revenues, annuity sales and bankcard fees, partially offset by a decline in trust fees. Operating noninterest expense, excluding a special charge of $15.5 million in 2000, increased 3.7%. Average shareholders' equity was $702.4 million or 8.85% of total average assets for 2001, compared with $650.3 million or 8.05% for 2000. At December 31, 2001, Citizens' risk-based capital levels exceeded all regulatory requirements to be designated "well capitalized". An analysis of the major components of net income in 2001, 2000 and 1999 is presented below. Additional data on Citizens' performance during the past five years appear in Table 1, "Five-Year Summary of Selected Financial Data".
----------------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, -------------------------------------------------------- (in thousands) 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------------------- Interest income $ 573,559 $ 622,008 $541,559 Interest expense 265,578 307,134 231,917 ---------- --------- -------- Net interest income 307,981 314,874 309,642 Provision for loan losses 26,407 20,983 17,875 Noninterest income 97,676 90,344 79,895 Noninterest expense 251,183 242,221 230,683 Income taxes 36,878 41,890 43,825 ---------- --------- -------- NET INCOME BEFORE NONRECURRING ITEMS 91,189 100,124 97,154 ---------- --------- -------- Nonrecurring gains on sale of equity investments and assets 19,805 --- 5,693 Nonrecurring expenses, special charges and merger related expenses: Special charge --- 15,541 40,198 Other merger related expenses --- --- 10,396 Check kiting fraud loss --- --- 6,095 Tax expense (benefit) on nonrecurring items 6,337 (6,077) (15,836) ---------- --------- -------- Subtotal 13,468 (9,464) (35,160) ---------- --------- -------- NET INCOME AS REPORTED $ 104,657 $ 90,660 $ 61,994 ========== ========= ======== -----------------------------------------------------------------------------------------------------------------------------------
LINES OF BUSINESS REPORTING Citizens is managed along the following business lines: Commercial Banking, Retail Banking, Financial Services, F&M and Other. A description of each business, selected financial performance and the methodologies used to measure financial performance are presented in Note 18 to the Consolidated Financial Statements. Prior year amounts have been restated to reflect the current business unit structure and cost allocation methodology. The following table summarizes net income by line of business for each of the last three years:
------------------------------------------------------------- Net Income ------------------------------ (in thousands) 2001 2000 1999 ------------------------------------------------------------- Commercial Banking $ 35,723 $ 35,789 $ 30,410 Retail Banking 40,409 33,401 20,430 Financial Services 6,508 6,354 4,794 F&M 20,065 25,967 11,202 Other 1,952 (10,851) (4,842) -------- -------- -------- Total $104,657 $ 90,660 $ 61,994 ======== ======== ======== -------------------------------------------------------------
Commercial Banking net income in 2001 was consistent with the prior year as higher net interest income and noninterest income were offset by an increased provision for loan losses and higher operating expenses. Net interest income increased due to higher average commercial loan balances in 2001. The improvement in noninterest income reflects greater deposit service charges and increased cash management fees. The increased loan loss provision is the result of higher loan charge-offs. Operating expenses increased due to higher compensation and loan collection costs. Retail Banking net income improved due to increased noninterest income, nonrecurring gains on sale of assets and a lower provision for loan losses offset, in part, by a decline in net interest income and higher operating expenses. The growth in noninterest income before nonrecurring gains reflects increased mortgage income from higher mortgage loan origination volume and increased sales of new mortgage production into the secondary market. Noninterest income also increased due to greater title insurance fees and higher annuity sales by licensed retail bankers. In 2001, nonrecurring gains from the sale of securitized mortgages and the sale of the A-5 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES Michigan-based credit card portfolio totaled $5.2 million after tax. The provision for loan loss declined due to lower net charge-offs in the indirect loan and credit card portfolio. The decline in net interest income was due in part to the sale of the Michigan-based credit card portfolio in June 2001 and narrower interest spreads on retail deposits due to the lower interest rate environment. Net interest income also declined as a result of lower average balances in the mortgage portfolio. Mortgage loan balances declined due to the securitization and sale of $247 million of seasoned mortgage loans in the first half of 2001 and the sale of most new mortgage loan production throughout 2001. Financial Services net income improved slightly in 2001 despite lower revenue as operating expenses decreased more than the decline in noninterest income. Noninterest income decreased due to lower trust and brokerage revenues. Trust fees were impacted by the weak equity markets, which reduced asset values upon which fees are based. Lower transaction volume led to the decline in brokerage revenue. Operating expenses decreased due to lower volume-oriented incentive compensation and efficiencies achieved from the strategic realignment of the financial services organizational structure. The decline in net income at F&M reflects lower net interest income, a higher provision for loan losses and higher operating expenses, partially offset by an increase in noninterest income. The decrease in net interest income resulted from a decline in earning assets and a lower net interest margin. The higher loan loss provision resulted primarily from an increase in commercial loan net charge-offs. Net income in the Other category was favorably affected by an improvement in net interest income. Net interest income improved due to a decline in the cost of borrowed funds. The lower cost of borrowed funds resulted from the decrease in interest rates and a reduced reliance on borrowed funds due to the balance sheet restructuring activities. Net income was also favorably affected by a nonrecurring gain of $7.2 million after tax, on the sale of NYCE stock, an ATM network provider in which Citizens held an equity position. NET INTEREST INCOME The primary source of Citizens' traditional banking revenue is net interest income. Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, including interest-bearing deposits and borrowings, used to fund those assets. Net interest income is affected by market interest rates on both earning assets and interest-bearing liabilities, the level of earning assets being funded by interest-bearing liabilities, noninterest-bearing liabilities and equity, and the volume and composition of earning assets and funding sources. Other factors, such as Federal Reserve Board monetary policy and changes in tax laws, may also have an impact on changes in net interest income from one period to another. Net interest income, on a fully-taxable equivalent basis, decreased 1.9% to $322.8 million in 2001 from $329.0 million in 2000. A lower level of earning assets led to the decline. Earning assets were lower during 2001 due to balance sheet restructuring initiated to reduce interest rate risk and decrease reliance on borrowed funds. This balance sheet restructuring included the securitization and sale of $247 million of seasoned mortgage loans, the sale of most new mortgage loan production into the secondary market, the sale of the $30 million Michigan-based credit card portfolio, and the sale of the $27 million F&M Bank-Minnesota. Additionally, Citizens limited growth in its indirect lending portfolio and refocused the commercial loan portfolio in Wisconsin to de-emphasize certain types of commercial real estate lending. This resulted in lower earning assets in 2001 but improved net interest margin throughout the year. Net interest margin improved from 4.10% in the fourth quarter of 2000 to 4.48% in the fourth quarter of 2001. For the full year, net interest margin was 4.32%, unchanged from the prior year. An analysis of how changes in volume and rates have affected net interest income for the years ended December 31, 2001 and 2000 is presented in Table 2. A detailed analysis of net interest income, with average balances and related interest rates for the past three years, appears in Table 3. Interest income declined $48.4 million in 2001 due primarily to the lower interest rate environment and, to a lesser extent, the balance sheet restructuring. Yields on commercial loans were particularly impacted by lower interest rates as many of these loans vary directly with the prime interest rate. The prime rate was reduced 475 basis points throughout 2001 in response to the slower economy and Federal Reserve Board monetary policy. Certain consumer home equity loan yields, which vary with prime, were also negatively affected by the lower interest rate environment. The ratio of average loans to total earning assets declined slightly in 2001 to 81.3% from 81.8% in the prior year. Investment securities, including money market investments, comprise the remaining 18.7% of earning assets, up from 18.2% in 2000. The average yield on earning assets decreased to 7.87% in 2001 from 8.36% in 2000. Interest expense decreased $41.5 million in 2001 reflecting the lower interest rate environment and the reduction in borrowed funds due to the balance sheet restructuring. The average rates paid on all categories of interest bearing liabilities, except interest bearing demand deposits, decreased significantly in 2001 from the prior year reflecting the lower interest rate environment. Average rates paid on interest bearing demand accounts increased due to growth of a highly successful new product offering with a tiered rate structure, which pays higher rates of interest. Average interest bearing deposits declined $48.3 million or 0.9% in 2001 from the prior year as clients sought higher yielding investment alternatives such as fixed and variable annuities offered through Citizens' retail and brokerage units and to a lesser extent the sale of F&M Bank-Minnesota. Average short-term and long-term borrowings comprised 18.1% of interest bearing liabilities in 2001 down from 19.1% in the prior year. Average short-term borrowings declined A-6 $381.6 million as Citizens reduced reliance on borrowed funds through the balance sheet restructuring and extended maturities of borrowed funds as long term debt in the lower interest rate environment.
--------------------------------------------------------------------------------------------------------------------------------- TABLE 2. ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE 2001 COMPARED TO 2000 2000 Compared to 1999 --------------------------------------------- ------------------------------------------ INCREASE (DECREASE) Increase (Decrease) Year Ended December 31 DUE TO CHANGE IN Due to Change in NET -------------------------- Net ------------------------- (in thousands) CHANGE(1) RATE VOLUME(2) Change(1) Rate Volume(2) --------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Money market investments $ 2,091 $ (120) $ 2,211 $ (2,298) $ 493 $ (2,791) Investment securities: Taxable (9,107) (653) (8,454) 6,536 4,409 2,127 Tax-exempt 1,365 21 1,344 3,199 (163) 3,362 Loans: Commercial (9,614) (32,461) 22,847 67,166 9,684 57,482 Real estate (27,914) (943) (26,971) (8,734) 190 (8,924) Consumer (5,270) (4,384) (886) 14,580 1,724 12,856 -------- -------- -------- -------- -------- -------- Total (48,449) (38,540) (9,909) 80,449 16,337 64,112 -------- -------- -------- -------- -------- -------- INTEREST EXPENSE: Deposits: Demand 5,495 2,774 2,721 (479) (522) 43 Savings (20,410) (16,786) (3,624) 5,718 4,439 1,279 Time (9,293) (10,473) 1,180 27,027 13,916 13,111 Short-term borrowings (31,074) (10,060) (21,014) 34,840 6,767 28,073 Long-term debt 13,726 (2,866) 16,592 8,111 2,129 5,982 -------- -------- -------- -------- -------- -------- Total (41,556) (37,411) (4,145) 75,217 26,729 48,488 -------- -------- -------- -------- -------- -------- NET INTEREST INCOME $ (6,893) $ (1,129) $ (5,764) $ 5,232 $(10,392) $ 15,624 ======== ======== ======== ======== ======== ======== ---------------------------------------------------------------------------------------------------------------------------------
(1) Changes are based on actual interest income and do not reflect taxable equivalent adjustments. (2) Rate/Volume variances are allocated to changes due to volume. A-7 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES
TABLE 3. AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES 2001 2000 1999 -------------------------------- -------------------------------- ---------------------------- Year Ended December 31 AVERAGE AVERAGE Average Average Average Average (in millions) BALANCE INTEREST(1) RATE(2) Balance Interest(1) Rate(2) Balance Interest(1) Rate(2) ------------------------------------------------------------------------------------------------------------------------------------ EARNING ASSETS Money market investments $ 65.9 $ 2.3 3.50% $ 4.1 $ 0.3 5.67% $ 48.3 $ 2.5 5.24% Investment securities (3): Taxable 877.1 57.1 6.51 1,007.0 66.2 6.57 974.6 59.6 6.12 Tax-exempt 419.2 21.7 7.97 393.2 20.3 7.96 328.3 17.2 8.04 Loans (4): Commercial 3,440.8 269.7 7.93 3,178.2 279.3 8.89 2,525.1 212.1 8.51 Real estate mortgage 1,133.1 85.9 7.57 1,488.7 113.8 7.64 1,601.9 122.6 7.65 Consumer 1,535.2 136.8 8.91 1,535.2 142.1 9.26 1,401.9 127.5 9.10 -------- ------- -------- -------- ---------- ------- Total earning assets (3) 7,471.3 573.6 7.87 7,606.4 622.0 8.36 6,880.1 541.5 8.05 NONEARNING ASSETS Cash and due from banks 201.8 222.6 231.3 Premises and equipment 132.5 141.5 135.1 Investment security fair value adjustment 39.0 (21.5) (4.5) Other assets 172.4 204.2 171.6 Allowance for loan losses (81.2) (80.2) (71.4) -------- -------- ---------- Total assets $7,935.8 $8,073.0 $ 7,342.2 ======== ======== ========== INTEREST-BEARING LIABILITIES Deposits: Interest-bearing demand $ 744.8 14.0 1.88 $ 581.5 8.5 1.46 $ 578.5 9.0 1.55 Savings 1,474.5 34.8 2.36 1,701.7 55.2 3.24 1,751.6 49.5 2.83 Time 2,907.6 156.2 5.37 2,892.1 165.4 5.72 2,672.0 138.4 5.18 Short-term borrowings 538.7 27.5 5.09 920.3 58.5 6.36 478.9 23.7 4.95 Long-term debt 596.4 33.2 5.57 303.6 19.5 6.41 210.3 11.3 5.40 -------- ------- -------- -------- ---------- ------- Total interest-bearing liabilities 6,262.0 265.6 4.24 6,399.2 307.1 4.80 5,691.3 231.9 4.07 NONINTEREST-BEARING LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits 881.2 946.1 904.6 Other liabilities 90.3 77.5 74.1 Shareholders' equity 702.4 650.2 672.2 -------- -------- ---------- Total liabilities and shareholders' equity $7,935.8 $8,073.0 $ 7,342.2 ======== ======== ========== NET INTEREST INCOME $ 308.0 $ 314.9 $ 309.6 ======= ======== ======= NET INTEREST INCOME AS A PERCENT OF EARNING ASSETS 4.32% 4.32% 4.68% ------------------------------------------------------------------------------------------------------------------------------------
(1) Interest income is shown on an unadjusted basis and therefore does not include taxable equivalent adjustments. (2) Average rates include taxable equivalent adjustments to interest income of $14,835,000, $14,097,000, and $12,204,000 for the years ended December 31, 2001, 2000, and 1999, respectively, based on a 35% tax rate. (3) For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts. (4) Nonaccrual loans are included in average balances. A-8
-------------------------------------------------------------------------------------------------------------------------------- TABLE 4. SUMMARY OF LOAN LOSS EXPERIENCE Year Ended December 31 (in thousands) 2001 2000 1999 1998 1997 -------------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses - January 1 $ 80,070 $ 76,397 $ 69,740 $ 67,010 $ 59,029 Allowance of acquired (sold) banks and branches (240) -- 2,400 1,745 1,329 Provision for loan losses 26,407 20,983 24,675 16,528 20,511 CHARGE-OFFS: Commercial 18,265 10,920 8,675 4,557 4,555 Real estate 189 169 436 359 861 Consumer 14,278 14,359 17,751 14,879 13,064 ----------- ----------- ----------- ----------- ----------- Total charge-offs 32,732 25,448 26,862 19,795 18,480 ----------- ----------- ----------- ----------- ----------- RECOVERIES: Commercial 1,950 3,577 2,483 1,387 1,581 Real estate 47 45 149 28 12 Consumer 4,797 4,516 3,812 2,837 3,028 ----------- ----------- ----------- ----------- ----------- Total recoveries 6,794 8,138 6,444 4,252 4,621 ----------- ----------- ----------- ----------- ----------- Net charge-offs 25,938 17,310 20,418 15,543 13,859 ----------- ----------- ----------- ----------- ----------- Allowance for loan losses - December 31 $ 80,299 $ 80,070 $ 76,397 $ 69,740 $ 67,010 =========== =========== =========== =========== =========== Loans outstanding at year-end $ 5,922,406 $ 6,422,806 $ 5,917,483 $ 5,264,706 $ 5,074,230 Average loans outstanding 6,109,111 6,202,157 5,528,963 5,159,584 4,843,507 Ratio of allowance for loan losses to loans outstanding at year-end 1.36% 1.25% 1.29% 1.32% 1.32% Ratio of net loans charged off as a percentage of average loans outstanding 0.42 0.28 0.37 0.30 0.29 --------------------------------------------------------------------------------------------------------------------------------
PROVISION AND ALLOWANCE FOR LOAN LOSSES The provision for loan losses represents a charge against income and a corresponding increase in the allowance for loan losses. The provision for loan losses was $26.4 million in 2001, up from $21.0 million in 2000. Net charge-offs in 2001 as a percentage of average loans were 0.42%, compared with 0.28% in 2000. The increase is the result of higher net charge-offs in the commercial loan portfolio, particularly in the F&M markets. A summary of Citizens' loan loss experience from 1997 through 2001 appears in Table 4. The allowance for loan losses at December 31, 2001 was $80.3 million, or 1.36% of loans, compared with $80.1 million, or 1.25% of loans at the end of 2000. At December 31, 2001, the allowance equaled 109.6% of nonperforming loans, compared with 130.5% at year-end 2000. The decline in the ratio of allowance for loan losses to nonperforming loans primarily reflects increases in nonperforming commercial and commercial real estate loans in 2001. The increase in nonperforming loans in these categories is reflected in the allowance for loan losses through specific and formula based allocations, as discussed below under the caption "Allowance Policy and Methodology". The allowance also incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan". At December 31, 2001 total impaired loans were $62.1 million and the associated impairment allowance was $10.4 million, compared with $52.9 million and $5.1 million, respectively, at December 31, 2000. Citizens' maintains what management believes is an adequate allowance for possible loan losses to meet presently known credit risks in the loan portfolio. Citizens' loan portfolio has no significant concentrations in any one industry nor any exposure in foreign loans. Citizens has generally not extended credit to finance highly leveraged transactions nor does it intend to do so in the future. Employment levels and other economic conditions in Citizens' local markets may have a significant impact on the level of credit losses. Management continues to identify and devote attention to credits that may not be performing as well as expected. Nonperforming loans are further discussed in the section titled "Nonperforming Assets". ALLOWANCE POLICY AND METHODOLOGY Citizens maintains an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance analysis is based on a regular, quarterly assessment of the probable losses inherent in the loan portfolios. The methodology for measuring the adequacy of the allowance relies on several key elements, which include specific allowances for identified problem loans, reserves by formula and the unallocated allowance. A-9 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------ TABLE 5. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES(1) 2001 2000 1999 1998 1997 ----------------- ----------------- ----------------- ----------------- ----------------- LOAN Loan Loan Loan Loan December 31 (in millions) AMOUNT PERCENT(2) Amount Percent(2) Amount Percent(2) Amount Percent(2) Amount Percent(2) ------------------------------------------------------------------------------------------------------------------------------------ Commercial $ 42.0 54.8% $ 35.2 51.9% $ 21.3 48.6% $ 19.2 45.8% $ 16.7 40.7% Real estate construction 0.5 3.7 1.1 3.7 0.8 3.2 0.3 2.8 0.2 2.2 Real estate mortgage 3.5 16.4 5.9 20.0 6.0 24.3 8.2 26.9 7.9 28.4 Consumer 16.2 25.1 16.4 24.4 23.5 23.9 21.4 24.5 18.0 28.7 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total allocated 62.2 100.0% 58.6 100.0% 51.6 100.0% 49.1 100.0% 42.8 100.0% ======= ======= ======= ======= ======= Unallocated 18.1 21.5 24.8 20.6 24.2 ------- ------- ------- ------- ------- Total $ 80.3 $ 80.1 $ 76.4 $ 69.7 $ 67.0 ======= ======= ======= ======= ======= ====================================================================================================================================
