-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KRar6+7dy8lkn0fn4KRE4IzLYwBzaetuVuaVShfQbLFNgxMVcx2y+YedJPG3CTJR 2VXR8Pm3E81dxTQDHONlNA== 0000950124-98-001632.txt : 19980330 0000950124-98-001632.hdr.sgml : 19980330 ACCESSION NUMBER: 0000950124-98-001632 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: D&N FINANCIAL CORP CENTRAL INDEX KEY: 0000830143 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 342790646 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-17137 FILM NUMBER: 98575207 BUSINESS ADDRESS: STREET 1: 400 QUINCY ST CITY: HANCOCK STATE: MI ZIP: 49930 BUSINESS PHONE: 2024146100 10-K405 1 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 1997 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [NO FEE REQUIRED] For the transition period from to ------------ --------------- Commission File Number 0-17137 D & N FINANCIAL CORPORATION ----------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 38-2790646 ------------------------------- --------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 400 Quincy Street, Hancock, Michigan 49930 ----------------------------------------- -------------------- (Address of Principal Executive Offices (Zip Code) Registrant's telephone number, including area code (906) 482-2700 ------------- Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share ------------------------------------------------------------------ (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. YES X . NO . --- --- Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 10, 1998, there were issued and outstanding 9,120,324 shares of the Registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of such stock at March 10, 1998, was $208,862,000. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant.) DOCUMENTS INCORPORATED BY REFERENCE PARTS II and IV of Form 10-K - Annual Report to Stockholders for the Fiscal Year Ended December 31, 1997. PART III of Form 10-K - Portions of the Proxy Statement for the Annual Meeting of Stockholders to be held in 1998. ========================================================================== 2 PART I ITEM 1. BUSINESS D&N Financial Corporation ("D&N" or the "Company") is a financial services holding company organized under the laws of the state of Delaware. The Company's principal subsidiary is D&N Bank (the "Bank"), a federally chartered stock savings bank headquartered in Hancock, Michigan. The Bank was founded in 1889 and operated as a state-chartered mutual savings and loan association until February 1984, when it converted to a federal charter. In 1985, the Bank converted to a stock association, and in 1986, converted to a federal savings bank. The Bank adopted a holding company structure in July 1988. With total assets of $1.82 billion at December 31, 1997, D&N is one of the largest savings institutions headquartered in Michigan. D&N's primary business consists of attracting deposits from the general public and making real estate loans, business loans, and consumer loans and other types of investments. The Company conducts its business through a network of 37 full-service community banking offices, including its main office in Hancock, Michigan, seven savings agency offices which provide depository services and four mortgage banking offices. The Bank's deposits are insured up to the maximum extent permitted by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a member of the Federal Home Loan Bank ("FHLB") of Indianapolis, which is one of the 12 regional banks comprising the FHLB System. The Bank is subject to supervision by the Office of Thrift Supervision, Department of the Treasury ("OTS") and by the FDIC. The executive office of the Company is located at 400 Quincy Street, Hancock, Michigan 49930, telephone (906) 482-2700. Like many financial institutions, the operations of the Company's subsidiary are materially affected by general economic conditions, the monetary and fiscal policies of the federal government and the policies of the various regulatory authorities, including the OTS, the FDIC and the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). Its results of operations are largely dependent upon its net interest income which is the difference between the interest it receives on its loans and investment securities, and the interest it pays on its liabilities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Asset/Liability Management." FORWARD LOOKING STATEMENTS When used in this Form 10-K or future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or - 2 - 3 other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "would be", "will allow", "intends to", "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors, could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. The Company does not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. LENDING ACTIVITIES GENERAL. The Bank, has concentrated its lending activities on first mortgage conventional loans secured by residential and commercial real estate and both installment and revolving consumer and business loans. Approximately $411.9 million or 50% of the Bank's total loans, excluding loans held for sale, secured by real estate as of December 31, 1997, permit periodic interest rate adjustments. LOAN PORTFOLIO COMPOSITION. The following table sets forth information concerning the composition of D&N's loan portfolio in dollar amounts and percentages, by type of loan.
December 31 ---------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------------ ------------------ ------------------ ----------------- ---------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in thousands) TYPE OF LOAN REAL ESTATE One to four family Permanent $ 703,580 54.08% $ 600,923 56.91% $ 597,892 62.78% $ 526,572 64.07% $ 387,252 59.89% Construction 13,864 1.07 13,201 1.25 19,982 2.10 2,159 0.26 2,083 0.32 Income producing property Permanent 81,830 6.29 85,619 8.11 89,176 9.36 115,162 14.01 131,372 20.31 Construction 42,582 3.27 26,472 2.51 21,074 2.21 17,741 2.16 10,475 1.62 ----------- ------ --------- ------ -------- ------ --------- ------ --------- ------ Total real estate loans 841,856 64.71 726,215 68.78 728,124 76.45 661,634 80.50 531,182 82.14
- 3 - 4
CONSUMER LOANS Automobile loans 198,505 15.26 141,056 13.36 81,885 8.60 46,711 5.68 Home equity 99,122 7.62 82,305 7.79 60,003 6.30 39,939 4.86 Home improvement 47,845 3.68 46,545 4.41 41,542 4.36 39,279 4.78 Mobile home loans 213 0.02 289 0.03 417 0.04 619 0.08 Unsecured 12,395 0.95 15,172 1.44 19,637 2.06 22,197 2.70 Other 91,471 7.03 53,901 5.10 35,975 3.78 22,194 2.70 ---------- ------ ---------- ------ -------- ------- -------- ------ Total consumer loans 449,551 34.56 339,268 32.13 239,459 25.14 170,939 20.80 COMMERCIAL LOANS Revolving business loans 11,363 0.87 2,363 0.22 1,119 0.12 -- -- Term business loans 27,072 2.08 9,982 0.95 6,650 0.70 4,748 0.58 ---------- ------ ---------- ------ -------- ------- -------- ------ Total commercial loans 38,435 2.95 12,345 1.17 7,769 0.82 4,748 0.58 ---------- ------ ---------- ------ -------- ------- -------- ------ Loans receivable, gross 1,329,842 102.22 1,077,828 102.08 975,352 102.41 837,321 101.88 Less: Discounts (premiums) on loans purchased (2,356) (0.18) (2,035) (0.19) (1,709) (0.18) 999 0.12 Allowance for losses 10,549 0.81 11,042 1.05 10.081 1.06 8,349 1.02 Undisbursed portion of loan proceeds 20,315 1.56 12,085 1.14 13,198 1.38 4,213 0.51 Deferred income 375 0.03 860 0.08 1,423 0.15 1,885 0.23 ----------- ------ ---------- ------ -------- ------ -------- ------ 28,883 2.22 21,952 2.08 22,993 2.41 15,446 1.88 ----------- ------ ---------- ------ -------- ------ -------- ------ Loans receivable, net $ 1,300,959 100.00% $1,055,876 100.00% $952,359 100.00% $821,875 100.00% =========== ======= ========== ====== ======== ====== ======== ======
CONSUMER LOANS Automobile loans 34,220 5.29 Home equity 23,058 3.57 Home improvement 40,017 6.19 Mobile home loans 776 0.12 Unsecured 20,328 3.14 Other 16,245 2.51 -------- ------- Total consumer loans 134,644 20.82 COMMERCIAL LOANS Revolving business loans -- -- Term business loans -- -- -------- ------- Total commercial loans -- -- -------- ------- Loans receivable, gross 665,826 102.96 Less: Discount (premiums) on loans purchased 2,896 0.45 Allowance for losses 11,570 1.79 Undisbursed portion of loan proceeds 2,750 0.43 Deferred income 1,901 0.29 -------- ------- 19,117 2.96 -------- ------- Loans receivable, net $646,709 100.00% ======== =======
LOAN MATURITIES. The following schedule illustrates the maturity structure of the Company's loan portfolio at December 31, 1997. Loans are shown as maturing in the period in which payment is due. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
Residential Commercial and Real Estate Business Income Producing Construction Property Property Loans Consumer Loans Total Amounts ----------------- ------------------ ------------------ ------------------ ---------------- Due in Years Weighted Weighted Weighted Weighted Weighted Ending Average Average Average Average Average December 31, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate - ------------ ------- -------- ------ -------- ------- --------- ------- ------- ------- ------- (Dollars in thousands) 1998 $ 13,973 9.53% $ 12,441 8.70% $ 28,177 9.24% $ 87,562 9.17% $ 142,153 9.18% 1999 4,218 9.20 17,641 8.51 4,981 9.84 89,431 8.99 116,271 8.96 2000 5,135 9.32 44,017 7.65 10,083 9.87 86,825 9.03 146,060 8.68 2001-2002 10,363 9.39 55,478 8.42 10,038 10.30 139,265 9.17 215,144 9.04 2003-2007 3,803 9.43 57,255 7.99 1,903 9.24 35,091 9.13 98,052 8.48 2008-2012 571 8.79 91,861 7.86 833 9.32 8,743 8.24 102,008 7.91 Thereafter 101 8.87 502,650 7.77 -- -- 165 8.03 502,916 7.76 -------- -------- -------- ---------- ---------- Total $ 38,164 9.40% $781,343 7.86% $ 56,015 9.60% $ 447,082 9.08% $1,322,604 8.39% ======== ======== ======== =========
- 4 - 5 Plus: Accrued interest receivable, net of reserve for uncollected interest 7,311 Deferred income and premiums 1,908 Less: Loans in process 20,315 Loss and valuation allowances 10,549 ---------- $1,300,959 ==========
The total amount of loans, excluding loans held for sale, due after December 31, 1998 which have fixed interest rates is $403.8 million, while the amount of loans due after such date having floating or adjustable rates is $771.3 million. LOAN ORIGINATIONS, PURCHASES AND SALES. Federally chartered savings institutions, like the Bank, have general authority to make real estate loans throughout the United States. D&N has originated residential mortgage loans secured by property both within and outside the State of Michigan. D&N has also purchased residential mortgage loans secured by property located in various states. In addition, the Company has originated income producing property loans secured by real estate located in the State of Michigan and has purchased such loans secured by property located in Michigan and elsewhere. Since 1990, the Bank has chosen to focus the activities of its community banking offices on loan originations in their market areas. At December 31, 1997, 73% of D&N's real estate loans receivable (excluding government agency insured or guaranteed mortgage-backed and derivative products) were secured by real estate located in Michigan. The following table presents information regarding the geographic location of the properties securing D&N's residential mortgage and income producing property loans at December 31, 1997. See "- Classified Assets, Loan Delinquencies and Defaults" for a discussion of other real estate owned.