(1) The allocation of the allowance for loan losses in the above table is based upon ranges of estimates and is not intended to imply either limitations on the usage of the allowance or precision of the specific amounts. Citizens and its subsidiaries do not view the allowance for loan losses as being divisible among the various categories of loans. The entire allowance is available to absorb any future losses without regard to the category or categories in which the charged-off loans are classified. (2) Percentage reflects the ratio of outstanding loans by category to total outstanding loans at the end of the respective year. Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate it is probable that a loss has been or will be incurred. Credits are identified based on quarterly reviews by our Credit Risk department of all commercial and commercial real estate loans over a fixed dollar amount where the internal credit rating is at or below a predetermined classification. The allowance amount is determined by analyzing the financial condition, collateral value and other qualitative factors as well as by a method prescribed by SFAS No. 114, "Accounting by Creditors for Impairment of a Loan". The formula allowance is calculated by applying loss factors to outstanding loans (excluding specifically identified credits) based on loan type, accrual status and internal risk grade of such loans and pools of loans. Minimum loss factors for criticized loan categories are consistent with regulatory agency factors. Loss factors for non-criticized loan categories are determined based on historical (generally three-year) averages adjusted quarterly for recent loss experience in the specific portfolios. In addition, adjustments are made to any loss factor used in the computation of the formula allowance in the event that, in management's judgment, significant factors which affect the collectibility of the portfolio as of the valuation date, are not reflected in the loss factors. The unallocated portion of the allowance is determined based upon management's evaluation of various conditions, the effects of which are not directly measured in the determination of the specific and formula allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits. The conditions evaluated in connection with the unallocated allowance at December 31, 2001, included general economic and business conditions in Citizens' key lending markets, the level and composition of nonperforming loans, underwriting standards within specific portfolio segments, specific industry conditions within portfolio segments, collateral values, loan volumes and concentrations, regulatory examination results, internal credit examination results and other factors. Management reviews these conditions quarterly in discussion with Citizens' senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment, as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance, applicable to such specific credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment, as of the evaluation date, management's evaluation of the probable loss related to such condition is reflected in the unallocated allowance. An allocation of the allowance for loan losses by major loan type at year-end for each of the last five years is presented in Table 5. CHANGES IN THE ALLOWANCE ALLOCATION The total "allocated" portion of the allowance for loan losses increased $3.6 million in 2001. This included an increase of $4.0 million in the specific allowance due to growth in the commercial and commercial real estate portfolios as well as increases in both the level of impaired loans and the degree of the impairment. The formula based allocated allowance decreased $0.4 million reflecting primarily a lower allocation factor for 2001 in the mortgage portfolio, offset in part, by an increase in classified credits. At December 31, 2001, the allocated portion of the allowance for credit losses included $29.8 million related to classified credits, compared to $21.0 million at December 31, 2000. Classified credits are those that are internally risk rated, special mention, or 8, substandard, or doubtful. Credits considered a loss are charged off. Special mention credits are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize A-10 repayment of the loan and result in further downgrade. Substandard credits have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A credit classified as "doubtful" has critical weaknesses that make full collection improbable. The allocation methods used for December 31, 2001 and 2000 were consistent. As shown in Table 5, the allocation of the allowance for loan losses related to commercial and commercial real estate loans, increased $6.8 million to $42.0 million at December 31, 2001 from the prior year-end. The increase was a function of changes in the commercial and commercial real estate category, including: a greater amount of loans in criticized categories and a corresponding increase in specific allocations in 2001 compared to 2000. Nonperforming commercial and commercial real estate loans increased to $48.0 million, or 1.5% of total commercial loans, at year-end 2001 from $37.2 million, or 1.1%, a year ago. Commercial real estate loans represented $11.1 million in 2001 and $12.5 million in 2000 of such nonperforming loans. Management believes the risk of loss in the commercial real estate nonperforming loans is significantly less than the total principal balance, due to the nature of the underlying collateral and the value of such collateral to the total credit exposure. These loans are generally for owner-occupied properties and do not rely on the performance of the real estate market to generate funds for repayment. The amount allocated to residential construction and real estate loans at December 31, 2001 decreased to 5.0% of the allowance for loan losses from 8.7% in 2000. This decrease was predominately a function of lower loan balances from balance sheet restructuring efforts in 2001 and a reduction in the allocation factor. Nonperforming loans in this portfolio remained essentially the same from the prior year and historical loss ratios in this portfolio are very low. The decrease in amount allocated to the consumer loan portfolio in 2001 was predominantly a function of the sale of $30 million of credit card receivables in mid 2001 and fewer net loan losses in the remaining consumer portfolio for the year ended December 31, 2001. Nonperforming consumer loans comprised 0.54% of total consumer loans at year-end 2001, up from 0.45% a year ago. Management expects net loan charge-offs in this portfolio to remain stable, primarily due to a risk-adjusted pricing structure and aggressive collection efforts. At December 31, 2001, the unallocated allowance decreased $3.4 million from the previous year-end because management believed that the inherent losses related to certain conditions, described previously under the caption "Allowance Policy and Methodology" considered in its evaluation of the unallocated allowance at December 31, 2000 had been recognized through charge-off, had been reflected in the formula or specific allowance, or had declined. NONINTEREST INCOME Noninterest income, before nonrecurring items and securities gains and losses, increased to $96.9 million in 2001 from $90.3 million in 2000, an improvement of 7.2%. On this same basis, noninterest income accounted for 23.9% of total operating revenue in 2001, compared with 22.3% in 2000. The increase is primarily due to higher mortgage loan originations and the subsequent sale of those mortgages in the secondary market. --------------------------------------------------------------------------------
NONINTEREST INCOME Year Ended December 31, Changes in 2001 ---------------------- ------------------------ (in thousands) 2001 2000 Amount Percent ----------------------------------------------------------------------------------- Service charges on deposit accounts $ 27,773 $ 26,260 $ 1,513 5.8% Trust fees 21,028 24,253 (3,225) (13.3) Mortgage and other loan income 13,159 4,997 8,162 163.3 Bankcard fees 11,799 11,258 541 4.8 Brokerage and investment fees 8,157 7,693 464 6.0 ATM network user fees 3,448 3,202 246 7.7 Cash management services 2,855 2,651 204 7.7 Title insurance fees 1,906 1,121 785 70.0 Other 6,728 8,909 (2,181) (24.5) -------- -------- ------- TOTAL FEES & OTHER INCOME 96,853 90,344 6,509 7.2 Securities gains 823 -- 823 -- -------- -------- ------- TOTAL BEFORE NONRECURRING ITEMS 97,676 90,344 7,332 8.1 Equity investment gain 11,017 -- 11,017 -- Gain on securitized mortgages 5,372 -- 5,372 -- Gain on sale of credit card 2,623 -- 2,623 -- Gain on sale of bank 793 -- 793 -- -------- -------- -------- TOTAL NONINTEREST INCOME $117,481 $ 90,344 $ 27,137 30.0 ======== ======== ========
=============================================================================== Service charges on deposit accounts increased $1.5 million or 5.8% reflecting new marketing strategies and pricing structures. Trust fees were down $3.2 million in 2001 as the value of managed assets upon which fees are based declined due to the weak equity markets. Total trust assets under administration were $3.162 billion at December 31, 2001 compared to $3.448 billion at December 31, 2000. Mortgage and other loan income was up $8.2 million, or 163.3% in 2001 due to higher gains on the sale of loans. Mortgage originations totaled $1.1 billion in 2001 compared to $457 million in 2000. The majority of all new mortgage loan originations were sold in the secondary market during 2001 resulting in higher gains on the sale of such loans and the related servicing. The higher mortgage loan volume also resulted in increased title insurance fees of 70.0% in 2001 over the comparable period in 2000. Bankcard fees increased 4.8% in 2001 generated by higher volume of debit card and merchant transactions, offset in part by lower credit card fees due to the midyear sale of the Michigan credit card portfolio. Brokerage and investment fees increased 6.0% to $8.2 million in 2001 compared to $7.7 million in 2000 due to successful A-11 MANAGEMENT'S DISCUSSION AND ANALYSIS (continued) CITIZENS BANKING CORPORATION AND SUBSIDIARIES retail efforts. Citizens recorded a gain of $5.4 million from the sale of $247 million of securitized mortgage loans in the first half of 2001. This sale was part of Citizens' strategy to restructure the balance sheet to decrease reliance on borrowed funds and minimize interest rate risk. In addition to the gain on sale of securitized mortgages, Citizens recorded net gains of $823,000 on other investment securities during 2001. As presented in Note 5 to the Consolidated Financial Statements, Citizens realized gross gains on sale of investment securities of $6.2 million and gross losses of $7,000 in 2001. In 2000 gross realized gains of $67,000 were offset by losses realized of $67,000. Nonrecurring income in 2001 consisted of a $793,000 gain on the sale of F&M Bank-Minnesota, $2.6 million gain on sale of credit card assets, the aforementioned $5.4 million gain from the securitization and subsequent sale of $247 million of portfolio mortgage loans and a gain on the sale of NYCE stock of $11.0 million. NYCE Corporation was an ATM network provider in which Citizens held an equity interest. NONINTEREST EXPENSE Excluding the Special Charge in 2000, noninterest expense increased $9.0 million, or 3.7%, to $251.2 million in 2001 from $242.2 million in the prior year. Increased incentive-based compensation, pension costs and professional service expenses generated the majority of the increase. Salaries and employee benefits increased $3.7 million, or 3.0%, in 2001 over 2000 due to normal merit increases, higher incentive-based compensation and increased pension costs. Occupancy costs were up $943,000 or 5.6% due to increased maintenance and energy costs. Professional services increased $2.2 million, or 21.7% due to higher legal costs associated with loan and other collection activities, increased technology support costs at F&M and other Corporate initiatives. Postage and delivery expenses increased 11.9% due to centralization of the check processing operations and outsourcing of the cash vault function. Partially offsetting this increase were reductions in staffing costs. Telephone and stationery and supplies expense decreased $2.0 million due to efficiencies from the F&M merger and expense reduction initiatives. Other expenses increased to $19.2 million in 2001 from $17.3 million in the prior year primarily due to an increase of $1.6 million in forgery, fraud and other losses. The Special Charge in 2000 included $12.3 million of merger-related integration costs and an additional $3.2 million of restructuring and other costs associated with separate strategic initiatives and impairment write-offs. These charges are more fully described under the caption "Mergers, Acquisitions, Divestitures and Other Initiatives" on page 4 of this report and in Note 3 of the Consolidated Financial Statements. All initiatives in respect to these Special Charges were completed by December 31, 2001. --------------------------------------------------------------------------------
NONINTEREST EXPENSE Year Ended December 31, Changes in 2001 -------------------------- ------------------------------ (in thousands) 2001 2000 Amount Percent ------------------------------------------------------------------------------------------ Salaries and employee benefits $126,278 $122,577 $ 3,701 3.0% Equipment 19,317 19,264 53 0.3 Occupancy 17,713 16,770 943 5.6 Data processing services 13,101 12,608 493 3.9 Professional services 12,277 10,088 2,189 21.7 Intangible asset amortization 11,063 10,733 330 3.1 Bankcard fees 9,308 8,959 349 3.9 Postage and delivery 7,746 6,924 822 11.9 Telephone 5,556 6,364 (808) (12.7) Advertising and public relations 5,219 5,034 185 3.7 Stationery and supplies 4,426 5,602 (1,176) (21.0) Other 19,179 17,298 1,881 10.9 -------- -------- -------- SUBTOTAL 251,183 242,221 8,962 3.7 Special Charge -- 15,541 (15,541) (100.0) -------- -------- -------- TOTAL NONINTEREST EXPENSE $251,183 $257,762 $ (6,579) (2.6) ======== ======== ========
-------------------------------------------------------------------------------- FEDERAL INCOME TAXES Income tax expense was $43.2 million in 2001, an increase of 20.7% over the 2000 total of $35.8 million. The increase reflected higher pre-tax earnings. The Corporation's effective tax rate was 29.2% in 2001 and 28.3% in 2000. The Corporation's effective tax rate is lower than the statutory tax rate due to tax-exempt interest income. FINANCIAL CONDITION Proper management of the volume and composition of Citizens' earning assets and funding sources is essential for ensuring strong and consistent earnings performance, maintaining adequate liquidity and limiting exposure to risks caused by changing market conditions. Citizens' investment securities portfolio is structured to provide a source of liquidity through maturities and generate an income stream with relatively low levels of principal risk. Loans comprise the largest component of earning assets and are Citizens' highest yielding assets. Client deposits are the primary source of funding for earning assets while short-term debt and other managed sources of funds are utilized as market conditions and liquidity needs change. Average total assets for 2001 were $7.936 billion, a decrease of $137 million or 1.7% from 2000. Average earning assets as a percent of average total assets was 94.6% for 2001, up from 94.0% in 2000. Average loans comprised 77.0% of average assets during 2001, up slightly from 76.8% in 2000. Interest-bearing deposits comprised 81.9% of average interest-bearing liabilities for 2001, increasing from 80.9% in 2000. The ratio of average noninterest-bearing deposits to average deposits decreased to 14.7% in 2001, from 15.5% in 2000. A-12 INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS Average investment securities, including money market investments, comprised 18.7% of total average earning assets in 2001, up from 18.2% in 2000. The increase is consistent with the overall balance sheet restructuring initiatives and the decline in loans as a percentage of earning assets. Mortgage-backed assets declined $22.4 million or 3.7% in 2001 as prepayment rates increased on these securities in the declining rate environment. State and municipal securities were purchased during 2001 due to their higher tax equivalent yields and Citizens' capacity to utilize tax-exempt income. At December 31, 2001, state and municipal securities represented 35.2% of total investment securities, compared with 31.1% in the prior year. Other securities, consisting primarily of Federal Reserve stock, Federal Home Loan Bank stock and privately issued asset-backed securities, remained virtually unchanged from 2000 as a percentage of total investment securities. Money market investments primarily federal funds sold and government money market investments averaged $65.9 million for 2001, up from $4.1 million in 2000. The amount of funds invested in these assets is based on the present and anticipated interest rate environment, liquidity needs and other economic factors. Citizens' present policies with respect to the classification of investments in debt and equity securities are discussed in Note 1 to the Consolidated Financial Statements. A summary of investment securities available for sale at December 31, 2001 and 2000 is presented below. Maturities and average yields of available for sale securities at year-end 2001 is presented in Table 6. As of December 31, 2001, the estimated aggregate fair value of Citizens' investment securities portfolio was $34.3 million above amortized cost consisting of gross unrealized gains of $36.9 million and gross unrealized losses of $2.6 million. A summary of estimated fair values and unrealized gains and losses for the major components of the investment securities portfolio is provided in Note 5 to the Consolidated Financial Statements. --------------------------------------------------------------------------------
AVAILABLE FOR SALE SECURITIES Balances Changes in 2001 ------------------------------ ---------------------------- Year Ended December 31 (in thousands) 2001 2000 Amount Percent ----------------------------------------------------------------------------------------------------------------- U.S. Treasury $ 8,163 $ 21,490 $ (13,327) (62.0)% Federal agencies Mortgage-backed securities 565,393 582,618 (17,225) (3.0) Other agencies 166,236 269,127 (102,891) (38.2) State and municipal: Taxable 10,776 12,257 (1,481) (12.1) Tax-exempt 433,180 418,518 14,662 3.5 Mortgage and asset-backed 10,558 15,755 (5,197) (33.0) Other securities 65,200 64,343 857 1.3 ---------- ---------- ---------- Total $1,259,506 $1,384,108 $ (124,602) (9.0) ========== ========== ========== ================================================================================================================== ------------------------------------------------------------------------------------------------------------------
TABLE 6. MATURITIES AND AVERAGE YIELDS OF AVAILABLE FOR SALE SECURITIES AT DECEMBER 31, 2001 U.S. Treasury and Federal Agency(1) State and Municipal(1), (2) --------------------------------- ------------------------------------------ Amortized Fair Amortized Fair (in millions) Cost Value Yield Cost Value Yield ---------------------------------------------------------------------------------------------------------- Due within one year $ 114.6 $ 115.7 4.96% $18.8 $ 19.1 7.80% One to five years 493.6 515.6 6.60 79.1 82.3 7.71 Five to ten years 94.7 94.3 6.92 157.6 163.5 8.00 After ten years 14.3 14.2 4.98 176.9 179.1 7.46 -------- -------- -------- -------- Total $ 717.2 $ 739.8 6.35 $ 432.4 $ 444.0 7.66 ======== ======== ======== ======== ======= Average maturity (3) 3.62 yrs 7.63 yrs. Other(1) Total ---------------------------------- -------------------------------------------- Amortized Fair Amortized Fair Cost Value Yield Cost Value Yield -------------------------------------------------------------------------------- Due within one year $ 4.3 $ 4.7 6.27% $ 137.7 $ 139.5 5.39% One to five years 7.7 6.0 5.70 580.4 603.9 6.74 Five to ten years 1.4 2.5 5.46 253.7 260.3 7.58 After ten years 62.2 62.5 6.21 253.4 255.8 7.02 ------ ------- --------- --------- Total $ 75.6 $ 75.7 6.18 $ 1,225.2 $ 1,259.5 6.82 ====== ======= ========= ========= Average maturity (3) 3.25 yrs. 5.09 yrs. ================================================================================================================== (1) Maturities for Federal agency, collateralized mortgage obligations and asset-backed securities are based upon projections of independent cash flow models. Maturities for state and municipal securities incorporate early call features, if applicable. (2) Yields for state and municipal securities are calculated on a tax equivalent basis using a 35% tax rate. (3) Average maturity information excludes Federal Reserve and Federal Home Loan Bank stocks with no stated maturity.
A-13 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------ TABLE 7. LOAN PORTFOLIO (in millions) 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------------ LOANS OUTSTANDING AT DECEMBER 31 Commercial $ 1,923.4 $ 2,127.2 $ 1,822.4 $ 1,619.9 $ 1,370.3 Commercial real estate 1,323.0 1,205.0 1,053.0 790.5 694.0 Real estate construction 216.0 235.1 185.4 149.5 113.5 Real estate mortgage 971.5 1,282.8 1,440.1 1,417.9 1,439.4 Consumer 1,488.5 1,572.7 1,416.6 1,286.9 1,457.0 ---------- ---------- ---------- ---------- ---------- Total $ 5,922.4 $ 6,422.8 $ 5,917.5 $ 5,264.7 $ 5,074.2 ========== ========== ========== ========== ========== LOAN MATURITIES AND INTEREST RATE SENSITIVITY AT DECEMBER 31, 2001 Within One to After One Year Five Years Five Years Total --------------------------------------------------------------------------------------------------------------- Commercial and commercial real estate $ 1,363.7 $ 1,669.6 $ 213.1 $ 3,246.4 Real estate construction 216.0 -- -- 216.0 ---------- ---------- -------- ---------- Total $ 1,579.7 $ 1,669.6 $ 213.1 $ 3,462.4 ========== ========== ======== ========== Loans above: With floating interest rates $ 994.5 $ 414.9 $ 96.4 $ 1,505.8 With predetermined interest rates 585.2 1,254.7 116.7 1,956.6 ---------- ---------- -------- ---------- Total $ 1,579.7 $ 1,669.6 $ 213.1 $ 3,462.4 ========== ========== ======== ========== ===============================================================================================================
LOANS Citizens extends credit primarily within the local markets of its banking subsidiaries located in Michigan, Wisconsin, Iowa and Illinois. Citizens' loan portfolio contains no loans to foreign governments, enterprises or foreign operations of domestic companies and is widely diversified by borrowers with no concentration within a single industry that exceeds 10% of total loans. Loan balances at December 31 and an analysis of the maturity and interest rate sensitivity of commercial and real estate construction loans is presented above. Total loans decreased $500.4 million or 7.8% in 2001 with average loans comprising 81.3% of total average earning assets during 2001, as compared with 81.8% during 2000. Commercial and commercial real estate loans decreased $85.8 million, or 2.6%, in 2001 from year-end 2000. A reduction of $182.0 million in commercial loans occurred within the F&M markets as a result of business loan portfolio restructuring and the implementation of Citizens' credit standards and loan structuring criteria in these markets. Commercial loans in the Michigan market grew 4.9% in 2001 from the prior year-end, a slower rate than the previous year due to the slowing economy. Residential mortgage loan balances declined $311.3 million, or 24.3% in 2001 from the prior year-end. The decline in mortgage loans reflects the securitization and sale of $247 million of portfolio mortgage loans and the sale of new mortgage loan production into the secondary market as part of the balance sheet restructuring initiatives. Consumer loans, which include installment and home equity loans, decreased $84.2 million, or 5.4%, to $1.489 billion at year-end 2001. The decline in consumer loans reflects the sale of $30 million of credit card assets, declines in the indirect lending portfolio and decreased direct auto loans, partially offset by growth in home equity loans. At December 31, 2001 and 2000, $257.9 million and $362.3 million, respectively, of residential real estate loans originated and subsequently sold in the secondary market were being serviced by Citizens bank. Capitalized servicing rights relating to the service loans totaled $1.7 million at December 31, 2001 and $2.7 million at year-end 2000. NONPERFORMING ASSETS A five-year history of nonperforming assets is presented in Table 8. Nonperforming assets are comprised of nonaccrual, restructured loans and repossessed assets. Although these assets have more than a normal risk of loss, they will not necessarily result in a higher level of losses in the future. Nonperforming assets totaled $79.2 million as of December 31, 2001, an increase of 19.5% from the year-end 2000 balance of $66.3 million. As a percentage of total assets, nonperforming assets increased to 1.03% at December 31, 2001, from 0.79% at December 31, 2000. The increase is primarily attributable to higher nonperforming commercial loans at the F&M Banks. A-14
------------------------------------------------------------------------------------------------------------------------ TABLE 8. NONPERFORMING ASSETS AND PAST DUE LOANS December 31 (in thousands) 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------ NONPERFORMING LOANS(1),(2) Nonaccrual Less than 30 days past due $ 6,528 $ 7,237 $ 1,661 $ 2,016 $ 5,128 From 30 to 89 days past due 5,218 7,297 772 1,641 2,021 90 or more days past due 57,047 44,881 26,498 31,485 28,813 ------- ------- ------- ------- ------- Total 68,793 59,415 28,931 35,142 35,962 90 days past due and still accruing 4,168 889 2,139 2,474 3,022 Restuctured (1) 337 1,068 9 114 446 ------- ------- ------- ------- ------- Total nonperforming loans 73,298 61,372 31,079 37,730 39,430 OTHER REPOSSESSED ASSETS ACQUIRED 5,947 4,917 4,039 4,790 4,869 ------- ------- ------- ------- ------- Total nonperforming assets $79,245 $66,289 $35,118 $42,520 $44,299 ======= ======= ======= ======= ======= Nonperforming assets as a percent of total loans plus other repossessed assets acquired 1.34% 1.03% 0.59% 0.81% 0.87% Nonperforming assets as a percent of total assets 1.03 0.79 0.45 0.61 0.67 NONPERFORMING LOANS BY TYPE Commercial $47,978 $37,229 $18,005 $19,830 $23,031 Real estate mortgage 17,304 17,057 7,366 8,032 9,487 Consumer 8,016 7,086 5,708 9,868 6,912 ------- ------- ------- ------- ------- Total $73,298 $61,372 $31,079 $37,730 $39,430 ======= ======= ======= ======= ======= ========================================================================================================================
(1) Nonperforming loans include loans on which interest is being recognized only upon receipt (nonaccrual), those on which interest has been renegotiated to lower than market rates because of the financial condition of the borrowers (restructured), and loans 90 days past due and still accruing. (2) Gross interest income that would have been recorded in 2001 for nonaccrual and restructured loans, as of December 31, 2001, assuming interest had been accrued throughout the year in accordance with original terms was $6.392 million. The comparable 2000 and 1999 totals were $4.953 million, and $3.383 million, respectively. Interest collected on these loans and included in income was $3.344 million in 2001, $3.045 million in 2000 and $1.861 million in 1999. Therefore, on a net basis, total income foregone due to these loans was $3.048 million in 2001, $1.908 million in 2000 and $1.522 million in 1999. Nonperforming commercial and commercial real estate loans increased to $48.0 million at year-end 2001 from $37.2 million a year ago. These loans comprised 65.5% of total nonperforming loans at December 31, 2001, compared with 60.7% in 2000. Commercial real estate loans represented $11.1 million in 2001 and $12.5 million in 2000 of such nonperforming loans. The increase in nonperforming commercial and commercial real estate loans is reflected in the allowance for loan losses through specific and formula based loss allocations as of December 31, 2001. The loss allocation for commercial and commercial real estate loans increased $6.8 million to $42.0 million at December 31, 2001 from the prior year-end. Management believes, as previously stated, that the risk of loss in the commercial real estate nonperforming loans is significantly less than the total principal balance, due to the nature of the underlying collateral and the value of such collateral to the total credit exposure. These loans are generally for owner-occupied properties and do not rely on the performance of the real estate market to generate funds for repayment. The consumer portfolio is comprised of automobile, personal, marine and other recreational vehicle, home equity and credit card loans of which automobile and home equity comprise 50.0% of 2001 average balances. At December 31, 2001, consumer loans represented 10.9% of nonperforming loans, down from 11.5% in 2000. Citizens maintains formal policies and procedures to control and monitor credit risk within these portfolios. Based upon present information, management believes the allowance for loan losses is adequate to meet presently known credit risks. The level and composition of nonperforming assets are affected by economic conditions in Citizens' local markets. Nonperforming assets, charge-offs and provisions for loan losses tend to decline in a strong economy and increase in a weak economy, potentially impacting Citizens' results. In addition to loans classified as nonperforming, management carefully monitors other credits that are current in terms of principal and interest payments but, in management's opinion, may deteriorate in quality if economic conditions change. As of December 31, 2001, such loans amounted to $78.9 million or 1.3% of total loans compared with $70.2 million or 1.1% of total loans as of December 31, 2000. These loans are primarily commercial and commercial real estate loans made in the normal course of business and do not represent a concentration in any one industry. Under Citizens' credit policies and practices, a loan is placed on nonaccrual status when there is doubt regarding A-15 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES collection of principal or interest, or when principal or interest is past due 90 days or more and the loan is not well secured and in the process of collection. Interest accrued but not collected is reversed and charged against income when the loan is placed on nonaccrual status. A loan is considered impaired when management determines it is probable that all the principal and interest due under the contractual terms of the loans may not be collected. In most instances, impairment is measured based on the fair value of the underlying collateral. Impairment may also be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. Citizens maintains a valuation allowance for impaired loans. Interest income on impaired nonaccrual loans is recognized on a cash basis. Interest income on all other impaired loans is recorded on an accrual basis. Certain of Citizens' nonperforming loans included in Table 8 are considered to be impaired. Citizens measures impairment on all large balance nonaccrual commercial and commercial real estate loans. Certain large balance accruing loans rated substandard or lower are also measured for impairment. Impairment losses are included in the provision for loan losses. The policy does not apply to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment, except for those loans restructured under a troubled debt restructuring. Loans collectively evaluated for impairment include certain smaller balance commercial loans, consumer loans, residential real estate loans, and credit card loans, and are not included in the impaired loan data in the following paragraphs. At December 31, 2001, loans considered to be impaired totaled $62.1 million of which $43.5 million were on a nonaccrual basis. Included within this amount is $39.8 million of impaired loans for which the related allowance for loan losses is $10.4 million and $22.3 million of impaired loans for which fair value exceeded the recorded investment in the loan. The average recorded investment in impaired loans during the year ended December 31, 2001 was approximately $78.0 million. For the year ended December 31, 2001, Citizens recognized interest income of $3.3 million on impaired loans. Cash collected on nonaccrual impaired loans totaled $3.1 million which was applied to principal. At December 31, 2000, loans considered to be impaired totaled $52.9 million of which $36.3 million were on a nonaccrual basis. Included with this amount is $32.5 million of impaired loans for which the related allowance for loan losses is $5.1 million and $20.4 million of impaired loans for which the fair value exceeded the recorded investment in the loan. The average recorded investment in impaired loans during the year ended December 31, 2000 was approximately $38.9 million. For the year ended December 31, 2000, Citizens recognized interest income of $2.5 million on impaired loans. Cash collected on nonaccrual impaired loans totaled $2.3 million of which $1.2 million was applied to principal and $1.1 million was recognized using the cash basis method of income recognition. During 2001, Citizens' banking subsidiaries received a normally scheduled examination by their governing regulatory agencies. There was no material reclassification of assets as nonperforming resulting from these examinations.
---------------------------------------------------------------------------------------------------------------------------- TABLE 9. AVERAGE DEPOSITS 2001 2000 1999 -------------------- ---------------------- ---------------------- AVERAGE AVERAGE Average Average Average Average Year Ended December 31 (in millions) BALANCE RATE Balance Rate Balance Rate --------------------------------------------------------------- ---------------------- ---------------------- Noninterest-bearing demand $ 881.2 --% $ 946.1 --% $ 904.6 --% Interest-bearing demand 744.8 1.88 581.5 1.46 578.5 1.55 Savings 1,474.5 2.36 1,701.7 3.24 1,751.6 2.83 Time 2,907.6 5.37 2,892.1 5.72 2,672.0 5.18 ---------- ---------- ---------- Total $ 6,008.1 3.41 $ 6,121.4 3.74 $ 5,906.7 3.33 ========== ========== ========== ============================================================================================================================
DEPOSITS Average deposit balances and rates for the past three years are summarized in Table 9. Total average deposits were 1.9% lower in 2001 as compared with 2000. Time and interest bearing demand deposits increased while savings deposits and noninterest bearing demand deposits decreased. Average interest-bearing demand balances increased 28.1% in 2001 versus the prior year primarily due to growth of a highly successful new product offering which pays higher rates of interest. Time deposits increased 0.5% in 2001 as compared with 2000 primarily due to an increase in average brokered deposit balances. Savings accounts and noninterest bearing demand deposits declined 13.4% and 6.9%, respectively, in 2001 due to a shift in client preferences, particularly in F&M's Wisconsin market, from noninterest bearing demand and money market savings accounts to the new higher-rate interest bearing demand product. The overall average rate for the deposit portfolio declined in 2001 to 3.41% from 3.74% in 2000. The decrease was the result of the lower interest rate environment in 2001. As of December 31, 2001, certificates of deposits of $100,000 or more accounted for approximately 13.7% of total deposits. The maturities of these deposits are summarized in Table 10. A-16 -------------------------------------------------------------------------------- TABLE 10. MATURITY OF TIME CERTIFICATES OF DEPOSIT OF $100,000 OR MORE AT DECEMBER 31, 2001 (in thousands) -------------------------------------------------------------------------------- Three months or less $314,552 After three but within six months 90,901 After six but within twelve months 261,996 After twelve months 150,926 --------- Total $818,375 =========
================================================================================ Citizens gathers deposits primarily from the local markets of its banking subsidiaries and has not traditionally relied on purchased deposits for any significant funding. Brokered deposits and time deposits greater than $100,000 declined $219 million at December 31, 2001 from the prior year end due to the balance sheet restructuring initiatives. Citizens will continue to evaluate the use of alternative funding sources such as brokered deposits as funding needs change. Management continues to promote relationship driven core deposit growth and stability through focused marketing efforts and competitive pricing strategies. BORROWED FUNDS Short-term borrowings are comprised primarily of Federal funds purchased, securities sold under agreements to repurchase, FHLB advances and Treasury Tax and Loan notes. Total short-term borrowings averaged $538.7 million in 2001 or 8.6% of total average interest-bearing liabilities, compared with $920.3 million or 14.4% during 2000. The decline in short-term borrowings is a result of the balance sheet restructuring and the extension of debt maturities in the lower interest rate environment. See Note 10 to the Consolidated Financial Statements for additional information on short-term borrowings. As of December 31, 2001, Citizens' Parent company maintained a $75 million short-term revolving credit facility with three unaffiliated banks, which had an unused commitment of $45 million. The current facility will mature on August 29, 2002 and is expected to renew at that time. The interest rate on the $30 million outstanding at December 31, 2001 reprices daily and is based on the Federal funds rate. The Parent company services the debt's principal and interest payments with dividends from the subsidiary banks. The agreement also requires Citizens to maintain certain financial covenants. Citizens is in full compliance with all debt covenants as of December 31, 2001. Long-term debt comprised primarily of FHLB notes, accounted for $596.4 million, or 9.5%, of average interest-bearing funds during 2001 increasing from $303.6 million or 4.7% during 2000. This increase reflects an extension of wholesale funding maturities in the low interest rate environment. A summary of long-term debt balances as of December 31, 2001 and 2000 appears in Note 11 to the Consolidated Financial Statements. Borrowed funds are expected to remain an important, reliable and cost-effective funding vehicle for Citizens and its subsidiary banks. CAPITAL RESOURCES Citizens continues to maintain a strong capital position which supports its current needs and provides a sound foundation to support further expansion. At December 31, 2001, shareholders' equity was $697.5 million, compared with $680.0 million at December 31, 2000. Book value per common share at December 31, 2001 and 2000 was $15.46 and $14.62, respectively. Citizens has consistently maintained regulatory capital ratios at or above the "well-capitalized" standards and all bank subsidiaries of Citizens have sufficient capital to maintain a well-capitalized designation. Citizens' capital ratios for the past three years are presented below. --------------------------------------------------------------------------------
Regulatory Minimum ---------------------- "Well- December 31, ---------------------------- Required Capitalized" 2001 2000 1999 ------------------------------------------------------------------- Risk based: Tier 1 capital 4.00% 6.00% 9.87% 9.05% 9.22% Total capital 8.00 10.00 11.12 10.30 10.47 Tier 1 leverage 4.00 5.00 7.79 7.11 7.21 -------------------------------------------------------------------
During 2001, Citizens maintained two stock repurchase plans. The stock repurchase plan initiated in May 2000 allowed for the repurchase of up to 3,000,000 shares of common stock for general bank purposes. As of December 31, 2000, 1,234,100 shares had been purchased under this plan. Citizens purchased the remaining 1,765,900 shares under this plan in 2001. In October 2001, a new plan was approved to repurchase up to an additional 3,000,000 shares of Citizens common stock for general corporate purposes. At December 31, 2001, 187,700 shares of common stock had been purchased under this plan. For the year ended December 31, 2001 a total of 1,953,600 shares were purchased under the plans at an average price of $29.94. Citizens declared cash dividends of $1.085 per share in 2001, an increase of 6.9% over 2000 dividends of $1.015 per share. Citizens has paid dividends every year since 1892 except for several years during the depression of the 1930's. A-17 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZENS BANKING CORPORATION AND SUBSIDIARIES LIQUIDITY AND DEBT CAPACITY The liquidity position of Citizens is monitored for its subsidiaries and its Parent company to ensure that funds are available at a reasonable cost to meet financial commitments, to finance business expansion and to take advantage of unforeseen opportunities. Citizens' subsidiary banks derive liquidity primarily through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans. Additionally, Citizens' subsidiary banks have access to market borrowing sources on an unsecured, as well as a collateralized basis, for both short-term and long-term purposes including, but not limited to, the Federal Reserve and Federal Home Loan Banks where the subsidiary banks are members. Another source of liquidity is the ability of Citizens' Parent company to borrow funds on both a short-term and long-term basis. The parent has established borrowing facilities with a group of unaffiliated banks and has used portions of this revolving credit agreement for various corporate purposes. Proactive management of Citizens' liquidity capacity and generation has increased sources of funds and borrowing capacities enabling Citizens and its subsidiary banks to operate effectively, safely and with improved profitably. The subsidiary banks manage liquidity to meet client cash flow needs while maintaining funds available for loan and investment opportunities. As discussed in Note 19 to the Consolidated Financial Statements, the Federal Reserve Bank requires Citizens' banking subsidiaries to maintain certain noninterest-bearing deposits with the Federal Reserve Bank. These balance requirements averaged $41.9 million and $56.8 million during 2001 and 2000, respectively, and were primarily satisfied with cash balances maintained by Citizens' subsidiaries. The liquidity of the Parent company is managed to provide funds to pay dividends to shareholders, service debt, invest in subsidiaries and to satisfy other operating requirements. The primary source of liquidity for the Parent company is dividends and returns of investment from its subsidiaries. During 2001, the Parent company received $107.4 million in dividends from subsidiaries and paid $50.2 million in dividends to its shareholders. Despite the higher level of dividends to the Parent, all Citizens' subsidiary banks maintained sufficient capital to be designated well capitalized. As discussed in Note 19 to the Consolidated Financial Statements, approximately $24.8 million was available as of January 1, 2002 for payment to the Parent company as dividends by Citizens' banking subsidiaries without further regulatory approval. Amounts earned by subsidiaries in 2002 will also become available for such dividend payments. Additional amounts may be available for payment subject to regulatory approval. Citizens' long-term debt to equity ratio was 90.2% as of December 31, 2001 compared to 69.3% in 2000. Changes in long-term debt during 2001 are discussed in the section titled "Borrowed Funds". Management believes that Citizens has sufficient liquidity and capacity sources to meet presently known cash flow requirements arising from ongoing business transactions. INTEREST RATE RISK Interest rate risk generally arises when the maturity or repricing structure of Citizens' assets and liabilities differ significantly. Asset/liability management, used by Citizens to address such risk, is the process of developing, testing and implementing strategies that seek to maximize net interest income, maintain sufficient liquidity and minimize exposure to significant changes in interest rates. This process includes monitoring contractual and expected repricing of assets and liabilities as well as forecasting earnings under different interest rate scenarios and balance sheet structures. Generally, management seeks a structure that insulates net interest income from large swings attributable to changes in market interest rates. Table 11 depicts Citizens' asset/liability static sensitivity (GAP) as of December 31, 2001 and 2000. As shown, Citizens' interest rate risk position at December 31, 2001 is asset sensitive in the less than one-year time frame with rate sensitive assets exceeding rate sensitive liabilities by $308.5 million. Application of GAP theory would suggest that with such a position Citizens' net interest income could decline if interest rates fall; i.e., assets are likely to reprice faster than liabilities, resulting in a decrease in net income in a declining rate environment. Conversely, net income could increase in a rising rate environment. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth and the timing of changes in these variables. Management is continually reviewing its interest rate risk position and modifying its strategies based on projections to minimize the impact of future interest rate changes. While traditional GAP analysis does not always incorporate adjustments for the magnitude or timing of non-contractual repricing, Table 11 does incorporate appropriate adjustments as indicated in footnotes 1 and 2 to the table. Because of these and other inherent limitations of any GAP analysis, management utilizes net interest income simulation modeling as its primary tool to evaluate the impact of changes in interest rates and balance sheet strategies. Management uses these simulations to develop strategies that can limit interest rate risk and provide liquidity to meet client loan demand and deposit preferences. A-18 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZEN'S BANKCORP CORPORATION AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------ TABLE 11. INTEREST RATE SENSITIVITY TOTAL 0 - 3 4 - 6 7 - 12 WITHIN 1 - 5 (dollars in millions) Months Months Months 1 YEAR Years ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2001 RATE SENSITIVE ASSETS(1) Loans and leases $ 2,486.5 $ 271.4 $ 516.5 $ 3,274.4 $ 2,175.6 Investment securities 95.5 21.5 47.1 164.1 568.0 Short-term investments 42.5 -- -- -- 42.5 ----------- ----------- ----------- ----------- ----------- Total $ 2,624.5 $ 292.9 $ 563.6 $ 3,481.0 $ 2,743.6 =========== ========== ========== ========== =========== RATE SENSITIVE LIABILITIES Deposits (2) $ 873.6 $ 666.4 $ 1,192.5 $ 2,732.5 $ 2,029.2 Other interest bearing liabilities 320.2 19.7 100.1 440.0 221.0 ----------- ----------- ----------- ----------- ----------- Total $ 1,193.8 $ 686.1 $ 1,292.6 $ 3,172.5 $ 2,250.2 =========== ========== ========== ========== =========== Period GAP (3) $ 1,430.7 $ (393.2) $ (729.0) $ 308.5 $ 493.4 Cumulative GAP 1,430.7 1,037.5 308.5 801.9 1,219.7 Cumulative GAP to total assets 18.63% 13.51% 4.02% 4.02% 10.44% Multiple of rate sensitive assets to liabilities 2.20 0.43 0.44 1.10 1.22 -------------------------------------------------------------------------------- Over 5 Years Total -------------------------------------------------------------------------------- DECEMBER 31, 2001 RATE SENSITIVE ASSETS(1) Loans and leases $ 472.4 $ 5,922.4 Investment securities 527.4 1,259.5 Short-term investments -- 42.5 --------- ----------- Total $ 999.8 $ 7,224.4 ========= =========== RATE SENSITIVE LIABILITIES Deposits (2) $ 299.5 $ 5,061.2 Other interest bearing liabilities 282.5 943.5 --------- ----------- Total $ 582.0 $ 6,004.7 ========= =========== Period GAP (3) $ 417.8 $ 1,219.7 Cumulative GAP Cumulative GAP to total assets 15.88% 15.88% Multiple of rate sensitive assets to liabilities 1.72 1.20 ==================================================================================================================================== DECEMBER 31, 2000 RATE SENSITIVE ASSETS(1) Loans and leases $ 2,128.9 $ 350.2 $ 669.6 $ 3,148.7 $ 2,581.4 Investment securities 64.1 40.1 30.0 134.2 589.7 Short-term investments 27.5 -- -- -- 27.5 ----------- --------- ----------- ----------- ----------- Total $ 2,220.5 $ 390.3 $ 699.6 $ 3,310.4 $ 3,171.1 =========== ========= =========== =========== =========== RATE SENSITIVE LIABILITIES Deposits (2) $ 990.2 $ 842.5 $ 1,414.2 $ 3,246.9 $ 1,799.6 Other interest bearing liabilities 1,029.1 75.0 210.2 1,314.3 81.5 ----------- --------- ----------- ----------- ----------- Total $ 2,019.3 $ 917.5 $ 1,624.4 $ 4,561.2 $ 1,881.1 =========== ========= =========== =========== =========== Period GAP (3) $ 201.2 $ (527.2) $ (924.8) $ (1,250.8) $ 1,290.0 Cumulative GAP 201.2 (326.0) (1,250.8) 39.2 Cumulative GAP to total assets 2.39% (3.88)% (14.88)% (14.88)% 0.47% Multiple of rate sensitive assets to liabilities 1.10 0.43 0.43 0.73 1.69 DECEMBER 31, 2000 RATE SENSITIVE ASSETS(1) Loans and leases $ 692.7 $ 6,422.8 Investment securities 660.2 1,384.1 Short-term investments -- 27.5 ----------- ----------- Total $ 1,352.9 $ 7,834.4 =========== =========== RATE SENSITIVE LIABILITIES Deposits (2) $ 223.7 $ 5,270.2 Other interest bearing liabilities 8.6 1,404.4 ----------- ----------- Total $ 232.3 $ 6,674.6 =========== =========== Period GAP (3) 1,120.6 $ 1,159.8 Cumulative GAP 1,159.8 Cumulative GAP to total assets 13.80% 13.80% Multiple of rate sensitive assets to liabilities 5.82 1.17
================================================================================ (1) Incorporates prepayment projections for certain assets which may shorten the time frame for repricing or maturity compared to contractual runoff. (2) Includes interest bearing savings and demand deposits without contractual maturities of $770 million in the less than one year category and $1.636 billion in the over one year category as of December 31, 2001. The same amounts as of December 31, 2000 were $779 million and $1.414 billion, respectively. This runoff is based on historical trends, which reflects industry standards. (3) GAP is the excess of rate sensitive assets (liabilities). A-19 INTEREST RATE SENSITIVITY A number of measures are used to monitor and manage interest rate risk, including income simulation and interest sensitivity GAP analyses. An income simulation model is management's primary tool used to assess the direction and magnitude of variations in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of financial instruments held for purposes other than trading; changes in market conditions, loan volumes, and pricing; deposit sensitivity; client preferences; and management's financial capital plans. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment and, as a result, the model cannot precisely estimate net interest income nor exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of balance sheet component and interest rate changes, differences in client behavior, market conditions and management strategies, among other factors. Results of the multiple simulations done as of December 31, 2001 suggest that Citizens could expect net interest income to decrease by $3.7 million (if asset and liability balances remain static and interest rates gradually decline by 200 basis points over the next twelve months) and, to increase by $8.3 million (if asset and liability balances remain static and interest rates gradually increase by 200 basis points over the next twelve months) from 2001 levels of net interest income. These variances in net interest income were well within Citizens' policy parameters established to manage such risk. Management performed a large number of net interest income simulations using varying balance sheet scenarios and differing interest rate environments. The model results presented herein are intended to illustrate the potential variation in net interest income from the indicated changes in interest rates, and not to project future levels of net interest income. In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including the growth, composition and absolute levels of deposits, loans, and other earning assets and interest bearing liabilities, economic and competitive conditions, client preferences and other factors. RECENT ACCOUNTING PRONOUNCEMENTS Please refer to Note 4 of the Consolidated Financial Statements "Recent Accounting Pronouncements". FORWARD-LOOKING STATEMENTS The foregoing disclosure contains "forward-looking statements" within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, both as amended, with respect to expectations for future periods. These forward looking statements involved are subject to risk and uncertainties that could cause actual results to differ. These risks and uncertainties include unanticipated changes in the competitive environment and relationships with third party vendors and clients and certain other factors discussed in this report. Management believes that the expectations used in the forward looking statements are reasonable, however actual results may vary significantly. A-20
------------------------------------------------------------------------------------------------------------------------- TABLE 12. SELECTED QUARTERLY INFORMATION 2001 2000 ----------------------------------------- ----------------------------------- (in thousands except, per share data) FOURTH THIRD SECOND FIRST Fourth Third ------------------------------------------------------------------------------------------------------------------------- Interest income $ 129,335 $ 140,406 $ 147,260 $ 156,558 $ 161,169 $ 160,347 Interest expense 51,659 62,146 70,835 80,938 84,909 80,722 Net interest income 77,676 78,260 76,425 75,620 76,260 79,625 Provision for loan losses 7,496 8,500 6,362 4,049 5,895 4,642 Noninterest income before securities gains (losses) (1) 25,599 34,658 28,587 22,442 23,015 23,215 Investment securities gains (losses) (2) 423 49 3,504 2,219 6 (5) Noninterest expense before special charge 60,586 64,270 63,616 62,711 57,579 61,670 Special charges (3) -- -- -- -- 8,352 (99) Net income (loss) 25,742 27,962 27,148 23,805 20,355 25,729 PER SHARE OF COMMON STOCK Net income (loss): Basic 0.57 0.60 0.59 0.51 0.44 0.54 Diluted 0.56 0.60 0.58 0.51 0.44 0.54 Cash dividends declared 0.275 0.275 0.275 0.260 0.260 0.260 Market value:(4) High 34.02 32.75 30.55 29.38 29.81 23.94 Low 27.70 27.30 24.51 23.69 21.19 16.00 Close 32.88 32.08 29.25 26.69 29.06 23.00 ------------------------------------------------------------------------ 2000 Second First ------------------------------------------------------------------------ Interest income $ 153,406 $ 147,086 Interest expense 73,878 67,625 Net interest income 79,528 79,461 Provision for loan losses 5,162 5,284 Noninterest income before securities gains (losses) (1) 22,819 21,295 Investment securities gains (losses) (2) -- (1) Noninterest expense before special charge 61,928 61,044 Special charges (3) 3,289 3,999 Net income (loss) 22,691 21,885 PER SHARE OF COMMON STOCK Net income (loss): Basic 0.48 0.46 Diluted 0.47 0.46 Cash dividends declared 0.260 0.235 Market value:(4) High 20.00 22.50 Low 16.00 15.50 Close 16.23 19.50
================================================================================ (1) Noninterest income in 2001 includes a $2.6 million gain on the sale of the credit card portfolio in the second quarter, an $11.0 million gain on sale of NYCE stock in the third quarter and a $793,000 gain on the sale of F&M Bank-Minnesota in the fourth quarter. (2) In 2001 investment securities gains include $2.1 million in the first quarter and $3.3 million in the second quarter from the securitization of mortgages and subsequent sale of mortgage-backed securities. (3) Special charges in 2000 includes restructuring, conversion, integration and other non-recurring costs incurred in connection with mergers, acquisitions and other corporate initiatives. (4) Citizens Banking Corporation common stock is traded on the National Market tier of the Nasdaq stock market (trading symbol: CBCF). At December 31, 2001, there were approximately 16,354 shareholders of the Corporation's common stock. A-21 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) CITIZEN'S BANKCORP CORPORATION AND SUBSIDIARIES YEAR ENDED DECEMBER 31, 2000 COMPARED WITH 1999 Citizens reported net income of $90.7 million, or $1.91 per diluted share, in 2000 compared with $62.0 million, or $1.28 per diluted share, in 1999. Net income included after-tax merger, restructuring, conversion and other non-recurring items of $9.5 million in 2000 and $35.2 million in 1999. Returns on average assets and equity were 1.12% and 13.94%, respectively, in 2000, as compared with 0.84% and 9.22% in 1999. Excluding nonrecurring items, the increase in net income in 2000 reflects improvement in net interest income from growth in earning assets and higher noninterest income, partially offset, by higher loan loss provision and noninterest expense. Net interest income increased 1.7% in 2000 to $314.9 million as compared with $309.6 million in 1999. Higher levels of earning assets, particularly commercial and commercial real estate loans, partially offset by an increase in short-term borrowings and a lower net interest margin, led to the increase in 2000. Yields on earning assets increased to 8.36%, from 8.05% in 1999 reflecting a rising interest rate environment in the first half of 2000 and a favorable shift in the earning asset mix to higher yielding loans. Loan growth outpaced deposit growth and Citizens used short-term FHLB advances and other purchased funds to support the higher level of earning assets. This change in the funding mix increased average borrowings to 19.1% of interest-bearing liabilities in 2000, up from 12.1% in 1999. Higher rates paid on interest-bearing deposits and long-term debt increased the cost of interest-bearing funding sources to 4.80% in 2000 from 4.07% in 1999. Net interest margin declined to 4.32% in 2000 as compared with 4.68% in 1999. The provision for loan losses decreased to $21.0 million in 2000 from $24.7 million in 1999. The 1999 provision included a $6.8 million special provision to conform F&M's allowance for loan losses to Citizens' methodology and credit risk standards. Net loan charge-offs to average total loans decreased nine basis points to 0.28% as compared to 0.37% in 1999. The improvement is the result of lower net charge-offs in Citizens' indirect consumer loan portfolio and to a lessor extent, lower net charge-offs at the F&M banks. The allowance for loan losses as a percentage of total loans was 1.25% at December 31, 2000 compared to 1.29% at the end of 1999. Noninterest income, before nonrecurring income and securities gains and losses, increased to $90.3 million in 2000 from $79.9 million in 1999, an improvement of 13.1%. On the same basis, noninterest income accounted for 22.3% of total operating revenues in 2000, compared with 20.5% in 1999. Noninterest income increased $10.4 million from 1999 primarily due to growth in deposit service charges, trust fees, bankcard fees and brokerage and investment fees. Excluding nonrecurring items, noninterest expense increased $11.5 million or 5.0% to $242.2 million in 2000, up from $230.7 million in 1999. Growth from the October 1999 and May 2000 branch purchases, partially offset by efficiencies achieved in 2000 from the conversion and integration of F&M and other cost savings initiatives, generated most of the increase. Compensation was unchanged from 1999 as the full year effect of additional staff from the branch purchases, higher health care costs and increased incentive pay were offset by decreased staffing levels at F&M and lower pension costs. Occupancy and equipment expenses were up a combined $4.0 million or 12.4%, due to the branch purchases and installation of new equipment and operating systems at F&M. Higher data processing costs reflect increased processing volumes and new services and information technology costs associated with the branch purchases and conversion of F&M onto Citizens' operating systems. Professional services were up due to the outsourcing in 2000 of Citizens' computer technology support functions and certain financial and credit audit procedures. Intangible asset amortization increased due to additional goodwill from the branch purchases and bankcard fees were higher due to additional transaction volume and costs from the full year effect of outsourcing bankcard operations in 1999. Citizens had total average assets of $8.073 billion during 2000, up from 1999 average assets of $7.342 billion. Total loans increased $505.3 million or 8.5% in 2000 with average loans comprising 81.8% of total earning assets in 2000, up from 80.4% in 1999. Growth occurred primarily in the commercial loan and commercial real estate portfolios due to enhanced sales efforts and strong loan demand. Average investment securities, including money market investments, comprised 18.2% of total average earning assets in 2000, down from 19.6% in 1999. Total average deposits were 3.6% higher in 2000 as compared with 1999. Average short-term borrowings, comprised primarily of FHLB advances, Federal funds purchased, and securities sold under agreements to repurchase; averaged $920.3 million in 2000, or 14.4% of total average interest-bearing liabilities, compared with $478.9 million or 8.4% during 1999. The increase reflects additional borrowings to fund growth in loans and other earning assets. Long-term debt accounted for $303.6 million or 4.7% of average interest-bearing funds during 2000, increasing from $210.3 million or 3.7% in 1999. Average shareholders' equity was $650.2 million in 2000, a 3.3% decrease over the 1999 average of $672.2 million. A-22 -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS CITIZENS BANKING CORPORATION AND SUBSIDIARIES
December 31, (in thousands, except share amounts) 2001 2000 ---------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 224,416 $ 318,115 Money market investments: Interest-bearing deposits with banks 3,455 2,547 Short-term government fund 38,190 --- Federal funds sold 891 24,986 ------------ ------------ Total money market investments 42,536 27,533 Securities available for sale (amortized cost $1,225,230 in 2001; $1,366,063 in 2000) 1,259,506 1,384,108 Loans: Commercial 3,246,380 3,332,156 Real estate construction 216,041 235,096 Real estate mortgage 971,533 1,282,834 Consumer 1,488,452 1,572,720 ------------ ------------ Total loans 5,922,406 6,422,806 Less: Allowance for loan losses (80,299) (80,070) ------------ ------------ Net loans 5,842,107 6,342,736 Premises and equipment 128,805 137,094 Intangible assets 79,405 90,808 Other assets 102,100 104,697 ------------ ------------ TOTAL ASSETS $ 7,678,875 $ 8,405,091 ============ ============ LIABILITIES Noninterest-bearing deposits $ 903,900 $ 973,938 Interest-bearing deposits 5,061,226 5,270,203 ------------ ------------ Total deposits 5,965,126 6,244,141 Federal funds purchased and securities sold under agreements to repurchase 233,077 394,466 Other short-term borrowings 81,353 538,784 Other liabilities 72,756 76,604 Long-term debt 629,099 471,117 ------------ ------------ Total liabilities 6,981,411 7,725,112 SHAREHOLDERS' EQUITY Preferred stock - no par value: Authorized - 5,000,000 shares; Issued - none Common stock - no par value: Authorized - 100,000,000 shares Issued and outstanding - 45,097,614 in 2001; 46,510,111 in 2000 155,720 201,549 Retained earnings 521,191 466,692 Other accumulated comprehensive net income 20,553 11,738 ------------ ------------ Total shareholders' equity 697,464 679,979 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,678,875 $ 8,405,091 ============ ============ ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. A - 23 -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME CITIZENS BANKING CORPORATION AND SUBSIDIARIES
(in thousands, except share amounts) 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------------------ INTEREST INCOME Interest and fees on loans $ 492,437 $ 535,235 $ 462,223 Interest and dividends on investment securities: Taxable 57,083 66,190 59,654 Tax-exempt 21,715 20,350 17,151 Money market investments 2,324 233 2,531 ----------- ----------- ------------ Total interest income 573,559 622,008 541,559 INTEREST EXPENSE Deposits 204,929 229,137 196,871 Short-term borrowings 27,458 58,532 23,692 Long-term debt 33,191 19,465 11,354 ----------- ----------- ------------ Total interest expense 265,578 307,134 231,917 ----------- ----------- ------------ NET INTEREST INCOME 307,981 314,874 309,642 Provision for loan losses 26,407 20,983 24,675 ----------- ----------- ------------ Net interest income after provision for loan losses 281,574 293,891 284,967 ----------- ----------- ------------ NONINTEREST INCOME Service charges on deposit accounts 27,773 26,260 21,378 Trust fees 21,028 24,253 21,701 Mortgage and other loan income 13,159 4,997 6,078 Bankcard fees 11,799 11,258 9,163 Brokerage and investment fees 8,157 7,693 4,325 Investment securities gains (losses) 6,195 -- (3,052) Equity security gains 11,017 -- 5,693 Gain on sale of credit card assets 2,623 -- -- Gain on sale of bank 793 -- -- Other 14,937 15,883 16,706 ----------- ----------- ------------ Total noninterest income 117,481 90,344 81,992 ----------- ----------- ------------ NONINTEREST EXPENSE Salaries and employee benefits 126,278 122,577 122,572 Equipment 19,317 19,264 16,645 Occupancy 17,713 16,770 15,414 Data processing fees 13,101 12,608 9,924 Professional services 12,277 10,088 7,330 Intangible asset amortization 11,063 10,733 8,363 Bankcard fees 9,308 8,959 7,477 Postage and delivery 7,746 6,924 5,985 Telephone 5,556 6,364 5,601 Advertising and public relations 5,219 5,034 5,223 Stationery and supplies 4,426 5,602 5,674 Special charges -- 15,541 40,198 Other 19,179 17,298 26,570 ----------- ----------- ------------ Total noninterest expense 251,183 257,762 276,976 ----------- ----------- ------------ INCOME BEFORE INCOME TAXES 147,872 126,473 89,983 Income taxes 43,215 35,813 27,989 ----------- ----------- ------------ NET INCOME $ 104,657 $ 90,660 $ 61,994 =========== =========== ============ NET INCOME PER SHARE: Basic $ 2.27 $ 1.92 $ 1.29 Diluted 2.25 1.91 1.28 AVERAGE SHARES OUTSTANDING: Basic 46,085,405 47,310,375 48,169,121 Diluted 46,589,962 47,542,815 48,617,207 --------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. A - 24
----------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY CITIZENS BANKING CORPORATION AND SUBSIDIARIES Accumulated Other Common Retained Comprehensive (in thousands, except per share amounts) Stock Earnings Income (loss) Total ----------------------------------------------------------------------------------------------------------------------------- BALANCE - JANUARY 1, 1999 $ 276,439 $ 396,516 $ 7,546 $ 680,501 Net income 61,994 61,994 Net unrealized loss on securities available-for-sale, net of tax effect of $13,913 (24,989) (24,989) --------- Total comprehensive income 37,005 Exercise of stock options, net of shares purchased 3,349 3,349 Cash dividends - $0.915 per share (30,035) (30,035) Cash dividends of pooled company, pre-merger (11,766) (11,766) Shares acquired for retirement (53,866) (53,866) Pre-merger transactions of pooled company 1,050 7,431 8,481 ---------- ---------- --------- --------- BALANCE - DECEMBER 31, 1999 226,972 424,140 (17,443) 633,669 Net income 90,660 90,660 Net unrealized gain on securities available-for-sale, net of tax effect of $15,718 29,181 29,181 -------- Total comprehensive income 119,841 Exercise of stock options, net of shares purchased 1,879 1,879 Cash dividends - $1.015 per share (48,108) (48,108) Shares acquired for retirement (27,302) (27,302) ---------- ---------- --------- --------- BALANCE - DECEMBER 31, 2000 201,549 466,692 11,738 679,979 Net income 104,657 104,657 Net unrealized gain on securities available-for-sale, net of tax effect of $5,690 10,542 Minimum pension liability (1,727) ---------- Total comprehensive income 8,815 8,815 Exercise of stock options, net of shares purchased 12,662 12,662 Cash dividends - $1.085 per share (50,158) (50,158) Shares acquired for retirement (58,491) (58,491) ---------- ---------- --------- --------- BALANCE - DECEMBER 31, 2001 $ 155,720 $ 521,191 $ 20,553 $ 697,464 ========== ========== ========= ========= -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. A - 25