Outstanding Balance at December 31, 1997 -------------------- (In thousands) MICHIGAN One- to four-family residential.................... $506,959 Apartments......................................... 14,803 Mini warehouse, storage ........................... 1,440 Mobile home parks.................................. 2,063 Motels/hotels ..................................... 11,160 Shopping centers and retail ....................... 17,195 Office buildings .................................. 7,304
- 5 - 6
Outstanding Balance at December 31, 1997 ------------------- (In thousands) Industrial ................................................. 4,788 Condominiums and land development .......................... 31,694 Other ...................................................... 17,785 ------- 615,191 CALIFORNIA ................................................... . One- to four-family residential ............................ 23,466 Apartments ................................................. 6,325 Mobile home parks .......................................... 55 Shopping centers & retail .................................. 3,482 Office buildings ........................................... 681 Industrial ................................................. 372 Other ...................................................... 93 ------- 34,474 MASSACHUSETTS One- to four-family residential ............................ 19,889 ------- 19,889 NEW YORK One- to four-family residential ............................ 4,958 Apartments ................................................. 805 ------- 5,763 NORTH CAROLINA One- to four-family residential ............................ 7,514 ------- 7,514 TEXAS One- to four-family residential ............................ 12,110 ------- 12,110 PENNSYLVANIA One- to four-family residential ............................ 5,652 Apartments ................................................. 241 Industrial ................................................. 114 Other ...................................................... 50 ------- 6,057 FLORIDA One-to four-family residential ............................... 5,192 ------- 5,192 OTHER (31 STATES) One- to four-family residential ............................ 123,812 Apartments ................................................. 138 Motels/hotels .............................................. 331 Shopping centers and retail ................................ 1,951
- 6 - 7
Outstanding Balance at December 31, 1997 -------------------- (In thousands) Office buildings ............................................ 66 Other ....................................................... 250 --------- 126,548 Rated conventional residential participation certificates ................................... 4,621 --------- Total ......................................................... 837,359 Plus: Loan control and clearing ................................... 298 Accrued interest receivable, net of reserve for uncollected interest .................................... 4,199 Less: Deferred income, discounts and premiums .................... (1,131) Loans in process ........................................... 20,315 Loss and valuation allowances .............................. 5,955 --------- Total .................................................... $ 816,717 =========
Residential loan originations are attributable to direct marketing efforts of the Bank and of the Bank's subsidiary, D&N Mortgage Corporation, as well as to referrals from real estate brokers and builders. Income producing property loans are originated through the Bank's direct marketing efforts and through referrals by existing customers. In 1997, total loan originations increased $120.2 million, or 24% as a result of a significant increase in consumer lending activity. Consumer loan originations alone increased $52.1 million, or 19%. D&N Bank has sold loans and loan participations in the secondary market, generally without recourse. Loans held for sale are recorded at the lower of cost or market value. At December 31, 1997, the Bank had $5.3 million of net loans held for sale consisting of 15 and 30 year fixed rate loans. These sales have provided additional funds for loan originations and investments and also generated income. The Bank generally continues, after the sale, to service the loans and loan participations sold. Loan sales are made on a yield basis with a portion of the difference between the yield to the purchaser and the amount paid by the borrower constituting servicing income to D&N. On occasion, the Bank also purchased mortgage loan servicing rights from others in order to maintain its loan servicing portfolio economies of scale. The weighted average servicing fee for loans serviced for others was .31% at December 31, 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Noninterest Income." At - 7 - 8 December 31, 1997, D&N serviced for others approximately $519 million in loans and loan participations. See also Note A of Notes to Consolidated Financial Statements "Summary of Significant Accounting Policies - Mortgage Servicing Rights". The Bank's investment in mortgage servicing rights ("MSRs") totaled $2.1 million at December 31, 1997. The following table details the value of the Bank's investment in MSRs.
Year Ended December 31 -------------------------------------------- 1997 1996 1995 ------------ -------------- -------- (In thousands) Balance at beginning of year $ 1,443 $ 1,113 $ 968 Additions: Capitalized servicing 1,236 630 621 Reductions: Scheduled amortization 321 267 169 Additional amortization due to changes in prepayment assumptions 222 33 71 Impairment -- -- 234 Sales -- -- -- Transfers to loan portfolio under recourse and other provisions -- -- 2 ------- ------- ------- Total 543 300 476 ------- ------- ------- Balance at end of year $ 2,136 $ 1,443 $ 1,113 ======= ======= ======= Fair market value at end of year $ 2,389 $ 1,770 $ 1,161 ======= ======= =======
The following table shows origination, purchase, sale and repayment activities of D&N Bank, including mortgage-backed securities, for the periods indicated.
Year Ended December 31 ---------------------------------------------------------------- 1997 1996 1995 1994 1993 -------- ---------- ----------- ----------- -------- (In thousands) ORIGINATIONS Real estate: One- to four-family residential ..... $215,452 $194,357 $182,800 $ 81,279 $147,246 Income producing property ........... 45,594 33,816 17,614 17,350 13,014 Non-real estate: Consumer ............................ 323,676 271,622 195,109 132,836 95,129 Commercial .......................... 46,708 11,437 3,739 4,748 -- ---------- -------- -------- -------- -------- Total originations................. 631,430 511,232 399,262 236,213 255,389 PURCHASES Real estate: One- to four-family residential...... 234,886 148,405 103,524 188,481 72,125 Income producing property............ -- -- -- 1,852 -- Mortgage-backed securities........... 107,400 58,892 -- 68,391 108,749 --------- --------- -------- -------- -------- Total purchases ................... 342,286 207,297 103,524 258,724 180,874 --------- --------- -------- -------- -------- Total additions.................... 973,716 718,529 502,786 494,937 436,263
- 8 - 9 SALES Real estate: One- to four-family residential...... 85,778 68,024 107,080 45,311 106,167 Mortgage-backed securities(1)........ 23,555 -- 4,210 50,658 126,932 Non-real estate: Consumer loans....................... 2,383 2,810 2,976 2,894 2,229 -------- -------- --------- --------- ------- Total sales........................ 111,716 70,834 114,266 98,863 235,328 Principal repayments................... 504,972 426,291 288,485 239,816 316,624 -------- -------- --------- --------- --------- Total reductions................... 616,688 497,125 402,751 338,679 551,952 Transfers to other real estate owned... (961) (3,373) (1,936) (2,861) (9,380) Increase (decrease) in other items, net (3,944) 9,033 8,801 1,079 (19,622) -------- -------- --------- --------- --------- Net increase (decrease)............ $352,123 $227,064 $ 106,900 $ 154,476 ($144,691) ======== ======== ========= ========= =========
(1) Includes sales of CMO residuals which were carried at the lower of cost or market. Outstanding loan commitments of the Bank at December 31, 1997 amounted to $38.6 million for one- to four-family residential real estate loans and $40.1 million for commercial real estate loans. See "Regulation - Federal Savings Association Regulation." RESIDENTIAL MORTGAGE LOANS. At December 31, 1997, the Bank had $717.4 million in residential mortgage loans representing 55.1% of the Bank's total loan portfolio. This amount represents a 16.8% increase in the dollar value of the residential loan portfolio. However, it also represents a 3.1% decrease in the percentage of the Bank's portfolio consisting of residential real estate loans as the Bank shifted its focus to emphasize the origination of consumer loans. The original contractual loan payment period for residential loans originated by D&N Bank normally ranges from 15 to 30 years. Because borrowers may refinance or prepay their loans, however, such loans often remain outstanding for a substantially shorter period of time. Prior to 1992, most of the Bank's residential mortgage loans were originated by its mortgage banking subsidiary. The mortgage banking subsidiary originated loans in southeastern Michigan, Illinois, Arizona, Texas and North Carolina. The Bank now originates loans primarily in its Michigan market area through its community banking and mortgage banking offices. Substantially all of the residential loans being originated by the Bank are in a form which permits their sale in the secondary market. The Bank's first mortgages customarily include "due-on-sale" clauses, which are provisions giving the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. In general, the Bank enforces due-on-sale clauses in its first mortgages. - 9 - 10 In the case of conventional mortgage loans intended for sale, the Bank's policy is to lend a maximum of 95% of the appraised value of single-family residences. The Bank generally does not lend more than 90% of the appraised value of the property on those loans it intends to hold. Private mortgage insurance is required if the loan amount exceeds 80% of the appraised value, in an amount sufficient to reduce the Bank's exposure to 75% or less of the appraised value of the property. Property securing real estate loans made by the Bank is appraised by independent appraisers selected by the Bank and whose appraisals are reviewed by D&N personnel or other independent appraisers. Loans up to the maximum limits for single family homes of the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA") may be approved by qualified loan officers of the Bank. The Bank's Residential Loan Committee has single-family lending authority up to $500,000, if two members approve. Loans in excess of $500,000 must be approved by the Bank's Loan Committee (comprised of Messrs. Butvilas, Krupka, Janson, West and Sliwinski). Loans in excess of $2 million must also be approved by the Bank's Board of Directors. Title, fire and casualty insurance as well as surveys are generally required on all mortgage loans. D&N Bank also offers a variety of Adjustable Rate Mortgages, ("ARM") loans which offer adjustable rates of interest, payments, loan balances or terms to maturity which vary according to specified indices. The Bank's ARMs generally have a loan term of 30 years with rate adjustments every year or every three years during the term of the loan. ARMs currently originated by the Bank contain a 2% limit as to the maximum amount of change in the interest rate at any adjustment period and a 6% limit over the life of the loan. The Bank generally originates ARMs to hold in its portfolio. At December 31, 1997, residential ARMs totaled $328 million, or 47% of the Bank's total residential one- to four-family mortgage loan portfolio. Of this total ARM portfolio, $197 million or 60% were purchased from others. Due to consumer demand, residential loans originated during 1997 were predominately fixed rate loans. Despite the benefits of ARMs to the Bank's asset/liability management program, such loans also pose potential additional risks, primarily because as interest rates rise, the underlying payment by the borrower rises, increasing the potential for default. At the same time, marketability of the underlying property may be adversely affected by higher interest rates. MORTGAGE-BACKED SECURITIES. The Bank on occasion purchases mortgage-backed securities to supplement residential loan production. The types of securities purchased are based upon the Bank's asset/liability management strategy and balance sheet objectives. In 1997, the Company - 10 - 11 purchased $107.5 million of fixed rate Collateralized Mortgage Obligations ("CMO") with expected average lives of 2.7 to 4.3 years. CMOs are securitiesderived by reallocating cash flows from mortgage pass-through securities or pools of mortgage loans held by a trust. The CMO securities purchased by the Bank in 1997 are backed by pass-through securities of either FHLMC, FNMA or Government National Mortgage Association ("GNMA"). The Bank has in the past invested in interest only strip securities ("IOs") and principal only strip securities ("POs") as part of its asset/liability management strategy. At December 31, 1997, D&N had IOs with a book value and a market value of $1.4 million, and had no POs at that date. The following table sets forth information concerning the composition of D&N's mortgage-backed securities portfolio in dollar amounts and percentages, by type of security. See also Note F of Notes to Consolidated Financial Statements.