--------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS CITIZENS BANKING CORPORATION AND SUBSIDIARIES YEAR ENDED DECEMBER 31, (in thousands) 2001 2000 1999 --------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 104,657 $ 90,660 $ 61,994 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 26,407 20,983 24,675 Depreciation and amortization 16,241 15,995 14,148 Amortization of goodwill and other intangibles 11,063 10,733 8,363 Intangible asset impairment -- -- 2,349 Deferred income tax (credit) (279) 3,585 (7,953) Net amortization on investment securities (563) (147) 2,743 Investment securities losses (gains) (6,195) -- 3,052 Loans originated for sale (824,449) (132,878) (117,603) Proceeds from sales of mortgage loans held for sale 831,138 134,020 120,283 Gains from loan sales (6,689) (1,142) (2,471) Donation of equity security -- 1,116 -- Gains on sale of equity securities, credit card assets and bank (14,433) -- (5,693) Accrued merger related and other charges (3,337) (14,050) 17,387 Other (4,720) 87 (9,592) --------- --------- --------- Net cash provided by operating activities 128,841 128,962 111,682 INVESTING ACTIVITIES: Net (increase) decrease in money market investments (15,003) 36,270 45,745 Securities available-for-sale: Proceeds from sales 297,492 6,755 85,288 Proceeds from maturities 352,369 183,185 373,228 Purchases (502,261) (131,311) (697,238) Securities held-to-maturity: Proceeds from maturities -- -- 25,304 Purchases -- -- (71,454) Sale of credit card assets 29,454 Net (increase) decrease in loans and leases 444,768 (522,569) (520,999) Net increase in properties and equipment (7,952) (10,519) (20,221) Proceeds from sale of equity securities, credit card assets and bank 14,433 -- 5,693 Acquisitions (net of cash acquired) -- 26,008 317,214 --------- --------- --------- Net cash used by investing activities 613,300 (412,181) (457,440) FINANCING ACTIVITIES: Net increase (decrease) in demand and savings deposits 143,669 (231,753) (115,749) Net increase (decrease) in time deposits (422,684) 315,889 (70,131) Net increase (decrease) in short-term borrowings (618,820) (4,029) 751,888 Proceeds from issuance of long-term debt 183,182 740,150 58,598 Principal reductions in long-term debt (25,200) (396,137) (157,665) Cash dividends paid (50,158) (48,108) (41,801) Proceeds from stock options exercised 12,662 1,879 3,349 Shares acquired for retirement (58,491) (27,302) (53,866) --------- --------- --------- Net cash provided by financing activities (835,840) 350,589 374,623 --------- --------- --------- Net increase (decrease) in cash and due from banks (93,699) 67,370 28,865 Cash and due from banks at beginning of period 318,115 250,745 221,880 --------- --------- --------- Cash and due from banks at end of period $ 224,416 $ 318,115 $ 250,745 ========= ========= ========= Supplemental Cash Flow Information: Interest paid $ 278,979 $ 297,396 $ 233,689 Income taxes paid 40,481 30,647 38,444 ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. A - 26 NOTE 1. SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Citizens Banking Corporation (Citizens) and its subsidiaries conform to generally accepted accounting principles in the United States. Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. The following describes Citizens' policies: CONSOLIDATION: The Consolidated Financial Statements include the accounts of Citizens and its subsidiaries after elimination of all material intercompany transactions and accounts. INVESTMENT SECURITIES: Citizens classifies all debt and equity securities as available for sale. Available for sale securities are reported at fair value with unrealized gains and losses included in shareholders' equity. In the event that an investment security is sold, the adjusted cost of the specific security sold is used to compute the applicable gain or loss. ALLOWANCE FOR LOAN LOSSES: Citizens maintains an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on a regular, quarterly assessment of the probable losses inherent in the loan portfolios. The allowance is increased by the provision charged to income and reduced by the amount charged-off, net of recoveries. Citizens' methodology for measuring the adequacy of the allowance relies on several key elements, which include specific allowances for identified problem loans, reserves by formula and the unallocated allowance. Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate it is probable that a loss has been or will be incurred. The specific credit allocations are based on a regular analysis of all commercial and commercial mortgage loans over a fixed dollar amount where the internal credit rating is at or below a predetermined classification. The allowance amount is determined by analyzing the financial condition, collateral value and other qualitative factors as well as by a method prescribed by Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan". The formula allowance is calculated by applying loss factors to outstanding loans (excluding specifically identified credits) based on loan type, accrual status and internal risk grade of such loans and pools of loans. Minimum loss factors for criticized loan categories are consistent with regulatory agency factors. For non-criticized loan categories loss factors are determined based on historical averages (generally three-year) adjusted quarterly for recent loss experience in the specific portfolios. The unallocated portion of the allowance is determined based upon management's assessment of general economic conditions, as well as specific economic factors in the individual markets in which Citizens operates. This determination inherently involves a higher degree of uncertainty and considers current risk factors that may not have yet manifested themselves in the Company's specific allowances or in the historical loss factors used to determine the formula allowances. The allowance also incorporates the results of measuring impaired loans as provided in SFAS No. 114. Reserve allocations established for impaired loans are determined based on the fair value of the investment measured using either the present value of expected future cash flows discounted at the initial effective interest rate on the loan, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. A loan is considered impaired when management determines it is probable that all the principal and interest due under the contractual terms of the loan will not be collected. PREMISES AND EQUIPMENT: Premises and equipment, including leasehold improvements, are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on a straight-line basis and are charged to expense over the lesser of the estimated useful life of the assets or lease term. Maintenance and repairs as well as gains and losses on dispositions are charged to expense as incurred. OTHER REAL ESTATE: Other real estate includes properties acquired in satisfaction of a debt. These properties are carried at the lower of cost or fair value, net of estimated costs to sell, based upon current appraised value. Losses arising from the acquisition of such properties are charged against the allowance for loan losses. Subsequent valuation adjustments and gains or losses on disposal of these properties are charged to other expenses as incurred. INTANGIBLE ASSETS: Goodwill, the excess of cost over the fair value of net identifiable tangible and intangible assets acquired in acquisitions accounted for as purchases, is amortized on a straight-line basis over periods ranging from 10 to 20 years. The carrying amount of goodwill is reviewed for impairment as events or changes in facts and circumstances warrant. Impairment of goodwill is evaluated by geographic region and is based on a comparison of the recorded balance of goodwill to the applicable discounted cash flows over the remaining amortization period of the associated goodwill. To the extent that impairment may exist, the current carrying amount is reduced by the estimated shortfall. Effective January 1, 2002 with the adoption of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", goodwill will no longer be amortized. See Note 4. Recent Accounting Pronouncements, "Accounting for Goodwill and Other Intangible Assets." A - 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS LOAN SALES AND SERVICING RIGHTS: Gains and losses on the sales of loans are determined using the specific-identification method. When servicing is retained, the servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment of servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified by rate in the quarter in which the related loans were sold. INCOME TAXES: Citizens and its subsidiaries file a consolidated federal income tax return. Income tax expense is based on income as reported in the Consolidated Statements of Income. When income and expenses are recognized in different periods for tax purposes, applicable deferred taxes are provided in the Consolidated Financial Statements. LOAN INTEREST AND FEE INCOME: Interest on loans is generally accrued and credited to income based upon the principal amount outstanding. Loans are placed on nonaccrual status when the collection of principal or interest is considered doubtful, or payment of principal or interest is past due 90 days or more and the loan is not well secured and in the process of collection. When these loans (including a loan impaired) are placed on nonaccrual status, all interest previously accrued but unpaid is reversed against current year interest income. Interest payments received on nonaccrual loans are credited to income if future collection of principal is probable. Loans are normally restored to accrual status when interest and principal payments are current and it is believed that the financial condition of the borrower has improved to the extent that future principal and interest payments will be met on a timely basis. Loan origination fee income, net of direct origination costs and certain incremental direct costs, is deferred and amortized as a yield adjustment over the estimated term of the related loans by methods that approximate the level yield method. NET INCOME PER SHARE: Basic net income per share is based on net income divided by the weighted average number of shares outstanding in each period. Diluted net income per share shows the dilutive effect of additional common shares issuable upon the assumed exercise of stock options granted under Citizens' stock option plans, using the treasury stock method. CASH FLOWS: For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks. RECLASSIFICATIONS: Certain amounts have been reclassified to conform to the current year presentation. NOTE 2. MERGERS, ACQUISITIONS AND DIVESTITURES In November 2001, Citizens sold F&M Bank-Minnesota with assets of $27 million. The bank was Citizens' sole location in Minnesota. On May 12, 2000, Citizens purchased three Jackson, Michigan offices of Great Lakes National Bank. The purchase added approximately $31 million in deposits, for which Citizens paid a premium of $3.9 million. On October 8, 1999, Citizens acquired seventeen offices of Bank One located in the northern section of Michigan's Lower Peninsula. This purchase added approximately $88 million in loans and $442 million in deposits, for which Citizens paid a premium of $36.1 million or 10.13% of certain core deposits. These transactions were accounted for as purchases; accordingly, the financial statements include their results of operations only since the acquisition dates. On November 1, 1999, Citizens acquired F&M Bancorporation, Inc. (F&M) a $2.7 billion bank holding company headquartered in Kaukauna, Wisconsin. As part of the acquisition, Citizens issued 21 million shares of its common stock, based on a fixed exchange ratio of 1.303, for all of the outstanding shares of F&M. This transaction was accounted for as a pooling of interests and, accordingly, all periods presented include the results of F&M. A - 28 NOTE 3. MERGER, BUSINESS RESTRUCTURING AND OTHER CHARGES The following provides details on reserve activity in 2001, 2000 and 1999 in connection with mergers, business restructuring and other charges associated with various corporate initiatives.
------------------------------------------------------------------------------------------------------------------------------------ Contract termination Goodwill & Employee and other Facilities core deposit Equity Charitable benefits and conversion Professional and premium investment trust (in thousands) severance costs fees equipment write-downs write-down contribution Other Total ------------------------------------------------------------------------------------------------------------------------------------ FOURTH QUARTER 1999 CHARGE $ 7,482 $ 13,598 $ 6,345 $ 3,355 $ 2,349 $ 520 $ 2,500 $ 4,049 $ 40,198 Amount Utilized: Cash Payments (144) (4,241) (5,711) (2,500) (2,788) (15,384) Noncash -- -- -- (3,355) (2,349) (520) -- (1,203) (7,427) -------- -------- ------- ------- -------- ----- ------- ------- -------- RESERVE BALANCE AT DECEMBER 31, 1999 7,338 9,357 634 -- -- -- -- 58 17,387 Additional 4th Qtr. Reserve 1,962 1,962 Amount Utilized: Cash Payments (3,660) (5,387) (607) (30) (9,684) Noncash (2,324) (3,951) (25) -- -- -- -- (28) (6,328) -------- -------- ------- ------- -------- ----- ------- ------- -------- RESERVE BALANCE AT DECEMBER 31, 2000 3,316 19 2 -- -- -- -- -- 3,337 Amount Utilized: Cash Payments (3,316) (19) (2) (3,337) Noncash -- -- -- -- -- -- -- -- -- -------- -------- ------- ------- -------- ----- ------- ------- -------- RESERVE BALANCE AT DECEMBER 31, 2001 $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- ======== ======== ======= ======= ======== ===== ======= ======= ======== ------------------------------------------------------------------------------------------------------------------------------------
In the fourth quarter of 1999, Citizens recorded a pre-tax charge of $40.2 million consisting of $36.3 million ($25.9 million after-tax) in merger-related integration costs and $3.9 million ($2.5 million after-tax) of restructuring and other costs related to separate strategic initiatives and impairment write-offs. The charge was recorded as a separate component of noninterest expense, the "Special Charge." Merger-related integration costs recorded included employee termination benefits, transaction costs, contract termination and other conversion costs (primarily recognition of obligations under existing contractual agreements related to system conversions), asset-related write-downs, a write-down of impaired goodwill at an F&M bank, a contribution to Citizens' Charitable Trust for the acquired entities and other transaction related costs. Restructuring and other costs for non-merger activities consisted of employee termination benefits of $0.4 million, professional fees of $0.7 million, asset related write-downs of $1.8 million, and other costs of $0.1 million for strategic initiatives approved in the fourth quarter of 1999 as well as a write-down of a core deposit premium from a previous acquisition of $0.3 million and a loss for an other than temporary decline in the market value of an equity investment of $0.5 million. The approved initiatives included realignment of Citizens branch network, including closure of selected branches in Michigan and Illinois, and transfer of certain financial and credit audit functions to a third party. Also, in the fourth quarter of 1999, Citizens recorded $6.8 million ($4.4 million after-tax) of additional provision for loan losses and $3.6 million ($2.4 million after-tax) of securities losses related to the F&M merger. The additional loan loss provision was provided to conform F&M's allowance to that which results from applying Citizens' allowance methodology and credit risk standards to F&M's loan portfolio. The security losses resulted from the sale of $122.8 million of securities to reposition the portfolios of Citizens and F&M after the merger to normalize investment exposure and reduce overall interest rate risk. In 2000, net merger-related integration costs of $12.3 million ($7.4 million after-tax) were charged to the Special Charge for system conversions, business unit integration, branch closures and other items associated with the F&M merger. Included in this amount were reversals of prior year business restructuring reserves of $6.2 million due to successful settlement of a contract with a former vendor of F&M and favorable experience in employee separations. All system conversion activities related to the F&M merger were completed in 2000. In the fourth quarter of 2000, Citizens recorded an additional pre-tax charge of $3.2 million ($2.1 million after-tax) for restructuring costs of $2.0 million and asset impairment and other charges of $1.2 million associated with A - 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS new corporate and organizational re-engineering initiatives. The restructuring plans included reorganization of Citizens' trust and investment management business into one nationally chartered trust bank, streamlining of the Company's community bank organizational structure, consolidation of its direct and indirect lending operations, and exiting of certain unprofitable indirect lending dealer relationships. These initiatives were completed by year-end 2001. As shown in the table above, total deductions to Citizens' Special Charge reserve were $3.3 million in 2001, $16.0 million in 2000 and $22.8 million in 1999. Included in these deductions were cash payments of $3.3 million, $9.7 million and $15.4 million in 2001, 2000 and 1999, respectively. The components of the Special Charges in 2000 and 1999 recorded in noninterest expense were as follows:
(in thousands) 2000 1999 -------------------------------------------------------------------------------- MERGER, RESTRUCTURING & OTHER COSTS RELATED TO 1999 ACQUISITIONS & STRATEGIC INITIATIVES APPROVED IN 1999 Employee salaries, benefits & severance $ 2,098 $ 7,482 Contract termination and other conversion costs 9,981 13,598 Professional fees 477 6,345 Charitable Trust contribution -- 2,500 Other merger integration costs 3,838 2,845 Asset impairment and other writeoffs: Facilities and equipment 1,207 3,355 Goodwill & core deposit premium -- 2,349 Other real estate -- 964 Equity investment -- 520 Other writeoffs 982 240 Changes in 1999 reserve estimates: Contract settlement less than amount accrued (3,900) -- Changes in benefits and severance estimates (2,324) -- -------- -------- Subtotal 12,359 40,198 ADDITIONAL RESTRUCTURING & OTHER COSTS FOR STRATEGIC INITIATIVES APPROVED IN 2000 Employee benefits and severance 1,962 -- Software & equipment writeoffs 654 -- Professional fees 463 -- Other 103 -- -------- -------- Subtotal 3,182 -- -------- -------- Total $ 15,541 $ 40,198 ======== ======== --------------------------------------------------------------------------------
No special charges were recorded in 2001. NOTE 4. RECENT ACCOUNTING PRONOUNCEMENTS ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, establishes accounting and reporting standards for hedging activities and for derivative instruments, including certain derivative instruments embedded in other contracts. This statement requires a company to recognize all derivatives as either assets or liabilities in its balance sheet and measure those instruments at fair value. Citizens adopted this statement as amended effective January 1, 2001. At year-end 2001, Citizens did not have any outstanding material derivatives or hedging activities. Therefore the impact of adopting the provisions of this statement on Citizens' financial position, results of operations and cash flow was not material. ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES: SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--A Replacement of FASB Statement 125" was issued in September 2000 and replaces SFAS No. 125. SFAS No. 140, like SFAS No. 125, establishes accounting and reporting standards to assist in determining when to recognize or derecognize financial assets and liabilities in the financial statements after a transfer of financial assets has occurred. SFAS 140, however, requires certain additional disclosures related to transferred assets and is more restrictive in defining what constitutes a qualified special purpose entity (QSPE) as well as when transfers to a QSPE will be accorded sales treatment. SFAS No. 140 is effective for transfers occurring after March 31, 2001. The expanded disclosures, however, are effective for years ending after December 15, 2000, but are not required to be applied to prior periods. There was no impact to Citizens upon adoption of this statement as Citizens does not use unconsolidated special purpose entities. ACCOUNTING FOR BUSINESS COMBINATIONS: SFAS No. 141, "Business Combinations" supercedes APB Opinion No. 16, "Business Combinations", and FASB No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises", establishes financial accounting and reporting for all business combinations. This statement requires all business combinations be accounted for by a single method, the purchase method. The statement also requires that intangible assets be recognized apart from goodwill if they meet certain criteria and the disclosure of the primary reasons for the business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption. The statement is effective for all business combinations initiated after June 30, 2001. Citizens adopted this statement July 1, 2001 and will apply its provisions to any future business combination. A - 30 ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS: SFAS No. 142, "Goodwill and Other Intangible Assets" - a replacement of APB Opinion No. 17, "Intangible Assets", addresses how intangible assets should be accounted for that are acquired outside of a business combination and also addresses how intangibles should be accounted for once the intangibles have been initially recognized in the financial statements. The statement no longer assumes a finite life for all intangibles, but now requires that intangible assets with indefinite lives be tested at least annually for impairment with impairment losses recognized immediately and intangible assets with finite lives be amortized over an appropriate period. Citizens has adopted this statement effective January 1, 2002. Citizens anticipates no impairment under Statement No. 142. The effect of this statement will be to reduce goodwill amortization by $7.2 million ($5.4 million after tax) in 2002 from the prior year. NOTE 5. INVESTMENT SECURITIES The amortized cost, estimated fair value and gross unrealized gains and losses of investment securities follow:
------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2001 December 31, 2000 --------------------------------------------------- --------------------------------------------------- ESTIMATED GROSS GROSS Estimated Gross Gross AMORTIZED FAIR UNREALIZED UNREALIZED Amortized Fair Unrealized Unrealized (in thousands) COST VALUE GAINS LOSSES Cost Value Gains Losses ------------------------------------------------------------------------------------------------------------------------------------ AVAILABLE FOR SALE: U.S. Treasury $ 7,949 $ 8,163 $ 214 $ -- $ 21,555 $ 21,490 $ 27 $ 92 Federal agencies: Mortgage-backed 551,377 565,393 14,714 698 579,096 582,618 5,659 2,137 Other 157,921 166,236 8,316 1 264,348 269,127 5,205 426 State and municipal 432,425 443,956 13,378 1,847 420,835 430,775 11,925 1,985 Mortgage and asset-backed 10,448 10,558 170 60 15,884 15,755 9 138 Other 65,110 65,200 90 -- 64,345 64,343 4 6 ---------- ---------- ---------- -------- ---------- ---------- ---------- ---------- Total available for sale $1,225,230 $1,259,506 $ 36,882 $ 2,606 $1,366,063 $1,384,108 $ 22,829 $ 4,784 ========== ========== ========== ========== ========== ========== ========== ========== ------------------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair value of debt securities by contractual maturity at December 31, 2001 are shown below.
-------------------------------------------------------- Estimated Amortized Fair (in thousands) Cost Value -------------------------------------------------------- Due within one year $ 57,419 $ 57,877 One to five years 175,845 189,789 Five to ten years 191,407 194,878 After ten years 176,869 179,060 ---------- ---------- 601,540 621,604 Equity securities 61,865 61,951 Mortgage and asset-backed securities 561,825 575,951 ---------- ---------- Total $1,225,230 $1,259,506 ========== ========== --------------------------------------------------------
Sales of investment securities resulted in realized gains and losses as follows:
------------------------------------------------------------ Year Ended December 31, (in thousands) 2001 2000 1999 ------------------------------------------------------------ Securities gains $ 6,202 $ 67 $ 561 Securities losses (7) (67) (3,613) -------- ------ --------- Net gain (loss) $ 6,195 $ --- $ (3,052) ======== ====== ========= ------------------------------------------------------------
Securities with amortized cost of $799.3 million at December 31, 2001, and $530.4 million at December 31, 2000, were pledged to secure public deposits, repurchase agreements, and other liabilities. Except for obligations of the U.S. Government and its agencies, no holdings of securities of any single issuer exceeded 10% of consolidated shareholders' equity at December 31, 2001 or 2000. A - 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6. LOANS AND NONPERFORMING ASSETS Citizens extends credit primarily within the Midwestern states of Michigan, Wisconsin, Illinois and Iowa. In Michigan the primary market includes most parts of the Lower Peninsula. In Wisconsin the primary market area is the Fox Valley region extending from Green Bay to Appleton to Oshkosh as well as northeastern and southwestern Wisconsin. Other primary market areas are central Iowa and the western suburban market of Chicago, Illinois. Citizens seeks to limit its credit risk by establishing guidelines to review its aggregate outstanding commitments and loans to particular borrowers, industries and geographic areas. Collateral is secured based on the nature of the credit and management's credit assessment of the customer. Citizens' loan portfolio is widely diversified by borrowers with no concentration within a single industry that exceeds 10% of total loans. Citizens has no loans to foreign countries and generally does not participate in large national loan syndications or highly leveraged transactions. Most of Citizens' commercial real estate loans consist of mortgages on owner-occupied properties. Those borrowers are involved in business activities other than real estate, and the sources of repayment are not dependent on the performance of the real estate market. A summary of nonperforming assets follows:
-------------------------------------------------------------- December 31, (in thousands) 2001 2000 -------------------------------------------------------------- Nonperforming loans: Nonaccrual $68,793 $59,415 Loans 90 days past due (still accruing) 4,168 889 Restructured 337 1,068 ------- ------- Total nonperforming loans 73,298 61,372 Other real estate 4,463 3,734 Other assets acquired by repossession 1,484 1,183 ------- ------- Total nonperforming assets $79,245 $66,289 ======= ======= --------------------------------------------------------------
The effect of nonperforming loans on interest income follows:
-------------------------------------------------------------- Year Ended December 31, (in thousands) 2001 2000 1999 -------------------------------------------------------------- Interest income: At original contract rates $6,392 $4,953 $3,383 As actually recognized 3,344 3,045 1,861 ------ ------ ------ Interest foregone $3,048 $1,908 $1,522 ====== ====== ====== --------------------------------------------------------------
There are no significant commitments outstanding to lend additional funds to clients whose loans were classified as nonaccrual or restructured at December 31, 2001. At December 31, 2001, loans considered to be impaired totaled $62.1 million of which $43.5 million were on a nonaccrual basis. Included within this amount is $39.8 million of impaired loans for which the related allowance for loan losses is $10.4 million and $22.3 million of impaired loans for which fair value exceeded the recorded investment in the loan. The average recorded investment in impaired loans during the year ended December 31, 2001 was approximately $78.0 million. For the year ended December 31, 2001, Citizens recognized interest income of $3.3 million on impaired loans. Cash collected on nonaccrual impaired loans totaled $3.1 million which was applied to principal. At December 31, 2000, loans considered to be impaired totaled $52.9 million of which $36.3 million were on a nonaccrual basis. Included with this amount is $32.5 million of impaired loans for which the related allowance for loan losses is $5.1 million and $20.4 million of impaired loans for which the fair value exceeded the recorded investment in the loan. The average recorded investment in impaired loans during the year ended December 31, 2000 was approximately $38.9 million. For the year ended December 31, 2000, Citizens recognized interest income of $2.5 million on impaired loans. Cash collected on nonaccrual impaired loans totaled $2.3 million of which $1.2 million was applied to principal and $1.1 million was recognized using the cash basis method of income recognition. Certain directors and executive officers of Citizens and its significant subsidiaries, including their families and entities in which they have 10% or more ownership, were clients of the banking subsidiaries. Total loans to these clients aggregated $13.2 million and $19.1 million at December 31, 2001 and 2000, respectively. During 2001, new loans of $4.5 million were made and repayments totaled $10.4 million. Substantially all such loans were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those for comparable transactions with unrelated parties and did not involve more than normal risk of collectibility. The consolidated financial statements do not include loans serviced for others, which totaled $257.9 million and $362.3 million at December 31, 2001 and 2000, respectively. The carrying value of mortgage servicing rights approximates fair value at December 31, 2001 and 2000. At year-end 2000, Citizens recognized impairment of $260,000 on mortgage servicing rights to mark them to market. Changes in originated mortgage servicing rights for the years ended December 31 were as follows:
(in thousands) 2001 2000 ----------------------------------------------------------------------------- Balance - January 1 $ 2,680 $ 3,335 Mortgage servicing rights capitalized -- 161 Amortization (947) (556) Impairment loss -- (260) ------- ------- Balance - December 31 $ 1,733 $ 2,680 ======= ======= -----------------------------------------------------------------------------
A - 32 NOTE 7. ALLOWANCE FOR LOAN LOSSES A summary of changes in the allowance for loan losses follows:
------------------------------------------------------------------------------- (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------- Balance - January 1 $ 80,070 $ 76,397 $ 69,740 Allowance of acquired (sold) banks and branches (240) -- 2,400 Provision for loan losses 26,407 20,983 24,675 Charge-offs (32,732) (25,448) (26,862) Recoveries 6,794 8,138 6,444 -------- -------- -------- Net charge-offs (25,938) (17,310) (20,418) -------- -------- -------- Balance - December 31 $ 80,299 $ 80,070 $ 76,397 ======== ======== ======== -------------------------------------------------------------------------------
NOTE 8. PREMISES AND EQUIPMENT A summary of premises and equipment follows:
------------------------------------------------------------- December 31, (in thousands) 2001 2000 ------------------------------------------------------------- Land $ 21,806 $ 21,812 Buildings 146,775 142,814 Leasehold improvements 5,750 6,221 Furniture and equipment 124,939 132,026 --------- --------- 299,270 302,873 Accumulated depreciation and amortization (170,465) (165,779) --------- --------- Total $ 128,805 $ 137,094 ========= ========= -------------------------------------------------------------
Certain branch facilities and equipment are leased under various operating leases. Total rental expense, including expenses related to these operating leases, was $4.8 million in 2001, $4.8 million in 2000 and $4.1 million in 1999. Future minimum rental commitments under non-cancelable operating leases are as follows at December 31, 2001: $4.3 million in 2002, $3.5 million in 2003, $1.6 million in 2004, $1.1 million in 2005, $0.8 million in 2006, and $2.2 million after 2006. NOTE 9. DEPOSITS A summary of deposits follows:
--------------------------------------------------------------- December 31, (in thousands) 2001 2000 --------------------------------------------------------------- Noninterest-bearing demand $ 903,900 $ 973,938 Interest-bearing demand 995,191 574,029 Savings 1,411,429 1,618,884 Time deposits over $100,000 818,375 971,251 Other time deposits 1,836,231 2,106,039 ---------- ---------- Total $5,965,126 $6,244,141 ========== ========== ---------------------------------------------------------------
Excluded from total deposits are demand deposit account overdrafts, which have been reclassified as loans. At December 31, 2001 and 2000, these overdrafts totaled $5.6 million and $7.4 million, respectively. Time deposits with remaining maturities of one year or more are $686.9 million at December 31, 2001. The maturities of these time deposits are as follows: $441.9 million in 2003, $156.7 million in 2004, $52.4 million in 2005, $28.9 million in 2006 and $7.0 million after 2006. NOTE 10. SHORT-TERM BORROWINGS Short-term borrowings consist of Federal funds purchased and securities sold under agreements to repurchase, Federal Home Loan Bank (FHLB) borrowings, other bank borrowings, and demand notes to the U.S. Treasury. Federal funds purchased are overnight borrowings from other financial institutions. Securities sold under agreements to repurchase are secured transactions done principally with clients and generally mature within thirty days. Information relating to federal funds purchased and securities sold under agreements to repurchase follows:
----------------------------------------------------------------------------- (in thousands) 2001 2000 1999 ----------------------------------------------------------------------------- At December 31: Balance $233,077 $394,466 $276,805 Weighted average interest rate paid 1.81% 6.35% 5.20% During the year: Maximum outstanding at any month-end $354,612 $540,652 $326,339 Daily average 242,945 305,402 256,718 Weighted average interest rate paid 4.32% 6.18% 4.74% -----------------------------------------------------------------------------
A - 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A significant amount of short-term borrowings also consisted of FHLB advances and lines of credit to Citizens' subsidiary banks. Information relating to short-term FHLB borrowings follows:
------------------------------------------------------------------------------ (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------ At December 31: Balance $ -- $450,074 $555,874 Weighted average interest rate paid -- 6.54% 5.34% During the year: Maximum outstanding at any month-end $425,200 $622,874 $555,874 Daily average 222,310 581,467 196,055 Weighted average interest rate paid 6.25% 6.47% 5.26% ------------------------------------------------------------------------------
Citizens' Parent company maintains a short-term line of credit with three unaffiliated banks totaling $75 million. The interest rate on the outstanding balance of $30 million at December 31, 2001 reprices daily and is based upon the Federal funds rate. Interest is payable monthly and the remaining principal is due in August 2002. The Parent company services the debt's principal and interest payments with dividends from the subsidiary banks. The agreement also requires Citizens to maintain certain financial covenants. Citizens is in full compliance with all debt covenants as of December 31, 2001. NOTE 11. LONG-TERM DEBT A summary of long-term debt follows:
------------------------------------------------------------- December 31, (in thousands) 2001 2000 ------------------------------------------------------------- CITIZENS SUBSIDIARIES: FHLB Notes $628,818 $ 470,767 Other 281 350 -------- --------- Total long-term debt $629,099 $ 471,117 ======== ========= -------------------------------------------------------------
Long-term advances from the FHLB are at fixed and variable rates ranging from 2.13% to 7.73% and have original maturities ranging from three to fifteen years. Interest is paid monthly. At December 31, 2001 and 2000, qualifying mortgage loans of $899 million and $1.3 billion, respectively, as well as FHLB stock collateralized long and short-term advances from the FHLB. Maturities of long-term debt during the next five years follow:
-------------------------------------------------------------- (in thousands) -------------------------------------------------------------- 2002 $ 125,729 2003 101,209 2004 973 2005 120,769 2006 981 Over 5 Years 279,438 --------- Total $ 629,099 ========= --------------------------------------------------------------
NOTE 12. EMPLOYEE BENEFIT PLANS PENSION AND POSTRETIREMENT BENEFITS: Citizens maintains defined benefit pension plans covering the majority of its employees, and postretirement benefit plans for retirees that include health care benefits and life insurance coverage. Pension retirement benefits are based on the employee's length of service and salary levels. Actuarially determined pension costs are charged to current operations. It is Citizens' policy to fund pension costs in an amount sufficient to meet or exceed the minimum funding requirements of applicable laws and regulations, plus such additional amounts as Citizens deems appropriate up to that allowable by federal tax regulations. Citizens also maintains nonqualified supplemental benefit plans for certain key employees. These plans are provided for by charges to earnings sufficient to meet the projected benefit obligation. The defined pension benefits provided under these plans are unfunded and any payments to plan participants are made by Citizens. Effective January 1, 2002 the defined benefit plan for Citizens' Michigan and Illinois employees (CBC Plan) was amended to provide for a new cash balance pension benefit. This amendment increased the projected benefit obligation of the CBC Plan by $1.1 million. Full-time employees that retire within the next five years with at least 10 years of service under the CBC Plan may elect to receive a benefit under the old formula, which is, in part, based on the employees' final five-year average base pay. In 2000, Citizens changed its pension plan benefit for its F&M employees. Previously only two of the 24 former F&M banks provided defined benefit plans to their employees. Effective January 1, 2000, Citizens extended coverage to substantially all F&M employees. These employees receive a pension benefit under a new cash balance plan. The assets and benefit obligation liabilities of the two previous F&M Plans were rolled into the new plan. A plan amendment to retroactively provide benefits as of January 1, 2000 increased the projected benefit obligation by $0.8 million. Citizens' postretirement benefit plan, as amended, is available to full-time employees who retire at normal retirement age, were age 50 prior to January 1, 1993 and have A - 34 at least 15 years of credited service under Citizens' defined benefit pension plan. The medical portion of the plan is contributory to the participants. The life insurance coverage is noncontributory and provided on a reducing basis for 5 years. Those retired prior to January 1, 1993 receive benefits provided by the plan prior to its amendment. That plan included dental care, had some retiree contribution requirements, and had less restrictive eligibility requirements. The following information summarizes activity in Citizens' pension and postretirement benefit plans.