December 31 ----------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 MORTGAGE-BACKED ---------------- --------------- --------------- ---------------- ------------------ SECURITIES Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent - --------------------------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars In thousands) TYPE OF SECURITY One- to four-family: Mortgage-backed securities ........ $ 356,079 99.38% $ 249,186 99.18% $ 125,264 98.09% 147,988 97.81% $166,284 96.69% Interest only certificates ...... 1,456 0.41 2,070 0.82 2,456 1.92 3,886 2.57 4,321 2.51 --------- ----- --------- ------ --------- ------ -------- ------ -------- ------ Mortgage-backed securities, gross.. 357,535 99.79 251,256 100.00 127,720 100.01 151,874 100.38 170,605 99.20 Net (discounts) premiums .......... 761 0.21 -- -- (11) (0.01) (581) (0.38) 1,378 0.80 --------- ------ --------- ------ -------- ------ -------- ------ -------- ------ Mortgage-backed securities, net ... $ 358,296 100.00% $ 251,256 100.00% $127,709 100.00% $151,293 $100.00% $171,983 100.00% ========= ====== ========= ====== ======== ====== ======== ======= ======== ======
INCOME PRODUCING PROPERTY LOANS. The Bank has historically originated and purchased both permanent and, to a substantially lesser extent, construction loans secured by income producing property and land development loans. Essentially all permanent income producing property loans originated by the Bank to date have been secured by real property located in Michigan. To a substantially lesser extent, the Bank has also purchased income producing property loans and participation interests in these loans outside of Michigan. These loans may be in the form of mortgage-backed securities, may have fixed or variable interest rates and most have been outstanding for three to twelve years. At December 31, 1997, $16.5 million of D&N's portfolio of income producing property loans were purchased loans. - 11 - 12 The following table shows the composition of the Bank's income producing property and land development loans at December 31, 1997. See "Non- Performing Assets and Risk Elements."
Amount Non- Loans Percentage Performing or Outstanding of Total of Concern ----------- ---------- ------------- (Dollars in thousands) Apartments and multi-family residences $ 20,111 19.54% $ 207 Other income producing property: Motels/hotels 11,605 11.27 -- Offices 6,974 6.78 -- Mobile home parks 2,139 2.08 103 Shopping centers 22,406 21.77 184 Industrial 4,822 4.68 -- Nursing homes 5,344 5.19 18 Condominium development 4,282 4.16 -- Other 4,431 4.30 -- --------- ------ ------- Total 82,114 79.77 512 Land development loans and other 42,298 41.09 -- --------- ------ ------- Total 124,412 120.86 $ 512 ======= Allowance for losses (5,387) (5.23) Loans in process, deferred income and other miscellaneous credits (16,091) (15.63) --------- ------ Total $ 102,934 100.00% ========= ======
CONSUMER LENDING. Federal regulations permit federal savings institutions to make secured and unsecured consumer loans, together with investments in commercial paper and corporate debt securities, in an amount up to 35% of the institution's assets. In addition, a federal savings institution has lending authority above the 35% category for certain consumer loans, such as home equity loans, property improvement loans, mobile home loans and deposit account secured loans. Consumer loans originated by the Bank are offered at fixed and adjustable rates of interest. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. The Bank has established programs to originate consumer loans including automobile loans, home improvement loans, home equity loans, student loans under various guaranteed student loan programs, loans to depositors secured by pledges of their deposit accounts and unsecured loans. Although consumer loans involve a higher level of risk than one- to four-family - 12 - 13 residential mortgage loans, they generally carry higher yields and have shorter terms to maturity. The Bank has increased its origination of consumer loans during the past several years, and is continuing to emphasize these types of loans. At December 31, 1997, consumer loans totaled $449.6 million or 35% of the Bank's loan portfolio, an increase of $110.3 million or 33% from December 31, 1996. During 1997, net consumer loan charge-offs were $1,276,000 compared to $926,000 in 1996, $642,000 in 1995, $411,000 in 1994 and $354,000 in 1993. Indirect loan originations totaled $172.3 million in 1997. Indirect receivables amounted to $235.2 million at December 31, 1997 and make up 53% of the consumer loan portfolio. Indirect loans are underwritten according to the same guidelines as direct loans, and the maximum dollar exposure to any one dealer is typically limited to $5 million. Home equity loans and home equity credit lines are extended at fixed or variable rates of interest and normally do not exceed 80% of the property's appraised value less the amount owing, if any, on a first mortgage. Home equity loans are repaid according to fixed monthly payments over a maximum term of ten years. Home equity credit lines require a monthly interest payment based upon the outstanding balance. Home equity credit lines generally have five-year terms at which time the Bank may require payment in full or renew the loan for another five-year term. Amounts repaid are available for subsequent borrowing, subject to satisfactory loan performance. Home improvement loans are generally treated as home equity loans with a first or second mortgage lien securing the loan. A small number of home improvement loans are written as unsecured loans. The Bank has increased its emphasis in recent years on unsecured loans. These loans are underwritten according to strict guidelines, and loan officers generally have lower approval limits for unsecured loans than for secured loans. D&N Bank is subject to various state and federal limitations on the maximum rates of interest it may charge on consumer and certain other loans. These limitations have not had a significant effect on D&N's consumer loan activities. LOANS TO ONE BORROWER Under federal law, the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus. At December 31, 1997, the Bank's loans to - 13 - 14 one borrower limit was approximately $19.8 million. See "Regulation - Federal Regulation". At December 31, 1997, the Bank had no loans to one borrower in excess of its lending limit. CLASSIFIED ASSETS, LOAN DELINQUENCIES AND DEFAULTS The Bank's collection procedures provide that when a residential mortgage loan is 15 days past due, the borrower is contacted by mail and payment is requested. For loans secured by income producing property, the borrower is contacted by telephone when the loan is 15 days past due. If the delinquency continues, subsequent efforts are made by telephone and mail to contact the delinquent borrower. In certain instances, the Bank may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs. If the loan continues in a delinquent status for 90 days or more, the Bank generally initiates foreclosure proceedings. The process of non-judicial foreclosure in Michigan takes approximately six weeks. A sheriff's sale is then held at which the Bank normally bids for the purchase of the property. A conditional sheriff's deed is then awarded to the highest bidder, usually the Bank, and the customer is given six months (or in certain circumstances, one year) to redeem the conditional deed by repaying the bid amount in full. During this redemption period, the borrower may occupy and use the property as he sees fit. If he fails to redeem the sheriff's deed, then the Bank acquires clear title to the real estate and subsequently sells it to recover its investment. In most cases, it is not economical to obtain a deficiency judgment against the borrower if residential property is sold for less than the unpaid balance of the loan. The following table sets forth information concerning delinquent mortgage and other loans at December 31, 1997. The amounts presented represent the total remaining principal balances of the related loans (before reserves for losses), rather than the actual payment amounts which are overdue.
Real Estate --------------------------------------- Income Producing Commercial Residential Property Consumer ---------------- ---------------- ----------------- ------------------- Number Amount Number Amount Number Amount Number Amount ------ ------ ------ ------ ------ ------ ------ ------ (Dollars in thousands) Loans delinquent for: 30 - 59 days 5 $ 298 90 $4,283 5 $ 7,301 562 $ 3,963 60 - 89 days 1 145 18 765 1 68 219 1,186 90 days and over 2 72 44 2,110 5 512 153 804 ------- ------- ---- ------ ----- ------- ---- ------- Total delinquent loans 8 $ 515 152 $7,158 11 $ 7,881 934 $ 5,953 ======= ======= ==== ====== ====== ======= ==== =======
- 14 - 15 Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser credit quality as "substandard," "doubtful" or "loss" assets. The regulation requires insured institutions to classify their own assets and to establish prudent general allowances for loan losses for assets classified "substandard" or "doubtful." For the portion of assets classified as "loss", an institution is required to either establish specific allowances for loan losses for assets of 100% of the amount classified or charge off such amount. The OTS may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general credit quality of the asset portfolio of an institution. At December 31, 1997, $8.5 million of the Bank's assets were classified as "substandard", none of such assets were classified as "doubtful" or as "loss". The Bank's classification of assets is consistent with OTS examination classifications. Hotels and motels account for $3.4 million of classified assets and apartments account for $2.0 million. The balance of classified assets consists of loans and real estate owned of various income producing properties, land, residential real estate and consumer loans. Classified assets amounting to $2.0 million, or 10% of total classified assets, are secured by real estate located in the state of California. NONPERFORMING ASSETS AND RISK ELEMENTS Nonperforming assets, including other real estate owned, decreased to $5.3 million at December 31, 1997 compared to $8.1 million at December 31, 1996. The ratio of nonperforming assets to total assets was 0.29% at December 31, 1997 compared to 0.55% at December 31, 1996. Allowances for losses represented 199% of nonperforming assets at December 31, 1997. Loans are placed on nonaccrual status when the collection of principal and/or interest becomes doubtful. In addition, residential mortgage loans and income producing property loans are placed on nonaccrual status when the loan becomes 90 days or more contractually delinquent. All consumer loans more than 90 days delinquent are charged against the consumer loan allowance for loan losses. For 1997, the Bank would have recorded interest income of $369,000 if nonaccrual and restructured loans had performed in accordance with their original terms. The Bank recognized $52,000 of interest income on these loans in 1997. The following table sets forth the amounts and categories of risk elements in the Bank's loan portfolio: - 15 - 16
December 31 ------------------------------------------------ 1997 1996 1995 1994 1993 ------ ------ ------ ----- ---- (Dollars in thousands) Nonaccruing loans $ 3,552 $ 6,621 $ 8,225 $17,995 $30,102 Accruing loans delinquent more than 90 days 274 -- 24 5 13 Restructured loans -- -- -- -- 166 ------- ------- ------- ------- ------- Total nonperforming loans 3,826 6,621 8,249 18,000 30,281 Other real estate owned (OREO) 1,474 1,470 1,452 6,520 13,312 ------- ------- ------- ------- ------- Total nonperforming assets $ 5,300 $ 8,091 $ 9,701 $24,520 $43,593 ======= ======= ======= ======= ======= Nonperforming loans as a percentage of total loans 0.29% 0.62% 0.86% 2.17% 4.60% ======= ======= ======= ======= ======= Nonperforming assets as a percentage of total assets 0.29% 0.55% 0.79% 2.17% 4.04% ======= ======= ======= ======= ======= Allowance for loan losses as a percentage of nonperforming loans 275.72% 166.77% 122.21% 46.38% 38.21% ======= ======= ======= ======= ======= Allowances for loan and OREO losses as a percentage of nonperforming assets 199.04% 136.47% 105.29% 35.40% 28.03% ======= ======= ======= ======= =======
OTHER REAL ESTATE OWNED Other real estate owned, net of reserves, totaled $1.5 million at December 31, 1997, the same as at December 31, 1996. Other real estate owned consisted of single family homes, multi-family dwelling units and commercial real estate. At foreclosure, real estate is recorded at estimated fair value less disposal costs. Any difference between estimated fair value and the loan balance is charged to the allowance for loan losses. The largest asset in other real estate owned is a residential property located in Indiana. This asset had a carrying value of approximately $314,000 at December 31, 1997. OTHER LOANS OF CONCERN In addition to nonperforming assets, the Bank has other loans of concern aggregating $14.1 million. These are loans which are currently performing but which demonstrate a specific weakness or weaknesses which, if not corrected, could cause failure of the borrower and default. These loans are closely monitored by management, and as the weaknesses are corrected, may be reclassified as acceptable loans. - 16 - 17 Included in other loans of concern at December 31, 1997, are two income producing property loans located in California and one in Michigan totaling $4.8 million that have all paid as agreed but, for various reasons, indicate potential payment concerns. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established at levels considered appropriate based on management's judgment of potential losses in residential, income producing and consumer loan portfolios. The loan portfolios are reviewed at least quarterly for changes in performance, collateral value and overall quality. Allocated allowances are established for problem loans with expected losses, and in addition, allowances are established for unidentified potential losses. Regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based upon their judgment of the information available to them at the time of their examination. A $1.4 million provision for potential loan losses was made in 1997, compared to $1.1 million in 1996 and $2.4 million in 1995. Management's judgment in determining the level of the allowance for loan losses is influenced by several factors during the quarterly reviews. These factors include, but are not limited to, past loan performance and loss experience, current economic and market conditions, collateral location and market values, industry and geographic concentrations and delinquency statistics and ratios. Management also considers the different levels of risk between income producing property loans, installment loans and one- to four-family residential loans. In addition, management considers the level of nonperforming assets and classified assets, the level of lending activity and the overall size of the loan portfolio. Income-producing property charge-offs were primarily due to writedowns of loans to estimated fair value. Consumer loan charge-offs increased somewhat, but charge-off ratios decreased as the consumer loan portfolio grew at a faster rate. See "Lending Activities" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The following table sets forth an analysis of the Bank's allowance for loan losses:
Year Ended December 31 -------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------------------------------------------------------------- (Dollars in thousands) Balance at beginning of year................ $11,042 $10,081 $ 8,349 $11,570 $15,611 Charge-offs: Residential mortgages..................... 290 314 169 110 1,136 Mortgages on income producing property.... 277 -- 1,019 3,109 2,584 Consumer loans............................ 1,616 1,216 999 773 681 ------------------------------------------------------------------- 2,183 1,530 2,187 3,992 4,401
- 17 - 18 Recoveries: Residential mortgages.............................. -- 3 917 9 25 Mortgages on income producing property............. -- 1,098 245 300 8 Consumer loans..................................... 340 290 357 362 327 ------------------------------------------------------------------------ 340 1,391 1,519 671 360 ------------------------------------------------------------------------ Net charge-offs...................................... 1,843 139 668 3,321 4,041 Provision charged to operations...................... 1,350 1,100 2,400 100 -- ------------------------------------------------------------------------ Balance at end of year............................... $10,549 $11,042 $10,081 $ 8,349 $11,570 ======================================================================== Net charge-offs as a percentage of average loans................................... 0.15% 0.01% 0.07% 0.43% 0.59% ======================================================================== Allowance for loan losses as a percentage of total loans.......................... 0.80% 1.03% 1.05% 1.01% 1.76% ========================================================================
The following table summarizes the allocation of the allowance for loan losses by major categories at the dates indicated:
December 31 --------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------------- ----------------------- -------------------- --------------------- --------------- Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans Amount to Total Amount to Total Amount to Total Amount to Total Amount to Total ------ ---------- ------ ----------- ------ ---------- ------ ----------- ------ --------- (Dollars in thousands) Residential mortgages $ 569 54% $ 859 57% $ 1,170 63% $ 813 63% $ 429 60% Mortgages on income producing property 5,386 9 6,314 10 6,115 11 6,423 17 9,617 19 Commercial loans 400 3 400 1 400 1 -- -- -- -- Consumer loans 4,194 34 3,469 32 2,396 25 1,113 20 1,524 21 --------------------------------------------------------------------------------------------------------- Total $10,549 100% $11,042 100% $10,081 100% $ 8,349 100% $11,570 100% ================== ==================== ================== ================ ==================
INVESTMENT ACTIVITIES As a member of the FHLB System, the Bank must maintain minimum levels of liquid assets specified by federal regulations which vary from time to time. See "Regulation -- Federal Home Loan Bank System." Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to return on loans. Historically, the Bank has maintained liquid assets above the minimum requirements imposed by federal regulations and at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. Cash flow is regularly reviewed and updated to maintain adequate liquidity. For the month of December 1997, the Bank's average liquidity ratio (liquid assets as a percentage of net withdrawable deposits and current borrowings) was 13.9%, which was in excess of regulatory requirements. - 18 - 19 The following table sets forth information concerning the Bank's investment securities at the dates indicated. See also Note E of Notes to Consolidated Financial Statements for additional information regarding the contractual maturities and weighted average yields of the Bank's investment securities.
December 31 ---------------------------------------------------------------------- 1997 1996 1995 ---------------------------------------------------------------------- Book Market Book Market Book Market Value Value Value Value Value Value ---------------------------------------------------------------------- (In thousands) U.S. Treasury and government agencies and corporations................ $ 33,299 $ 33,369 $ 40,757 $ 40,801 $ 35,100 $ 35,229 U.S. Treasury available for sale............ 44,764 44,860 57,996 58,000 40,656 40,899 Valuation allowance......................... 96 -- 4 -- 244 -- -------------------------------------------------------------------- 78,159 78,229 98,757 98,801 76,000 76,128 Investment in Federal Home Loan Bank stock............................... 23,200 23,200 19,959 19,959 19,953 19,953 Other equity securities..................... 25 25 23 23 186 186 Other equity securities available for sale................................. 1,236 1,252 1,032 1,038 110 298 Valuation allowance......................... 16 -- 6 -- 187 -- -------------------------------------------------------------------- $102,636 $102,706 $119,777 $119,821 $ 96,436 $ 96,565 ====================================================================
The book value and market value of investment securities at December 31, 1997, by maturity ranges, were as follows:
Weighted Market Average Book Value Value Yield ----------------------------------------- (Dollars in thousands) U. S. Treasury and government agencies and corporate securities maturing: In one year or less................................... $ 67,859 $ 67,987 5.95% After one year through five years..................... 10,204 10,242 6.04 Valuation allowance........................................ 96 -- -- ----------------------------------------- 78,159 78,229 5.95 Equity securities.......................................... 24,461 24,477 7.85 Valuation allowance........................................ 16 -- -- ----------------------------------------- $102,636 $ 102,706 6.40% ========================================
SOURCE OF FUNDS GENERAL. Deposits are an important source of the Bank's funds for use in lending and for other general business purposes. In addition to deposits, the Bank derives funds from loan repayments, advances from the FHLB of Indianapolis, other borrowings, reverse repurchase agreements, and at times has derived funds from loan and securities sales. Scheduled loan repayments are a relatively stable source of funds, while loan prepayments and deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in normal sources of funds, such as deposit inflows at less than - 19 - 20 projected levels or deposit outflows, or to support expanded activities. Historically, the Bank has borrowed primarily from the FHLB of Indianapolis, through institutional reverse repurchase agreements and, to a lesser extent, from other sources. DEPOSIT ACTIVITIES. The Bank attracts both short-term and long-term deposits from the general public by offering a wide assortment of accounts and rates. In recent years, market conditions have required the Company to rely increasingly on short-term accounts that are more responsive to market interest rates. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed interest rate certificates with varying maturities, negotiated rate certificates of deposit of $100,000 or above ("Jumbo CDs") and individual retirement accounts. The composition of the Bank's deposits at the end of recent periods is set forth in Note J of Notes to Consolidated Financial Statements. At December 31, 1997, the Company had no brokered deposits. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." In addition, the Bank believes that, based on its experience over the past five years, its savings accounts are stable sources of deposits.
December 31 ------------------------------------------------------------------------- 1997 1996 1995 ------------------------------------------------------------------------- Percent Percent Percent of of of Amount Total Amount Total Amount Total ------------------------------------------------------------------------- (Dollars in thousands) Regular Accounts: Savings accounts, 1.75% - 5.07% ................. $ 163,119 15.64% $149,226 15.48% $149,728 16.22% Checking and NOW accounts, 0.00% - 2.50%.................... 119,412 11.45 107,550 11.16 91,621 9.93 Money market accounts, variable......................... 92,314 8.85 89,321 9.26 86,080 9.33 ------------------------------------------------------------------------ Total regular accounts....... 374,845 35.94 346,097 35.90 327,429 35.48 Certificates: 0.00 - 2.99%..................... 8,100 0.78 9,864 1.02 6,218 0.67 3.00 - 4.99%..................... 19,955 1.91 74,620 7.74 67,887 7.36 5.00 - 6.99%..................... 600,035 57.52 476,651 49.44 443,782 48.08 7.00 - 8.99%..................... 35,368 3.39 52,073 5.40 59,847 6.48 9.00 - 10.99%.................... 3,746 0.36 3,894 0.40 16,310 1.77 ------------------------------------------------------------------------- Total certificates........... 667,204 63.96 617,102 64.00 594,044 64.36 Accrued interest..................... 1,118 0.10 934 0.10 1,459 0.16 ------------------------------------------------------------------------- Total deposits................ $ 1,043,167 100.00% $964,133 100.00% $922,932 100.00% =========================================================================
The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and has allowed it to respond with flexibility (by paying rates of interest more closely approximating market rates of interest) to, although not eliminate the threat of, disintermediation (the flow of funds away - 20 - 21 from depository institutions such as savings institutions into direct investment vehicles such as government and corporate securities). In addition, the Bank has become much more subject to short-term fluctuations in deposit flows. The ability of the Bank to attract and maintain deposits, and its cost of funds, have been, and will continue to be, significantly affected by money market conditions. The following table sets forth the deposit flows at D&N Bank during the periods indicated.