---------------------------------------------------------------------------------------------------- Pension Postretirement Benefits Benefits ------------------------------------------------------------ (in thousands) 2001 2000 2001 2000 ---------------------------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION Benefit obligation, beginning of year $ 63,825 $ 47,846 $ 15,613 $ 14,423 Benefit obligation of former F&M plans, January 1 -- 6,621 -- -- Service cost 2,988 2,922 12 12 Interest cost 4,878 4,420 1,148 1,094 Participant contribution -- -- 304 150 Actuarial (gains) losses 3,916 3,453 160 1,285 Plan amendments 1,123 2,561 -- -- Benefits paid (3,200) (3,998) (1,523) (1,351) -------- -------- -------- -------- Benefit obligation, end of year $ 73,530 $ 63,825 $ 15,714 $ 15,613 ======== ======== ======== ======== CHANGE IN PLAN ASSETS Fair value of plan assets, beginning of year $ 69,036 $ 63,647 $ -- $ -- Actual return on plan assets (3,813) 943 -- -- Employer contribution 1,439 288 1,219 1,201 Participant contribution -- -- 304 150 Assets of F&M plans -- 8,260 -- -- Expenses paid (335) (104) -- -- Benefits paid (3,200) (3,998) (1,523) (1,351) -------- -------- -------- -------- Fair value of plan assets, end of year $ 63,127 $ 69,036 $ -- $ -- ======== ======== ======== ======== RECONCILIATION OF FUNDED STATUS (Under)/Over funded $(10,403) $ 5,211 $(15,714) $(15,613) Unrecognized: Net transition asset - 16 yr amortization (42) (163) -- -- Prior service cost (benefit) 3,404 2,908 (37) (42) Net actuarial (gain) loss 4,001 (11,544) 930 793 Adjustment to recognize minimum liability (5,961) -- -- -- -------- -------- -------- -------- Net amount recognized in the consolidated balance sheets $ (9,001) $ (3,588) $(14,821) $(14,862) ======== ======== ======== ======== ----------------------------------------------------------------------------------------------------
Pension plan assets consisted primarily of mutual and money market funds, and listed bonds and equity securities, including $686,000 and $606,000 of Citizens common stock at December 31, 2001 and 2000, respectively. The accrued pension benefit cost shown above includes the pension liabilities for plans where accumulated plan benefits exceed assets. In 2001, all plans had accumulated plan benefits in excess of assets. In 2000, only the supplemental benefit plans were under funded. The projected benefit obligation and accumulated benefit obligation for these plans were approximately $5.2 and $4.7 million, respectively, as of December 31, 2000. During 2000, the supplemental benefit plans were amended to enhance the benefit for active employees. This amendment increased Citizens' projected benefit obligation at December 31, 2000 by $1.8 million. The assumptions used in determining the actuarial present value of the benefit obligations and the net periodic pension expense follow:
--------------------------------------------------------------------- Pension Postretirement Benefits Benefits ----------------- ------------------- 2001 2000 2001 2000 --------------------------------------------------------------------- WEIGHTED-AVERAGE ASSUMPTIONS DECEMBER 31 Discount rate 7.25% 7.75% 7.25% 7.75% Expected return on plan assets 9.75 9.75 -- -- Rate of compensation increase (1) (1) -- -- ---------------------------------------------------------------------
(1) Scaled by age of plan participant - 9.00% at age 24 or under declining to 4.00% at age 50 or older. Prior service pension costs are amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plans. For postretirement health care benefit plans, Citizens assumed a constant 5% annual health care cost trend rate in 2001 and for all future years. This assumption can have a significant effect on the amounts reported. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
---------------------------------------------------------------- One Percentage One Percentage (in thousands) Point Increase Point Decrease --------------------------------------------------------------- Effect on total of service and interest cost components $ 97 $ (86) Effect on the postretirement benefit obligation 1,389 (1,234) ---------------------------------------------------------------
A - 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of net periodic benefit cost charged to operations each year for all plans follow:
------------------------------------------------------------------------------------ Year Ended December 31, (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------ DEFINED BENEFIT PENSION PLANS Service cost $ 2,988 $ 2,922 $ 2,304 Interest cost 4,878 4,420 4,018 Expected return on plan assets (6,873) (6,568) (5,554) Amortization of unrecognized: Net transition asset (123) (218) (218) Prior service cost 626 180 114 Net actuarial gain (586) (808) (464) ------- ------- ------- Net pension cost (income) 910 (72) 200 ------- ------- ------- POSTRETIREMENT BENEFIT PLANS Service cost 12 12 12 Interest cost 1,148 1,094 919 Amortization of unrecognized: Prior service cost (5) (385) (460) Net actuarial gain -- -- (57) ------- ------- ------- postretirement benefit cost 1,155 721 414 ------- ------- ------- DEFINED CONTRIBUTION RETIREMENT AND 401(K) PLANS Employer contributions 2,850 3,584 4,662 ------- ------- ------- Total periodic benefit cost $ 4,915 $ 4,233 $ 5,276 ======= ======= ======= ------------------------------------------------------------------------------------
In the third quarter of 1999, Citizens adopted an alternative market-related value methodology for pension plan assets to better reflect plan asset earnings, a component of pension expense, in 1999 and future years. The change reduced 1999 annual pension expense by approximately $556,000. DEFINED CONTRIBUTION SAVINGS AND RETIREMENT PLANS: Substantially all employees are eligible to contribute a portion of their pre-tax salary to a defined contribution 401(k) savings plan. Under the plan, employee contributions are partially matched by Citizens. The employer matching contribution is 75 percent of the first 6% (100 percent of the first 3% plus 50 percent of the next 3%) of each eligible employee's qualifying salary contributed to the plan. In addition, one third of these matching contributions are used to fund a postretirement medical savings account established within the plan for each contributing employee. Plan assets from a defined contribution 401(k) savings plan and an Employee Stock Ownership Plan maintained by F&M and one of its subsidiaries prior to the merger were transferred into Citizens' plan during 2000. Employer matching contributions for the F&M 401(k) savings plan were based on the company's return on equity and incorporated a discretionary profit-sharing contribution. NOTE 13. INCOME TAXES Significant components of income taxes are as follows:
---------------------------------------------------------------------- Year Ended December 31, (in thousands) 2001 2000 1999 ---------------------------------------------------------------------- Current tax expense: Federal $ 42,926 $ 31,773 $ 33,870 State 568 455 2,072 --------- --------- -------- Total current tax expense 43,494 32,228 35,942 Deferred tax expense (credit) (279) 3,585 (7,953) --------- -------- -------- Total income tax expense $ 43,215 $ 35,813 $ 27,989 ========= ========= ======== ----------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of Citizens' deferred tax assets and liabilities as of December 31, 2001 and 2000 follow:
-------------------------------------------------------------------- (in thousands) 2001 2000 -------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $29,349 $29,211 Accrued special charges -- 1,227 Accrued postemployment benefits other than pensions 5,288 5,395 Other deferred tax assets 9,366 7,794 ------- ------- Deferred tax assets 44,003 43,627 ------- ------- Deferred tax liabilities: Tax over book depreciation 4,212 4,551 Acquisition premium on loans 4,027 3,689 Net unrealized gains on securities 11,067 6,306 Other deferred tax liabilities 3,949 3,851 ------- ------- Deferred tax liabilities 23,255 18,397 ------- ------- Net deferred tax assets $20,748 $25,230 ======= ======= --------------------------------------------------------------------
A reconciliation of income tax expense to the amount computed by applying the federal statutory rate of 35% to income before income taxes follows:
-------------------------------------------------------------------------------- Year Ended December 31, (in thousands) 2001 2000 1999 -------------------------------------------------------------------------------- Tax at federal statutory rate applied to income before income taxes $ 51,755 $ 44,266 $ 31,494 Increase (decrease) in taxes resulting from: Tax-exempt interest (8,793) (8,229) (7,230) Other 253 (224) 3,725 -------- -------- -------- Total income tax expense $ 43,215 $ 35,813 $ 27,989 ======== ======== ======== --------------------------------------------------------------------------------
A - 36 NOTE 14. EARNINGS PER SHARE A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations follows:
-------------------------------------------------------------------------------- Year Ended December 31, (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------- NUMERATOR: Numerator for basic and dilutive earnings per share -- net income available to common shareholders $ 104,657 $ 90,660 $ 61,994 ========= ======== ======== DENOMINATOR: Denominator for basic earnings per share -- weighted average shares 46,085 47,310 48,169 Effect of dilutive securities - potential conversion of employee stock options 505 233 448 --------- -------- -------- Denominator for diluted earnings per share -- adjusted weighted-average shares and assumed 46,590 47,543 48,617 ========= ======== ======== BASIC EARNINGS PER SHARE $ 2.27 $ 1.92 $ 1.29 ========= ======== ======== DILUTED EARNINGS PER SHARE $ 2.25 $ 1.91 $ 1.28 ========= ======== ======== --------------------------------------------------------------------------------
All employee stock options were dilutive except for options granted in 1998 and 1999. See Note 15 for additional disclosures regarding employee stock options. NOTE 15. SHAREHOLDERS' EQUITY RIGHTS AGREEMENT: Citizens is a party to a Rights Agreement, dated May 23, 2000, designed to protect shareholders from unfair takeover offers by encouraging a potential buyer to negotiate with Citizens' board prior to attempting a takeover. Owners of Citizens' common shares have been granted rights under the Rights Agreement to purchase one one-thousandth of a share of Series B Preferred Stock at an exercise price of $65, subject to adjustment. The rights are not exercisable or separately tradable until after a public announcement that a person or group, without board approval, has acquired 15% or more of Citizens' common shares or has commenced a tender offer to do so. If a person or group acquires 15% or more of the common shares, the rights (other than those held by the acquiror, which become void) become exercisable to purchase common shares having a fair value of $130 for $65, or the board may exchange one common share for each outstanding right (other than those held by the acquiror). If the acquiror merges Citizens into another entity, the rights become exercisable for common shares of the surviving entity having a fair value of $130 for $65. The rights are redeemable by the board at any time prior to May 23, 2010 for $.001 per right. The Rights Agreement may be amended by the board without shareholder or right holder approval at any time prior to the acquisition by a person or group of 15% or more of the common shares. The rights will cause substantial dilution to a person or group attempting to acquire Citizens without action by Citizens' board to deactivate the rights. STOCK REPURCHASE PLANS: Citizens purchased shares under a stock repurchase program initiated May 2000. This program authorized Citizens to purchase up to 3,000,000 shares for treasury. During the year, 1,765,900 shares were purchased under this plan, completing that program. Citizens initiated a new stock repurchase program of 3,000,000 shares in October 2001. A total of 187,700 shares were purchased under this program through year-end. For the year ended December 31, 2001, a total of 1,953,600 shares were purchased under the plans at an average price of $29.94. As of December 31, 2001, there were 2,812,300 shares available for purchase under the current program. The treasury shares have been accorded the accounting treatment as if retired. STOCK OPTION PLAN: Citizens' stock option plan, as amended and restated in April 1997, authorizes the granting of incentive and nonqualified stock options, tandem stock appreciation rights, restricted stock and performance share grants to key employees. Aggregate grants under the plan may not exceed 3,000,000 shares within any six-year period and are limited annually to 3% of Citizens' outstanding common stock as of the first day of the year, plus any unused shares that first become available for grants in the prior year. The exercise price of all options granted under the plan is equal to the market price of Citizens' stock on the date of grant. Options may be granted until January 16, 2002 and expire ten years from the date of grant. Options granted since April 1992 are exercisable subject to a predetermined vesting schedule based on achievement of certain return on average asset or earnings per share targets. At December 31, 2001, options outstanding under the plan totaled 2,502,940 shares of which 1,115,941 shares are exercisable subject to future achievement of the performance targets. These options become exercisable after five years if the performance targets are not met. Canceled or expired options become available for future grants. OTHER STOCK OPTIONS: On May 18, 2000, Citizens granted stock options to all employees who did not receive grants under the key employee stock option plan. Each full-time employee received 200 shares and each part-time employee received 100 shares. The $16.66 exercise price of the grant was the market price of Citizens' stock on the grant date. The options are exercisable subject to Citizens achieving $2.65 earnings per share on a rolling four-quarter basis or three years, whichever comes first. No shares of this option grant are yet exercisable. The options expire ten years from A - 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the date of grant. A total of 550,700 shares were granted of which 398,900 shares were outstanding as of December 31, 2001. Citizens maintains a stock option plan for its directors. Under this plan, each non-employee director of Citizens serving on the board immediately following an annual meeting of shareholders receives an option grant of 1,500 shares. Options outstanding under the plan totaled 90,000 shares as of December 31, 2001. Other stock options of Citizens include those granted by F&M to its directors and key employees and converted into Citizens' options at the time of the merger. A total of 51,033 shares of these options were outstanding at year-end 2001. Citizens has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options as permitted by Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation." Under APB 25, no compensation expense is recognized by Citizens because the exercise price of the stock options equals the market price of the underlying stock on the date of grant. Statement 123 requires certain pro forma disclosures regarding net income and earnings per share as if Citizens had accounted for its stock options under the fair value method of that statement. The following table provides these disclosures along with significant assumptions used to estimate the fair value of these options:
------------------------------------------------------------------------------------------ 2001 2000 1999 ------------------------------------------------------------------------------------------ Pro forma amounts: Net income (in thousands) $ 102,808 $ 89,020 $ 60,590 Net income per share: Basic 2.23 1.88 1.26 Diluted 2.21 1.87 1.25 Assumptions: Dividend yield 3.5% 3.5% 3.0% Expected volatility 28.0% 25.0% 19.5% Risk-free interest rate 5.02% 6.80% 5.59% Expected lives 5 YRS. 5 yrs. 5 yrs. ------------------------------------------------------------------------------------------
A summary of stock option transactions under the plans for 2001, 2000 and 1999 follows:
--------------------------------------------------------------------------------------------------------------------------- Options Option Price ------------------------------------- --------------------------------------- Available Per Share for Grant Outstanding Range Average --------------------------------------------------------------------------------------------------------------------------- January 1, 1999 845,402 2,128,461 $ 5.40-36.31 $ 20.33 Authorized 201,237 -- -- -- Granted (455,229) 455,229 22.93-32.59 29.99 Exercised -- (287,906) 5.40-27.51 11.70 Canceled 29,287 (29,287) 24.85-35.63 31.88 ---------- ---------- ------------- --------- December 31, 1999 620,697 2,266,497 5.40-36.31 23.22 Authorized 803,897 -- -- -- Granted (1,224,350) 1,224,350 16.66-16.91 16.67 Exercised -- (158,544) 5.40-21.83 12.32 Canceled 52,336 (141,299) 16.66-35.63 20.54 ---------- ---------- ------------- --------- December 31, 2000 252,580 3,191,004 8.50-36.31 21.36 AUTHORIZED 566,858 -- -- -- GRANTED (651,200) 651,200 25.42-25.72 25.43 EXERCISED -- (591,602) 8.50-28.21 18.07 CANCELED 117,277 (207,729) 16.66-36.31 20.45 ---------- ---------- ------------- --------- DECEMBER 31, 2001 285,515 3,042,873 $ 11.75-36.31 $ 22.94 ========== ========== ============= ========= ---------------------------------------------------------------------------------------------------------------------------
A - 38 The following table summarizes information on stock options outstanding as of December 31, 2001:
--------------------------------------------------------------------------------------------------------- Options Outstanding Options Exercisable --------------------------------------------- ---------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range Amount Life Exercise Price Amount Exercise Price --------------------------------------------------------------------------------------------------------- $ 11.75 - 17.00 1,007,535 8.0 years $ 16.54 194,350 $16.03 17.00 - 25.00 717,801 4.5 20.22 717,801 20.22 25.00 - 36.31 1,317,537 7.8 29.31 615,881 31.22 --------- -------- $ 11.75 - 36.31 3,042,873 7.1 22.94 1,528,032 24.12 -----------------------------------------------------------------------------------------------------------
NOTE 16. COMMITMENTS AND CONTINGENT LIABILITIES The Consolidated Financial Statements do not reflect various loan commitments (unfunded loans and unused lines of credit) and letters of credit originated in the normal course of business. Loan commitments are made to accommodate the financial needs of clients. Generally, new loan commitments do not extend beyond 90 days and unused lines of credit are reviewed at least annually. Letters of credit guarantee future payment of client financial obligations to third parties. They are issued primarily for services provided or to facilitate the shipment of goods, and generally expire within one year. Both arrangements have essentially the same level of credit risk as that associated with extending loans to clients and are subject to Citizens' normal credit policies. Inasmuch as these arrangements generally have fixed expiration dates or other termination clauses, most expire unfunded and do not necessarily represent future liquidity requirements. Collateral is obtained based on management's assessment of the client and may include receivables, inventories, real property and equipment. Amounts available to clients under loan commitments and letters of credit follow:
------------------------------------------------------------- December 31, (in thousands) 2001 2000 ------------------------------------------------------------- LOAN COMMITMENTS AND LETTERS OF CREDIT: Commitments to extend credit $ 1,683,239 $1,699,174 Standby letters of credit 53,718 55,469 Commercial letters of credit 91,807 95,385 -------------------------------------------------------------
Loan commitments outstanding include $75.6 million of credit card commitments and $263.2 million of home equity credit lines in 2001. The same amounts for 2000 were $247.4 million and $230.0 million, respectively. Citizens and its subsidiaries are parties to litigation arising in the ordinary course of business. Management believes that the aggregate liability, if any, resulting from these proceedings would not have a material effect on Citizens' consolidated financial position. NOTE 17. FAIR VALUES OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosure About Fair Value of Financial Instruments". Where quoted market prices are not available, as is the case for a significant portion of Citizens' financial instruments, the fair values are based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the derived fair value estimates presented herein cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts Citizens could realize in a current market exchange. In addition, the fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, Citizens has a substantial trust department that contributes net fee income annually. The trust department is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include Citizens' brokerage network, net deferred tax asset, premises and equipment, goodwill and deposit based intangibles. In addition, tax ramifications related to the recognition of unrealized gains and losses such as those within the investment securities portfolio can also have a significant effect on estimated fair values and have not been considered in the estimates. Accordingly, the aggregate fair value amounts do not represent the underlying value of Citizens. A-39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated fair values of Citizens' financial instruments follow:
--------------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 2001 December 31, 2000 --------------------------- --------------------------- CARRYING ESTIMATED Carrying Estimated (in millions) AMOUNT FAIR VALUE Amount Fair Value --------------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and money market investments $ 267.0 $ 267.0 $ 345.6 $ 345.6 Investment securities 1,259.5 1,259.5 1,384.1 1,384.1 Net loans 5,842.1 5,965.8 6,342.7 6,376.5 Financial liabilities: Deposits 5,965.1 6,008.6 6,244.1 6,256.4 Short-term borrowings 314.4 314.6 933.3 933.5 Long-term debt 629.1 648.0 471.1 471.5 Off-balance sheet financial instrument liabilities: Loan commitments --- 3.2 --- 2.5 Standby and commercial letters of credit --- 0.7 --- 0.8 ---------------------------------------------------------------------------------------------------------------------------------