Year Ended December 31 ------------------------------------------------------ 1997 1996 1995 ------------------------------------------------------ (In thousands) Opening balance.............................. $ 964,133 $ 922,932 $ 817,674 Deposits..................................... 3,111,891 2,425,493 1,992,613 Withdrawals.................................. (3,075,490) (2,422,882) (1,922,325) Interest credited............................ 42,449 39,115 34,801 Accrued interest............................. 184 (525) 169 ------------ ------------ ------------ Ending balance............................... $ 1,043,167 $ 964,133 $ 922,932 ============ ============ ============
The following table sets forth the change in dollar amount of deposits in the various types of deposit programs offered by the Bank for the periods indicated.
Year Ended December 31 ---------------------------------------------------- 1997 1996 1995 ---------------------------------------------------- (In thousands) Savings accounts................................... $ 13,893 $ (502) $ 19,431 Checking and NOW accounts........................... 11,862 15,929 137 Money market accounts............................... 2,993 3,241 (9,493) Certificates with maturities: 7 to 91 days..................................... (76) 8,319 (2,162) 92 days to 6 months.............................. 9,211 1,133 12,448 6 months to 1 year............................... 55,669 33,200 21,925 1 year to 1 1/2 years............................ 22,838 16,156 15,004 1 1/2 years to 3 years........................... (38,039) (15,179) 34,840 3 years to 10 years.............................. (6,105) (26,232) 7,655 Negotiable rate certificates........................ 6,604 5,661 5,304 ------------------------------------------------- Increase (decrease).............................. 78,850 41,726 105,089 Change in accrued interest.......................... 184 (525) 169 ------------------------------------------------- Total increase (decrease)........................ $ 79,034 $ 41,201 $ 105,258 =================================================
- 21 - 22 The following table shows rate and maturity information for the Bank's deposits as of December 31, 1997.
Interest Rate Range -- Certificates ---------------------------------------------------------- 0.00 3.00 5.00 7.00 9.00 Percent to to to to to Amount of Total 2.99% 4.99% 6.99% 8.99% 10.99% -------------------- ---------------------------------------------------------- (Dollars in thousands) Savings accounts................... $ 163,119 15.64% $ -- $ -- $ -- $ -- $ -- Checking and NOW accounts.......... 119,412 11.45 -- -- -- -- -- Money market accounts.............. 92,314 8.85 -- -- -- -- -- -------------------------------------------------------------------------------- 374,845 35.94 -- -- -- -- -- Certificate accounts maturing in quarter ending: 03/31/98........................... 185,397 17.77 702 5,405 171,969 7,220 101 06/30/98........................... 152,006 14.57 2,630 3,696 139,056 6,498 126 09/30/98........................... 105,222 10.09 1,787 4,306 95,950 3,070 109 12/31/98........................... 89,006 8.53 1,781 2,765 80,540 3,729 191 03/31/99........................... 34,083 3.27 408 1,291 27,004 3,789 1,591 06/30/99........................... 26,515 2.54 171 793 20,983 3,037 1,531 09/30/99........................... 9,997 0.96 -- 522 8,984 374 97 12/31/99........................... 7,236 0.69 4 210 6,739 283 -- 03/31/2000......................... 7,204 0.69 180 229 4,785 2,010 -- 06/30/2000......................... 9,282 0.89 120 226 6,028 2,908 -- 09/30/2000......................... 6,092 0.58 189 138 5,699 66 -- 12/31/2000......................... 3,677 0.35 -- 26 3,438 213 -- Maturity over 3 years ............. 31,507 3.02 128 348 28,860 2,171 -- --------------------- ---------------------------------------------------- Total........................... $ 667,204 63.95 $ 8,100 $19,955 $600,035 $35,368 $3,746 ==================================================== Interest accrued................... 1,118 0.10 --------------------- Total deposits.................. $ 1,043,167 100.00% =====================
The following table shows the scheduled maturities of certificates of deposit of $100,000 or greater as of December 31, 1997.
December 31, 1997 ----------------- (In thousands) Certificates with maturities: Three months or less............................. $ 39,016 Over three through six months.................... 20,366 Over six through twelve months................... 21,915 Over twelve months............................... 12,836 -------- Total...................................... $ 94,133 ========
BORROWINGS. The FHLB of Indianapolis functions as a central reserve bank, providing credit for savings institutions within its assigned region. As a member of the FHLB of Indianapolis, D&N Bank is required to own capital stock in the FHLB of Indianapolis and is authorized to apply for advances on the security of such stock and certain of its residential mortgage loans and - 22 - 23 other assets (principally, securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. See "Regulation -- Federal Home Loan Bank System." FHLB advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. The FHLB of Indianapolis prescribes the acceptable uses to which the advances pursuant to each program may be made as well as limitations on the size of advances. Depending on the program limitations, the amount of advances are generally based on the FHLB of Indianapolis' assessment of the institution's creditworthiness. The FHLB of Indianapolis is required to review its credit limitations and standards at least once every six months. The Bank utilizes borrowings, in part, to fund increases in loan demand. The Bank has entered into reverse repurchase agreements with major investment bankers utilizing government securities or various mortgage instruments as collateral. These reverse repurchase agreements are generally utilized in connection with the Bank's investments. See "Investment Activities" and "Management's Discussion and Analysis of Financial Condition and Results of Operations". The following table sets forth the maximum month-end and average balance of FHLB advances, securities sold under agreements to repurchase and other borrowings as of the dates indicated:
Year Ended December 31 ------------------------------------- 1997 1996 1995 ------------------------------------- (In thousands) Maximum Balance: Advances from FHLB.................................. $464,003 $338,003 $226,003 Securities sold under agreements to repurchase.......................... 181,055 74,621 52,579 Other borrowings.................................... 14,643 13,385 12,368 Average Balance:....................................... Advances from FHLB.................................. 381,787 259,694 200,770 Securities sold under agreements to repurchase.......................... 98,471 40,095 24,020 Other borrowings.................................... 7,993 9,720 11,504
The following table sets forth certain information as to the Bank's FHLB advances, securities sold under agreements to repurchase and other borrowings at the dates indicated. See also Note L of Notes to Consolidated Financial Statements.
At December 31 ------------------------------------- 1997 1996 1995 ------------------------------------- (Dollars in thousands) Advances from FHLB.................................. $464,003 $338,003 $226,003
- 23 - 24 Securities sold under agreements to repurchase..................................... 149,092 58,040 -- Other borrowings....................................... 6,428 7,994 10,292 ------------------------------------- Total borrowings.................................. $619,523 $404,037 $216,295 ===================================== Weighted average interest rate of advances from FHLB........................... 5.91% 5.59% 5.82% Weighted average interest rate of securities sold under agreements to repurchase........................................ 5.80 5.66 -- Weighted average interest rate of other borrowings ............................ 10.04 9.76 9.59 Weighted average interest rate of total borrowings............................. 5.93 5.68 6.00
The following table sets forth the Bank's maturity and rate structure of FHLB advances as of December 31, 1997.
Weighted Average Rate Amount ------------------------------- (Dollars in thousands) Matures within: One year..................................... 5.85% $214,000(1) Two years.................................... 5.99 179,000 Three years.................................. 5.92 70,000 Four years................................... -- -- Thereafter................................... 4.00 1,003 ------------------------- Total FHLB advances....................... 5.91% $464,003 =========================
(1) Includes variable rate advances which adjust quarterly. SERVICE CORPORATION ACTIVITIES The Bank is permitted to invest an amount equal to 2% of its assets (excluding those of its subsidiaries) in its service corporations. Up to an additional 1% of assets may be invested in service corporations provided that such amount is used for certain types of community development projects. In addition, federal regulations permit institutions to make specified types of loans to such subsidiaries (other than special-purpose finance subsidiaries) in which the institution owns more than 10% of the stock, in an aggregate amount not exceeding 50% of the institution's total capital as defined below. - 24 - 25 As of December 31, 1997, the Bank's investment in stock of and loans to its subsidiaries (other than its special-purpose finance subsidiary and its Real Estate Investment Trust) was in compliance with the regulations and totaled $5.6 million. A federal institution may also invest up to 30% of its assets in special-purpose finance subsidiaries established and operated in accordance with federal regulations. The Bank's investment in its special purpose finance subsidiary, D&N Funding I Corp., was in compliance with these regulations at December 31, 1997. Federal law imposes special capitalization requirements on savings institutions such as the Bank which are engaged in activities through a subsidiary that are not permissible for national banks. See "Regulation -- Regulatory Capital Requirements." The following is a description of the Bank's service corporations. D&N Enterprises, Inc. ("Enterprises") was formed in 1972 for the purpose of developing real estate through joint venture arrangements. At December 31, 1997, the Company had a $300,000 investment in Enterprises and loans totaling approximately $1.5 million to the subsidiary. Enterprises entered into the Northside Joint Venture in March 1989 to acquire and develop commercial sites in Shelby Township, Michigan. Enterprises is in the process of marketing this property in its entirety. D&N Holdings, Inc. ("Holdings") was formed in 1985 and is involved in the sale of mortgage life insurance through its investment in Minnesota Mutual Life Insurance Company ("MIMLIC") and also offers insurance products and annuity contracts through Quincy Insurance Agency, Inc., a subsidiary of Holdings formed in 1995. In Michigan, MIMLIC's mortgage life insurance policies are marketed and sold primarily through Michigan savings institutions. At December 31, 1997, D&N Bank's investment in Holdings totaled approximately $200,000. MORTGAGE BANKING. On May 1, 1984, D&N Bank established a mortgage banking operation through a subsidiary, D&N Mortgage Corporation ("DNMC"). This subsidiary was relatively dormant from 1992 until 1995. Since restarting operations, D&N Mortgage Corporation has originated loans mainly for the Bank's portfolio. D&N Mortgage Corporation currently has four origination offices located in Michigan's lower peninsula in the cities of Grand Rapids, Hastings, West Bloomfield and St. Joseph. At December 31, 1997, the Bank had $2.4 million invested in this subsidiary. FINANCE SUBSIDIARY. In 1986, D&N Bank incorporated a special-purpose finance subsidiary, D&N Funding I Corp. ("Funding"). Funding was established solely for the purpose of issuing collateralized mortgage obligations ("CMOs"). In August 1986, Funding pledged $61.5 million in principal amount of FHLMC participation certificates to collateralize the issuance and sale of the CMOs from which the Bank received $56.4 million in net proceeds. The CMOs were sold through a third party conduit and were secured by the pledge of the - 25 - 26 participation certificates. D&N Bank reinvested the proceeds from the sale of the CMOs in residential and commercial mortgage loans. NEW BANK SUBSIDIARY D&N Capital Corporation ("D&N Capital") is a Delaware corporation incorporated on March 18, 1997 for the purpose of acquiring and holding real estate assets and is a Real Estate Investment Trust ("REIT"). All shares of common stock of D&N Capital are owned by D&N Bank. On July 17,1997, D&N Capital sold 1.21 million shares of its 9.0% noncumulative preferred stock, Series A with a liquidation preference of $25.00 per share (totaling $30,250,000). The Series A Preferred Shares are generally not redeemable prior to July 1, 2002. On or after July 1, 2002, the Series A Preferred Shares may be redeemed for cash at the option of the Bank, in whole or in part, at a redemption price of $25.00 per share. As part of this transaction, D&N Capital received $28,719,000 in net proceeds, after offering costs of $1,531,000. The net proceeds, along with the proceeds received from the sale of D&N Capital common stock to D&N Bank, were used to purchase $60,524,000 of mortgage loans from D&N Bank. The interest on these loans is being used to fund the dividends on D&N Capital's preferred and common stock. The preferred shares are treated as Tier-1 Capital by the Bank, and are traded on Nasdaq as DNFCP. During 1997, D&N Capital declared and paid preferred dividends totaling $1,217,563. COMPETITION At December 31, 1997, the Bank ranked second among all savings institutions headquartered in the State of Michigan with respect to total assets. D&N Bank experiences substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits are the ability to offer attractive rates, the availability of convenient office locations and the range and quality of services offered. Direct competition for deposits comes from other savings institutions, credit unions and commercial banks. Additional significant competition for deposits comes from money market mutual funds and corporate and government securities. The primary factors in competing for loans are interest rates, loan origination fees and the range of services offered. Competition for origination of real estate loans and consumer loans normally comes from other - 26 - 27 savings institutions, credit unions, commercial banks, mortgage bankers, mortgage brokers and insurance companies. The deposit programs of savings institutions such as the Bank compete with government securities, money market mutual funds and other investment alternatives. Legislative and regulatory action has increased competition between savings institutions and other financial institutions, such as commercial banks, by expanding the ranges of financial services that may be offered by savings institutions such as interest bearing checking accounts, trust services and consumer loan products, while reducing or eliminating the difference between savings institutions and commercial banks with respect to long-term lending authority, taxation and maximum rates of interest that may be paid on savings deposits. EMPLOYEES At December 31, 1997, the Bank had 513 employees, including 94 part-time employees. Management considers its relations with its employees to be satisfactory. The Bank's employees are not represented by any collective bargaining group. The Bank currently maintains a comprehensive employee benefit program providing, among other benefits, a 401(k) plan with an Employee Stock Ownership Program, hospitalization and major medical insurance, paid sick leave, long-term disability insurance and life insurance. EXECUTIVE OFFICERS The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company or its wholly owned subsidiary, other than the Chief Executive Officer, who do not serve on the Company's Board of Directors. Executive officers are elected annually to serve until their successors are elected or until they resign or are removed by the Board of Directors. There are no arrangements or understandings between the persons named and any other person pursuant to which such officers were elected. George J. Butvilas, age 52. Joining D&N as President in May 1990, Mr. Butvilas was named Chief Executive Officer of the Bank in 1991 and Chief Executive Officer of the Company in 1992. He brought with him over 16 years experience as a commercial and community banker. Mr. Butvilas was formerly Executive Vice President and Director of Boulevard Bancorp, Inc. of Chicago, Illinois. - 27 - 28 Frank R. Donnelly, age 57, is Senior Vice President/Commercial Lending of the Bank. He has been employed by the Bank in various capacities since 1965 and is presently responsible for the business and commercial real estate loan development for the Bank. Daniel D. Greenlee, age 45, is Senior Vice President/Controller of the Bank. He has been with D&N Bank in various capacities since 1984 and is presently responsible for the accounting, financial and regulatory reporting, financial analysis, tax and risk management functions of the Bank. Kenneth R. Janson, age 46, is Executive Vice President/Chief Financial Officer and Treasurer of the Company and the Bank. Prior to joining the Bank in May 1988 as Vice President/Financial Analysis, he was affiliated with various universities, the last six years as Associate Professor of Accounting at Michigan Technological University. Mr. Janson is responsible for directing the Bank's accounting, investment and investor relations functions. Robert J. Krupka, age 36, is Senior Vice President/Chief Credit Officer of the Bank. Prior to joining D&N Bank in March 1997, he was Commercial Loan Officer and Credit Manager with Old Kent Bank. Mr. Krupka is responsible for the commercial loan credit analysis and operations functions. Peter L. Lemmer, age 40, is Senior Vice President/General Counsel of the Company and the Bank. Prior to joining D&N Bank in October 1990, he held various positions involving legal services, the last five years as Senior Vice President/Compliance and Vice President, Associate General Counsel/Compliance Officer with Cal America Savings, later known as Columbus Savings, and American Federal Bank, respectively. Mr. Lemmer is responsible for the legal and regulatory functions of the Bank. Donald W. Schulze, age 47, is Senior Vice President/Human Resources of the Bank. He has been with D&N Bank in various capacities since 1986 and is presently responsible for the training and development, facilities management and human resources functions of the Bank. Alfred J. Sliwinski, age 51, is Executive Vice President/Community Banking. He has been employed by D&N Bank in various community banking capacities since May 1977 and is presently responsible for the community banking function of the Bank. Richard E. West, age 51, is Executive Vice President/Wholesale Lending. Prior to joining D&N Bank in January 1990, he was Servicing Manager for 20 years with Rothschild Financial Corporation and Valley National Bank of Arizona. Mr. West is responsible for directing the loan servicing, residential lending, consumer lending, bank operations and information systems functions of the Bank. - 28 - 29 REGULATION GENERAL The Bank is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all operations. The Bank is a member of FHLB of Indianapolis and is subject to certain limited regulation by the Federal Reserve Board. As the savings and loan holding company of the Bank, the Company also is subject to federal regulation and oversight. The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings institutions. The Bank is a member of the Savings Association Insurance Fund ("SAIF"), and the deposits of the Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Bank. Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document. FEDERAL REGULATION The OTS has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS examination of the Bank was as of June 30, 1997. Under agency scheduling guidelines, it is likely that another examination will be initiated in the near future. When these examinations are conducted by the OTS or the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 1997, the Bank's lending limit under this restriction was $19.8 million. The Bank is in compliance with the loans-to-one-borrower limitation. . INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC The Bank is a member of the SAIF, which is administered by the FDIC. Savings deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC- insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a - 29 - 30 serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk- based system under which all insured institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. D&N Bank, will continue to be subject to an assessment to fund repayment of the Financing Corporation's bond obligation of 6.5 cents per $100 of deposits while BIF insured institutions will pay 1.3 cents per $100 of deposits until the year 2000 when the assessment will be imposed at the same rate on all FDIC insured institutions. REGULATORY CAPITAL REQUIREMENTS Federally insured savings institutions, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings institutions. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. The capital regulations require tangible capital of at least 1.5% of - 30 - 31 adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets, other than a limited amount of mortgage servicing rights (MSRs) must be deducted from tangible capital. At December 31, 1997, the Bank had $2,136,000 of unamortized MSRs, none of which was required to be deducted from tangible capital. At December 31, 1997, the Bank had tangible capital of $119.5 million, or 6.55% of adjusted total assets, which is approximately $92.1 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. The capital standards also require core capital equal to at least 3% of adjusted total assets (as defined by regulation). Core capital generally consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card relationships. As a result of the prompt corrective action provisions discussed below, however, a savings institution must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. At December 31, 1997, the Bank had core capital equal to $119.5 million, or 6.55% of adjusted total assets, which is $64.7 million above the minimum leverage ratio requirement of 3% as in effect on that date. The OTS risk-based requirement requires savings institutions to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. At December 31, 1997 the Bank had $10.4 million of general loss reserves which could be counted as supplementary capital. On December 31, 1997, the Bank had total capital of $129.9 million (including $119.5 million in core capital and $10.4 million in qualifying supplementary capital) and risk-weighted assets of $1.08 billion (including $48.0 million in converted off-balance sheet assets); or total capital of 11.98% of risk-weighted assets. This amount was $43.1 million above the 8% requirement in effect on that date. The OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against institutions that fail to meet their - 31 - 32 capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized institution" (generally defined to be one with less than either a 4% core ratio, a 4% Tier 1 risk-based capital ratio or an 8% risk-based capital ratio). Any such institution must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions, discussed below, that are applicable to significantly undercapitalized institutions. On December 31, 1997, the Bank had a Tier 1 risk-based capital ratio of 11.02%. Any savings institution that fails to comply with its capital plan or is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions which may cover all aspects of its operations and include a forced merger or acquisition of the institution. An institution that becomes "critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized institutions. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized institution is also subject to the general enforcement authority of the OTS and the FDIC, including the appointment of conservator or a receiver. If the OTS determines that an institution is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice, it is authorized to reclassify a well-capitalized institution as an adequately capitalized institution and if the institution is adequately capitalized, to impose the restrictions applicable to an undercapitalized institution. If the institution is undercapitalized, the OTS is authorized to impose the restrictions applicable to a significantly undercapitalized institution. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank's operations and profitability. The Company's stockholders do not have preemptive rights, and therefore, if the Company is directed by the OTS or the FDIC to issue additional shares of Common Stock, such issuance may result in the dilution in the percentage of ownership of the Company. LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS OTS regulations impose various restrictions on institutions with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an institution from declaring or paying any dividends or - 32 - 33 from repurchasing any of its stock if, as a result, the regulatory capital of the institution would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion. Generally, institutions such as the Bank, that before and after the proposed distribution meet their capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the institution's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or 75% of its net income for the most recent four quarter period. However, an institution deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. The Bank may pay dividends in accordance with this general authority. Savings institutions that will meet their current minimum capital requirement following a proposed capital distribution need only submit written notice to the OTS 30 days prior to such distribution. The OTS may object to the distribution during the 30-day period based on safety and soundness concerns. See "Regulatory Capital Requirements." LIQUIDITY All savings institutions, including the Bank, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings institutions. At the present time, the minimum liquid asset ratio is 4%, as changed during 1997. During 1997, the OTS lowered the minimum liquid asset ratio from 5% to 4%, and changed the definition of "liquid assets" to include obligations of the United States which have a remaining life greater than five years. This allows the Bank to use substantially all of its investment security and mortgage-backed security portfolios, which are not otherwise encumbered. The OTS also discontinued the 1% short-term liquid asset requirement. At December 31, 1997, the Bank was in compliance with the liquidity ratio requirement, with a liquid asset ratio of 13.9%. - 33 - 34 ACCOUNTING An OTS policy statement applicable to all savings institutions clarifies and reemphasizes that the investment activities of a savings institution must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with GAAP. Under the policy statement, management must support its classification of and accounting for loans and securities (i.e., whether held for investment, available for sale or trading) with appropriate documentation. The Bank is in compliance with these rules. The OTS has adopted an amendment to its accounting regulations, which may be made more stringent than GAAP, to require that transactions be reported in a manner that best reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS. QUALIFIED THRIFT LENDER TEST All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its portfolio assets as defined by regulation in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. Such assets primarily consist of residential housing related loans and investments. At December 31, 1997, the Bank met the test and has always met the test since its inception. Any savings institution that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If the institution does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the Bank Insurance Fund. If an institution that fails the test has not yet requalified and has not converted to a national bank, its new investments and activities are limited to those permissible for both a savings institution and a national bank, and it is limited to national bank branching rights in its home state. In addition, the institution is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such institution has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any institution that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "Holding Company Regulation." - 34 - 35 COMMUNITY REINVESTMENT ACT Under the Community Reinvestment Act ("CRA"), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. The federal banking agencies, including the OTS, have recently revised the CRA regulations and the methodology for determining an institution's compliance with the CRA. Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank was examined for CRA compliance in 1995 and received a rating of "Satisfactory". HOLDING COMPANY REGULATION The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. If the Company acquires control of another savings institution as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than the Bank or any other SAIF-insured savings institution) would become subject to such restrictions unless such other institutions each qualify as a QTL and were acquired in a supervisory acquisition. If the Bank fails the QTL test, the Company must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within - 35 - 36 one year of such failure the Company must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See " Qualified Thrift Lender Test." The Company must obtain approval from the OTS before acquiring control of any other SAIF-insured institution. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings institutions in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings institution. FEDERAL RESERVE SYSTEM The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 1997, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "Liquidity." Savings institutions are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require institutions to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB of Indianapolis, which is one of 12 regional FHLBs, that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, the Bank is required to purchase and maintain stock in the FHLB of Indianapolis. At December 31, 1997, the Bank had $23.2 million in FHLB stock, which was in compliance with this requirement. In past years, - 36 - 37 the Bank has received substantial dividends on its FHLB stock. Over the past five calendar years such dividends have averaged 7.56% and were 7.99% for calendar year 1997. Under federal law the FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderate priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate- income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital. For the year ended December 31, 1997, the dividends paid by the FHLB of Indianapolis to the Bank totaled $1.6 million. The $447,000 dividend received for the quarter ended December 31, 1997 reflects an annualized rate of 8.00%. FEDERAL AND STATE TAXATION D&N and its subsidiaries file a consolidated federal income tax return on a calendar year basis using the accrual method of accounting. Savings institutions, such as the Bank, were permitted to establish reserves for bad debts and make annual additions thereto which could be taken as a deduction in computing taxable income for federal income tax purposes. This tax bad debt reserve method available to thrifts institutions was repealed for tax years beginning after 1995. As a result, the Bank was required to change from the reserve method to the specific charge-off method to compute its bad debt deduction. Basically, repeal of the thrift bad debt reserve method puts large thrifts, such as the Bank, on the tax method used by large commercial banks. Upon repeal, the Bank is required to recapture into income the portion of its bad debt reserves (other than the supplemental reserve) that exceeds its base year reserves (i.e. its tax reserves for the last tax year beginning before 1988). The recapture amount resulting from the change in the Bank's method of accounting for its bad debt reserves is taken into taxable income ratably (on a straight-line basis) over a six-year period. The base year reserve is frozen, not forgiven. Certain events can still trigger a recapture of the base year reserve. For example, while the base year reserve will not be recaptured if the thrift converts to a bank charter or is merged into a bank, it will be recaptured if the thrift ceases to qualify as a bank for federal income tax purposes. The base year reserves also remain - 37 - 38 subject to income tax penalty provisions which, in general, require recapture upon certain stock redemptions of, and excess distributions to, shareholders. In addition to the regular income tax, corporations, such as the Company, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. D&N and its consolidated subsidiaries have been audited or their books closed without audit by the IRS with respect to consolidated federal income tax returns through December 31, 1993. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of open returns (including returns of subsidiaries and predecessors of, or entities merged into, D&N) would not result in a deficiency which could have a material adverse effect on the financial condition of D&N and its consolidated subsidiaries. See Note M of Notes to Consolidated Financial Statements. During the third quarter of 1996, the Bank recognized an adjustment to its balance of deferred tax assets following the enactment in August of federal legislation which resolved the recapture status of previously allowed accelerated deductions for bad debts. Thrift institutions such as the Bank had been permitted to deduct a portion of their income as bad debt allowances. This practice was more advantageous than the specific-loss method of deduction which was mandated for other classes of financial institutions. The opportunity to use the percentage-of-income method expired in 1995, but the status of previously accelerated deductions remained in question until the 1996 legislation was enacted. The presence of unresolved prior deductions was felt to be hindrance to evolution and consolidation of the financial services industry because thrift institutions that had recorded such accelerated deductions were required to repay them before charter conversions or acquisitions by non-thrift institutions could be approved. The new legislation required that accelerated deductions recorded after 1987 would have to be repaid, but forgave that portion of institutions' accelerated loan loss deductions that were recorded before 1988. MICHIGAN TAXATION. The State of Michigan imposes a tax on intangible personal property in the amount of $.20 per $1,000 of deposits of a savings bank or a savings and loan institution less deposits owed to the federal or Michigan state governments, their agencies or certain other financial institutions. The Michigan intangibles tax is being phased out over four years - 38 - 39 until the tax is fully repealed effective January 1, 1998. The State of Michigan also imposes a "Single Business Tax." The Single Business Tax is a value-added type of tax for the privilege of doing business in the State of Michigan. The major components of the Single Business Tax are federal taxable income, compensation and depreciation as increased by net operating loss carryforwards, if any, utilized in arriving at federal taxable income, and decreased by the cost of acquisition of tangible assets during the year. The tax rate is 2.30% of the Michigan adjusted tax base. DELAWARE TAXATION. As a Delaware business corporation, the Company is required to file annual returns with and pay annual fees to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware based on the number of authorized shares of the Company stock. ITEM 2. PROPERTIES At December 31, 1997, the Bank operated through 37 full service community banking offices, seven savings agency offices and four mortgage banking offices. The net book value of the land, buildings and leasehold improvements owned by D&N Bank at that date was $11,686,000, and the net book value of its office furniture, fixtures and equipment was $4,936,000. COMPUTER EQUIPMENT. D&N Bank processes all depositor and borrower customer files and transactions through a third party data services provider including general ledger accounting and information reporting. The book value of all computer equipment and software owned by the Bank was $934,000 at December 31, 1997. The Bank also leases an insignificant amount of data processing hardware and software. ITEM 3. LEGAL PROCEEDINGS The Company is a defendant in a number of matters of litigation, substantially all of which have arisen in the ordinary course of business. It is the opinion of management that the resulting liabilities, if any, from these actions will not materially affect the Consolidated Financial Statements. D&N Bank is a plaintiff, like approximately 120 other institutions, in a currently pending claim in the United States Court of Federal Claims seeking substantial damages as a result of the 1989 Financial Institutions Reform, Recovery and Enforcement Act's mandatory phase-out of the regulatory capital treatment of supervisory goodwill. The ultimate outcome of these matters cannot be ascertained at this time. - 39 - 40 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 1997. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Page 52 of the attached 1997 Annual Report to Stockholders is herein incorporated by reference. ITEM 6. SELECTED FINANCIAL DATA Page 4 of the attached 1997 Annual Report to Stockholders is herein incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Pages 12 through 23 of the attached 1997 Annual Report to Stockholders are herein incorporated by reference. ITEM 8. FINANCIAL STATEMENTS SUPPLEMENTARY DATA Pages 24 through 49 of the attached 1997 Annual Report to Stockholders are herein incorporated by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning Executive Officers of the Company is - 40 - 41 contained on page 27 herein. Information concerning Directors of the Company, is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, except for information contained under the heading "Compensation Committee Report" and "Stockholder Return Performance Presentation." A copy of this Proxy Statement will be filed not later than 120 days after the close of the fiscal year. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference from the Company's definitive Proxy Statement or the Annual Meeting of Stockholders to be held in 1998, except for information contained under the heading "Compensation Committee Report" and "Stockholder Return Performance Presentation." A copy of this Proxy Statement will be filed not later than 120 days after the close of the fiscal year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, except for information contained under the heading "Compensation Committee Report" and "Stockholder Return Performance Presentation." A copy of this Proxy Statement will be filed not later than 120 days after the close of the fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, except for the information contained under the heading Compensation Committee Report" and "Stockholder Return Performance Presentation." A copy of this Proxy Statement will be filed not later than 120 days after the close of the fiscal year. - 41 - 42 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) Financial Statements The following information appearing in the Registrant's Annual Report to Stockholders for the year ended December 31, 1997, is incorporated by reference in this Annual Report on Form 10-K as Exhibit 13.