The various methods and assumptions used by Citizens in estimating fair value for its financial instruments are set forth below: CASH AND MONEY MARKET INVESTMENTS: The carrying amounts reported in the balance sheet for cash and money market investments approximate those assets' fair values because they mature within six months and do not present unanticipated credit concerns. INVESTMENT SECURITIES: The carrying amounts reported in the balance sheet for investment securities approximate those assets' fair values as all investment securities are classified as available for sale. SFAS No. 115 requires securities carried in the available for sale category to be carried at fair value - see Note 5. The fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. LOANS RECEIVABLE: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card, and other consumer. Each loan category is further segmented into fixed and variable-rate interest types and for certain categories by performing and nonperforming. For performing variable-rate loans that reprice frequently (within twelve months) and with no significant change in credit risk, fair values are based on carrying values. Similarly, for credit card loans with no significant credit concerns and average interest rates approximating current market origination rates, the carrying amount is a reasonable estimate of fair value. Fair values of other loans (e.g., fixed-rate commercial, commercial real estate, residential mortgage and other consumer loans) are estimated by discounting the future cash flows using interest rates currently being offered by Citizens for loans with similar terms and remaining maturities (new loan rates). Management believes the risk factor embedded in the new loan rates adequately represents the credit risk within the portfolios. Fair values for nonperforming loans are estimated after giving consideration to credit risk and estimated cash flows and discount rates based on available market and specific borrower information. The carrying amount of accrued interest for all loan types approximates its fair value. DEPOSIT LIABILITIES: Under SFAS 107, the fair value of demand deposits (e.g., interest and noninterest checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for certificates of similar remaining maturities. SHORT-TERM BORROWINGS: The carrying amounts of federal funds purchased, securities sold under agreement to repurchase and other short-term borrowings approximate their fair values. LONG-TERM DEBT: The carrying value of Citizens' variable-rate long-term debt approximates its fair value. The fair value of fixed-rate long-term debt is estimated using discounted cash flow analyses, based on Citizens' current incremental borrowing rates for similar types of borrowing arrangements. LOAN COMMITMENTS AND LETTERS OF CREDIT: The fair value of loan commitments and letter of credit guarantees is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. A-40 NOTE 18. LINES OF BUSINESS The financial performance of Citizens is monitored by an internal profitability measurement system, which provides line of business results and key performance measures. The profitability measurement system is based on internal management methodologies designed to produce consistent results and reflect the underlying economics of the businesses. The development and application of these methodologies is a dynamic process. Accordingly, these measurement tools and assumptions may be revised periodically to reflect methodological, product, and/or management organizational changes. Further, these policies measure financial results that support the strategic objectives and internal organizational structure of Citizens. Consequently, the information presented is not necessarily comparable with similar information for other institutions. Citizens is managed along the following business lines: Commercial Banking, Retail Banking, Financial Services, F&M and Other. COMMERCIAL BANKING: Commercial Banking provides a full range of credit and related financial services to middle market corporate, small business, government and leasing clients. Products and services offered include commercial loans, commercial mortgages, small business loans, letters of credit, deposit accounts, cash management and international trade services. RETAIL BANKING: Retail Banking includes consumer lending and deposit gathering, electronic banking and residential mortgage loan origination and servicing. This line of business offers a variety of retail financial products and services including deposit accounts, direct and indirect installment loans, debit and credit cards, home equity lines of credit, residential mortgage loans, fixed and variable annuities and ATM network services. FINANCIAL SERVICES: Financial Services provides commercial and retail clients with private banking, trust and investment, retirement plan, and brokerage and insurance services. Private banking focuses on high net-worth customers and offers a broad array of asset management, estate settlement and administration, deposit and credit products. Trust and investment includes personal trust and planning services, investment management services, estate settlement, administration and advises the Golden Oak family of mutual funds. Retirement plan services focus on investment management and fiduciary activities with special emphasis on 401(k) plans. The brokerage and insurance businesses deliver Citizens' retail mutual funds, other securities, variable and fixed annuities, personal disability and life insurance products and discounted brokerage services. F&M: F&M provides a full range of consumer and commercial banking services to individuals, and commercial and agricultural businesses, in Wisconsin and Iowa through a network of branch locations. Products and services offered include deposit accounts; commercial, commercial mortgage, agricultural, small business, residential mortgage and consumer loans; financial planning and trust; brokerage, insurance, ATM, credit card and cash management services. OTHER: All other includes activities that are not directly attributable to one of the four major lines of business. Included in this category is the parent company, Citizens' securities portfolio and asset liability management activities, inter-company eliminations, and the economic impact of certain assets, capital and support functions not specifically identifiable with the four primary lines of business. The accounting policies on the individual business units are the same as those of Citizens described in Note 1 to the Consolidated Financial Statements. Funds transfer pricing is used in the determination of net interest income by assigning a cost for funds used or credit for funds provided to assets and liabilities within each business unit. Assets and liabilities are match-funded based on their maturity, prepayment and/or repricing characteristics. As a result, the Commercial, Retail and Financial Services units are largely insulated from changes in interest rates. Changes in net interest income due to changes in interest rates are reported in Citizens' Treasury unit, which is a component of "Other". Changes in net interest income due to changes in interest rates for F&M are included in the operating income of F&M. Noninterest income and expenses directly attributable to a line of business are assigned to that business. Expenses for centrally provided services are allocated to the business lines as follows: product processing and technology expenditures are allocated based on standard unit costs applied to actual volume measurements; corporate overhead is allocated based on the ratio of a line of business' noninterest expenses to total noninterest expenses incurred by all business lines. The provision for loan losses was allocated in an amount based primarily upon the actual net charge-offs of each respective line of business, adjusted for loan growth and changes in risk profile. Selected segment information is included in the following table. A-41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------------------------------------------------------------------------------------------------ LINE OF BUSINESS INFORMATION Net Income Before Non- Non- Commercial Retail Financial recurring recurring (in thousands) Banking Banking Services F&M Other Items Items Total ----------------------------------------------------------------------------------------------------------------------------------- EARNINGS SUMMARY - 2001 Net interest income (taxable equivalent) $ 92,714 $ 125,418 $ 1,140 $ 94,000 $ 9,544 $ 322,816 $ -- $ 322,816 Provision for loan losses 6,949 7,046 -- 13,033 (621) 26,407 -- 26,407 --------- --------- --------- --------- --------- --------- --------- --------- Net interest income after provision 85,765 118,372 1,140 80,967 10,165 296,409 -- 296,409 Noninterest income 13,777 40,532 23,139 19,326 902 97,676 19,805 117,481 Noninterest expense 44,584 104,732 14,267 70,580 17,020 251,183 -- 251,183 --------- --------- --------- --------- --------- --------- --------- --------- Income (loss) before income taxes 54,958 54,172 10,012 29,713 (5,953) 142,902 19,805 162,707 Income tax expense (taxable equivalent) 19,235 18,960 3,504 10,758 (744) 51,713 6,337 58,050 --------- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 35,723 $ 35,212 $ 6,508 $ 18,955 $ (5,209) $ 91,189 $ 13,468 $ 104,657 Allocation of nonrecurring items -- 5,197 -- 1,110 7,161 (13,468) -- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 35,723 $ 40,409 $ 6,508 $ 20,065 $ 1,952 $ -- $ 104,657 ========= ========= ========= ========= ========= ========= ========= AVERAGE ASSETS (IN MILLIONS) $ 2,128 $ 2,804 $ 9 $ 2,633 $ 363 $ 7,936 ========= ========= ========= ========= ========= ========= ----------------------------------------------------------------------------------------------------------------------------------- EARNINGS SUMMARY - 2000 Net interest income (taxable equivalent) $ 91,718 $ 132,582 $ 1,330 $ 104,177 $ (857) $ 328,950 $ -- $ 328,950 Provision for loan losses 6,044 10,278 -- 4,103 558 20,983 -- 20,983 --------- --------- --------- --------- --------- --------- --------- --------- Net interest income after provision 85,674 122,304 1,330 100,074 (1,415) 307,967 -- 307,967 Noninterest income 12,352 31,914 26,618 16,633 2,827 90,344 -- 90,344 Noninterest expense 42,965 102,834 18,174 63,733 14,515 242,221 15,541 257,762 --------- --------- --------- --------- --------- --------- --------- --------- Income (loss) before income taxes 55,061 51,384 9,774 52,974 (13,103) 156,090 (15,541) 140,549 Income tax expense (taxable equivalent) 19,272 17,983 3,420 19,335 (4,044) 55,966 (6,077) 49,889 --------- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 35,789 $ 33,401 $ 6,354 $ 33,639 $ (9,059) $ 100,124 $ (9,464) $ 90,660 Allocation of special charge and related items -- -- -- (7,672) (1,792) 9,464 -- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 35,789 $ 33,401 $ 6,354 $ 25,967 $ (10,851) $ -- $ 90,660 ========= ========= ========= ========= ========= ========= ========= AVERAGE ASSETS (IN MILLIONS) $ 2,025 $ 2,596 $ 17 $ 2,745 $ 690 $ 8,073 ========= ========= ========= ========= ========= ========= ----------------------------------------------------------------------------------------------------------------------------------- EARNINGS SUMMARY - 1999 Net interest income (taxable equivalent) $ 76,788 $ 112,889 $ 1,357 $ 110,718 $ 20,095 $ 321,847 $ -- $ 321,847 Provision for loan losses 1,708 14,256 -- 2,975 (1,064) 17,875 6,800 24,675 --------- --------- --------- --------- --------- --------- --------- --------- Net interest income after provision 75,080 98,633 1,357 107,743 21,159 303,972 (6,800) 297,172 Noninterest income 10,526 28,500 24,177 15,994 6,391 85,588 2,097 87,685 Noninterest expense 38,821 95,703 18,159 63,002 21,093 236,778 46,293 283,071 --------- --------- --------- --------- --------- --------- --------- --------- Income (loss) before income taxes 46,785 31,430 7,375 60,735 6,457 152,782 (50,996) 101,786 Income tax expense (taxable equivalent) 16,375 11,000 2,581 22,785 2,887 55,628 (15,836) 39,792 --------- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 30,410 $ 20,430 $ 4,794 $ 37,950 $ 3,570 $ 97,154 $ (35,160) $ 61,994 Allocation of special charge and related items -- -- -- (26,748) (8,412) 35,160 -- --------- --------- --------- --------- --------- --------- --------- Net income (loss) $ 30,410 $ 20,430 $ 4,794 $ 11,202 $ (4,842) $ -- $ 61,994 ========= ========= ========= ========= ========= ========= ========= AVERAGE ASSETS (IN MILLIONS) $ 1,655 $ 2,138 $ 16 $ 2,602 $ 931 $ 7,342 ========= ========= ========= ========= ========= ========= -----------------------------------------------------------------------------------------------------------------------------------
A-42 NOTE 19. REGULATORY MATTERS The Federal Reserve Bank requires Citizens' banking subsidiaries to maintain certain noninterest-bearing deposits. These reserve balances vary depending upon the level of client deposits in the subsidiary banks. During 2001 and 2000, the average reserve balances were $41.9 million and $56.8 million, respectively. The bank subsidiaries are also subject to limitations under banking laws on extensions of credit to members of the affiliate group and on dividends that can be paid to Citizens. Generally extensions of credit are limited to 10% to any one affiliate and 20% in aggregate to all affiliates of a subsidiary bank's capital and surplus (net assets) as defined. Unless prior regulatory approval is obtained, dividends declared in any calendar year may not exceed the retained net profit, as defined, of that year plus the retained net profit of the preceding two years. At January 1, 2002, the bank subsidiaries could distribute to Citizens approximately $24.8 million in dividends without regulatory approval. Their 2002 net income will also become available for such dividends. Citizens and its banking subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require Citizens and its banking subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets (as defined in the regulations), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2001, that Citizens and its banking subsidiaries meet all capital adequacy requirements to which it is subject. As of December 31, 2001, the most recent notification from the Federal Reserve Board categorized Citizens and its banking subsidiaries as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized Citizens and its banking subsidiaries must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes would result in a change.
----------------------------------------------------------------------------------------------------------------- RISK BASED CAPITAL REQUIREMENTS To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------- ----------------------------- ---------------------------- (in thousands) Amount Ratio Amount Ratio Amount Ratio ----------------------------------------------------------------------------------------------------------------- CITIZENS BANKING CORPORATION AS OF DECEMBER 31, 2001: Total Capital to risk weighted assets (1) $ 669,332 11.1% $ 481,512 greater than or $ 601,889 greater than or equal to 8.0% equal to 10.0% Tier 1 Capital to risk weighted assets (1) 594,033 9.9 240,756 greater than or 361,134 greater than or equal to 4.0 equal to 6.0 Tier 1 Leverage (2) 594,033 7.8 304,854 greater than or 381,068 greater than or equal to 4.0 equal to 5.0 As of December 31, 2000: Total Capital to risk weighted assets (1) $ 659,901 10.3% $ 512,362 greater than or $ 640,453 greater than or equal to 8.0% equal to 10.0% Tier 1 Capital to risk weighted assets (1) 579,844 9.1 256,181 greater than or 384,272 greater than or equal to 4.0 equal to 6.0 Tier 1 Leverage (2) 579,844 7.1 326,142 greater than or 407,677 greater than or equal to 4.0 equal to 5.0 CITIZENS BANK AS OF DECEMBER 31, 2001: Total Capital to risk weighted assets (1) $ 425,456 10.4% $ 327,353 greater than or $ 409,191 greater than or equal to 8.0% equal to 10.0% Tier 1 Capital to risk weighted assets (1) 374,294 9.2 163,676 greater than or 245,515 greater than or equal to 4.0 equal to 6.0 Tier 1 Leverage (2) 374,294 7.5 199,801 greater than or 249,751 greater than or equal to 4.0 equal to 5.0 As of December 31, 2000: Total Capital to risk weighted assets (1) $ 435,996 10.6% $ 330,086 greater than or $ 412,608 greater than or equal to 8.0% equal to 10.0% Tier 1 Capital to risk weighted assets (1) 384,417 9.3 165,043 greater than or 247,565 greater than or equal to 4.0 equal to 6.0 Tier 1 Leverage (2) 384,417 7.5 205,479 greater than or 256,849 greater than or equal to 4.0 equal to 5.0 -----------------------------------------------------------------------------------------------------------------
(1) Total Capital is comprised of Tier 1 Capital plus a portion of the allowance for loan losses. Tier 1 Capital consists of total equity less unrealized gains and losses accumulated in other comprehensive income, certain intangible assets and adjustments related to the valuation of mortgage servicing assets. (2) Tier 1 Capital to quarterly average assets A-43 NOTE 20. CITIZENS BANKING CORPORATION (PARENT ONLY) STATEMENTS
------------------------------------------------------------------------------------------------------------------------------ BALANCE SHEETS CITIZENS BANKING CORPORATION (PARENT ONLY) December 31, (in thousands) 2001 2000 ------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash $ 5 $ 5 Money market investments 2,969 7,916 Investment securities 73 63 Investment in subsidiaries - principally banks 719,422 715,726 Goodwill - net 265 1,061 Other assets 5,349 5,771 ---------- ---------- TOTAL ASSETS $ 728,083 $ 730,542 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Short-term revolving credit $ 30,000 $ 48,000 Other liabilities 619 2,563 ---------- --------- Total liabilities 30,619 50,563 Shareholders' equity 697,464 679,979 ---------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 728,083 $ 730,542 ========== ========= ------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------ STATEMENTS OF INCOME CITIZENS BANKING CORPORATION (PARENT ONLY) Year Ended December 31, (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------------ INCOME Dividends from subsidiaries - principally banks $107,400 $ 79,400 $ 54,686 Interest from bank subsidiary 32 18 193 Service fees from bank subsidiaries 9,435 9,517 9,668 Equity security gain 11,017 --- 5,693 Other 890 646 205 -------- -------- -------- Total 128,774 89,581 70,445 -------- -------- -------- EXPENSES Interest 1,904 3,099 1,486 Amortization of goodwill 796 796 796 Salaries and employee benefits 9,955 9,333 9,780 Service fees paid to bank subsidiaries 1,265 1,215 1,156 Special charge --- (211) 3,464 Other noninterest expense 3,888 1,884 1,474 -------- ------ -------- Total 17,808 16,116 18,156 -------- ------- -------- Income before income taxes and equity in undistributed earnings of subsidiaries 110,966 73,465 52,289 Income tax benefit (1,197) 2,727 846 Equity in undistributed earnings of subsidiaries (5,112) 14,468 8,859 -------- -------- -------- NET INCOME $104,657 $ 90,660 $ 61,994 ======== ======== ======== ------------------------------------------------------------------------------------------------------------------------------
A-44
---------------------------------------------------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS CITIZENS BANKING CORPORATION (PARENT ONLY) Year Ended December 31, (in thousands) 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 104,657 $ 90,660 $ 61,994 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of goodwill 796 796 796 Equity security gain (11,017) --- (5,693) Accrued merger related charges --- --- 1,669 Equity in undistributed earnings of subsidiaries 5,112 (14,468) (8,859) Other (1,525) (2,657) (3,114) ------- -------- ------- Net cash provided by operating activities 98,023 74,331 46,793 ------- -------- ------- INVESTING ACTIVITIES Net decrease in interest-bearing deposit at subsidiary bank --- --- 4,500 Net (increase) decrease in money market investments 4,947 (6,814) 6,333 Purchases of investment securities --- (19) (5,996) Proceeds from sales and maturities of investment securities --- 33 5,995 Proceeds from sale of Magic Line, Inc. stock --- --- 5,693 Proceeds from sale of NYCE stock 11,017 --- --- ------- -------- -------- Net cash provided (used) by investing activities 15,964 (6,800) 16,525 ------- -------- -------- FINANCING ACTIVITIES Proceeds from short-term borrowings 6,000 6,000 42,000 Principal reductions in short-term borrowings (24,000) --- --- Proceeds from issuance of long-term debt --- --- 22,000 Principal reductions in long-term debt --- --- (35,000) Cash dividends paid (50,158) (48,108) (41,801) Proceeds from stock options exercised 12,662 1,879 3,349 Shares acquired for retirement (58,491) (27,302) (53,866) --------- -------- -------- Net cash used by financing activities (113,987) (67,531) (63,318) --------- -------- -------- Net increase in cash --- --- --- Cash at beginning of year 5 5 5 --------- -------- -------- Cash at end of year $ 5 $ 5 $ 5 ========= ======== ======== ----------------------------------------------------------------------------------------------------------------------------
A - 45 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS BOARD OF DIRECTORS CITIZENS BANKING CORPORATION We have audited the accompanying consolidated balance sheets of Citizens Banking Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform our audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens Banking Corporation and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Ernst & Young LLP Detroit, Michigan January 17, 2002 A-46 REPORT OF MANAGEMENT MANAGEMENT'S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management is responsible for the preparation of the Consolidated Financial Statements and all other financial information appearing in this Annual Report. The Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States. SYSTEM OF INTERNAL CONTROLS Citizens maintains a system of internal controls designed to provide reasonable assurance that assets are safe-guarded and that the financial records are reliable for preparing Consolidated Financial Statements. The selection and training of qualified personnel and the establishment and communication of accounting and administrative policies and procedures are elements of this control system. The effectiveness of the internal control system is monitored by a program of internal audit and by independent certified public accountants ("independent auditors"). Management recognizes that the cost of a system of internal controls should not exceed the benefits derived and that there are inherent limitations to be considered in the potential effectiveness of any system. Management believes Citizens' system provides the appropriate balance between costs of controls and the related benefits. AUDIT COMMITTEE OF THE BOARD The Audit Committee of the Board of Directors, comprised entirely of outside directors, recommends the independent auditors who are engaged upon approval by the Board of Directors. The committee meets regularly with the internal auditor and the independent auditors to review timing and scope of audits and review audit reports. The internal auditor and the independent auditors have free access to the Audit Committee. INDEPENDENT AUDITORS The Consolidated Financial Statements in this Annual Report have been audited by Citizens' independent auditors, Ernst & Young LLP, for the purpose of determining that the Consolidated Financial Statements are free of material misstatement. Their audit considered Citizens' internal control structure to the extent necessary to determine the scope of their auditing procedures. /s/ John W. Ennest /s/ Robert J. Vitito John W. Ennest Robert J. Vitito Vice Chairman, Chairman, Chief Financial Officer and Treasurer President and Chief Executive Officer A - 47