Annual Report Section Pages in Annual Report - ------------------------------------------------------ ---------------------- Selected Financial Data 4 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 23 Report of Independent Auditors 24 Consolidated Statements of Condition 25 Consolidated Statements of Income 26 Consolidated Statements of Stockholders' Equity 27 Consolidated Statements of Cash Flows 28 Notes to Consolidated Financial Statements 29 - 49 Stockholder Information 52
(a) (2) Financial Statement Schedules All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements. - 42 - 43 (A) (3) EXHIBITS
Reference to Sequential Prior Filing Page Number or Exhibit Where Attached/ Regulation Number Located in S-K Exhibit Attached This Form 10-K Number Document Hereto Report - ----------- ---------------------------- ------------- --------------- 3(I) Articles of Incorporation * Not applicable 3(ii) By-Laws * Not applicable 4 Instruments defining the * Not applicable rights of security holders, including debentures 9 Voting Trust Agreement None Not applicable 10 Material Contracts 1993 401(k) Plan & Trust * Not applicable (1994 Amendment) 1984 Stock Option Plan * Not applicable (1995 Amendment) 1994 Management * Not applicable Stock Incentive Plan (1995 Amendment) Employment Agreement of G. Butvilas * Not applicable 11 Statement re: computation Not required Not applicable of per share earnings 12 Statement re: computation Not required Not applicable of ratios 13 Annual Report to Security 13 Filed Herewith Holders 16 Letter re: change in None Not applicable Certifying Accountant 18 Letter re: change in None Not applicable accounting principles 21 Subsidiaries of Registrant 21 Filed Herewith 22 Published report regarding None Not applicable matters submitted to vote of security holders 23 Consent of Experts and 23 Filed Herewith Counsel 24 Power of Attorney Not required Not applicable
- 43 - 44 27.1 Financial Data Schedule 27 Page 104 27.2 Financial Data Schedule 27.3 Financial Data Schedule 27.4 Financial Data Schedule 27.5 Financial Data Schedule 27.6 Financial Data Schedule 27.7 Financial Data Schedule 27.8 Fiancial Data Schedule 27.9 Fiancial Data Schedule 28 Information from reports None Not applicable furnished to state insurance regulatory authorities 99 Additional exhibits None Not applicable
- -------------------- *Filed as exhibits to the Registrant's registration statement on Form S-2 (File No. 33-69300) filed with the Commission on September 23, 1993 or as part of reports filed for the purpose of updating such description. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. (b) Reports on Form 8-K None. - 44 - 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. D&N FINANCIAL CORPORATION Date March 25, 1998 By: /s/ GEORGE J. BUTVILAS --------------------------------- --------------------------- GEORGE J. BUTVILAS (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: /s/ GEORGE J. BUTVILAS By: /s/ KENNETH D. SEATON --------------------------------- --------------------------- GEORGE J. BUTVILAS KENNETH D. SEATON Director, President and Director, Chairman of the Board Chief Executive Officer (Principal Executive Officer) Date March 25, 1998 Date March 25, 1998 --------------------------------- --------------------------- By: /s/ JOSEPH C. BROMLEY By: /s/ MARY P. CAULEY --------------------------------- --------------------------- JOSEPH C. BROMLEY MARY P. CAULEY Director Director Date March 25, 1998 Date March 25, 1998 --------------------------------- --------------------------- By: /s/ STEVEN COLEMAN By: /s/ STANLEY A. JACOBSON --------------------------------- --------------------------- STEVEN COLEMAN STANLEY A. JACOBSON Director Director Date March 25, 1998 Date March 25, 1998 --------------------------------- --------------------------- - 45 - 46 By: /s/ RANDOLPH P. PIPER By: /s/ B. THOMAS M. SMITH, JR. --------------------------------- --------------------------- RANDOLPH P. PIPER B. THOMAS M. SMITH, JR. Director Director Date March 25, 1998 Date March 25, 1998 --------------------------------- --------------------------- BY: /s/ PETER VAN PELT By: /s/ STEVEN E. ZACK --------------------------------- --------------------------- PETER VAN PELT STEVEN E. ZACK Director Director Date March 25, 1998 Date March 25, 1998 --------------------------------- --------------------------- By: /s/ KENNETH R. JANSON --------------------------------- KENNETH R. JANSON Executive Vice President/ Chief Financial Officer Date March 25, 1998 --------------------------------- - 46 - 47
Reference to Sequential Prior Filing Page Number or Exhibit Where Attached/ Regulation Number Located in S-K Exhibit Attached This Form 10-K Number Document Hereto Report - ----------- ---------------------------- ------------- --------------- 3(I) Articles of Incorporation * Not applicable 3(ii) By-Laws * Not applicable 4 Instruments defining the * Not applicable rights of security holders, including debentures 9 Voting Trust Agreement None Not applicable 10 Material Contracts 1993 401(k) Plan & Trust * Not applicable (1994 Amendment) 1984 Stock Option Plan * Not applicable (1995 Amendment) 1994 Management * Not applicable Stock Incentive Plan (1995 Amendment) Employment Agreement of G. Butvilas * Not applicable 11 Statement re: computation Not required Not applicable of per share earnings 12 Statement re: computation Not required Not applicable of ratios 13 Annual Report to Security 13 Filed Herewith Holders 16 Letter re: change in None Not applicable Certifying Accountant 18 Letter re: change in None Not applicable accounting principles 21 Subsidiaries of Registrant 21 Filed Herewith 22 Published report regarding None Not applicable matters submitted to vote of security holders 23 Consent of Experts and 23 Filed Herewith Counsel 24 Power of Attorney Not required Not applicable
- 43 - 48 27.1 Financial Data Schedule 27 Filed Herewith 27.2 Financial Data Schedule 27.3 Financial Data Schedule 27.4 Financial Data Schedule 27.5 Financial Data Schedule 27.6 Financial Data Schedule 27.7 Financial Data Schedule 27.8 Fiancial Data Schedule 27.9 Fiancial Data Schedule 28 Information from reports None Not applicable furnished to state insurance regulatory authorities 99 Additional exhibits None Not applicable
- -------------------- *Filed as exhibits to the Registrant's registration statement on Form S-2 (File No. 33-69300) filed with the Commission on September 23, 1993 or as part of reports filed for the purpose of updating such description. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. (b) Reports on Form 8-K None. - 44 - EX-13 2 EXHIBIT 13 1 EXHIBIT 13 SELECTED FINANCIAL HIGHLIGHTS D&N FINANCIAL CORPORATION
----------------------------------------------------------------------------------- 1997 1996(2) 1995(2) 1994(2) 1993(2) - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands, except per share data) FOR THE YEAR: Net interest income $ 48,939 $ 42,763 $ 34,750 $ 23,786 $ 21,212 Provision for loan losses 1,350 1,100 2,400 100 -- Noninterest income(loss) 8,920 7,224 6,912 7,488 (21,536) Net income (loss) 14,325 8,995 10,417 3,383 (66,642)(1) Earnings (loss) per share Basic 1.58 1.08 1.27 0.41 (13.69) Diluted 1.53 1.01 1.24 0.41 (13.69) Shares outstanding: Basic 9,093,682 8,336,517 8,172,292 8,161,600 4,866,278 Diluted 9,364,874 8,906,109 8,403,028 8,185,146 4,945,579 Stock price range 14 57/64 - 26 3/4 10 29/32-16 9/64 6 19/32 -12 17/64 6 1/64-9 3/32 5 29/32 - 11 23/64 Cash dividends declared per common share 0.10 -- -- -- -- AT YEAR END: Total assets 1,815,315 1,473,054 1,228,497 1,128,732 1,080,131 Net loans receivable 1,300,959 1,055,876 952,359 821,875 646,709 Nonperforming assets 5,300 8,091 9,701 24,520 43,593 Mortgage-backed securities 358,296 251,256 127,709 151,293 171,983 Excess of cost over net assets of association acquired __ -- -- 384 845 Mortgage servicing rights 2,136 1,443 1,113 968 9,870 Deposits 1,043,167 964,133 922,932 817,674 844,012 Borrowings 619,523 404,037 216,295 226,956 101,648 Stockholders' equity 98,082 86,121 71,979 58,325 56,887 Per share 10.78 9.38 8.75 7.15 6.97 Tangible stockholders' equity 97,184 85,110 70,855 58,264 57,049 Per share 10.68 9.27 8.62 7.14 6.99 Number of offices 48 48 46 41 38 SELECTED RATIOS: Return on average assets 0.88% 0.67% 0.89% 0.31% (5.47)% Return on average equity 15.75 11.58 16.01 5.97 (74.99) Average equity to average assets 5.59 5.77 5.53 5.26 7.29 Net interest margin 3.08 3.26 3.04 2.31 1.95 General & administrative expenses to average assets 2.01 2.34 2.44 2.48 2.30 Nonperforming assets to total assets 0.29 0.55 0.79 2.17 4.04 Allowance for loan losses to nonperforming loans 275.72 166.77 122.21 46.38 38.21 Allowance for loan losses to total loans 0.80 1.03 1.05 1.01 1.76 Net loan charge-offs to average loans 0.15 0.01 0.07 0.43 0.59 Tangible capital ratio 6.55 5.11 5.41 5.05 4.89 Core capital ratio 6.55 5.11 5.41 5.09 4.97 Risk-based capital ratio 11.98 9.94 10.45 10.08 10.21
(1) Includes cumulative effect of change in accounting for goodwill of ($34,754,000). (2) All per share amounts have been restated to include the effects of a 10% stock dividend and adoption of SFAS 128 in 1997. 4 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL D&N Financial Corporation ("D&N" or "the Company") is a savings bank holding company whose sole subsidiary is D&N Bank ("the Bank"). D&N's primary focus is the delivery of retail financial services through its community banking offices in Michigan and loan origination network in the Upper Midwest. This discussion highlights important trends and events that have shaped the Company's financial performance in 1997. In 1997, D&N reported net income of $14.3 million, or $1.53 per diluted share. Earnings in 1996, before one-time regulatory charges and the tax benefit of a previous year's net operating loss, were $10.1 million or $1.14 per diluted share. In 1995 the Company earned $10.4 million or $1.24 per diluted share. On December 31, 1997, the Company's balance sheet included total assets of $1.82 billion, compared to $1.47 billion at the end of 1996. This 23% growth reflected primarily the Bank's loan origination success, with $856 million of new loans funded in 1997. Outstanding loan balances totaled $1.31 billion at December 31, 1997, an increase of 23% during the year. Mortgage-backed securities also increased by 43% to $358 million as the Bank securitized $86 million of its residential mortgage loan production with the Federal Home Loan Mortgage Corporation ("FHLMC" or "Freddie Mac"). Equity and capital support for D&N's robust growth in 1997 came from the retention of earnings, from the receipt, in December, 1996, of proceeds from the exercise of warrants to purchase the Company's common stock, and from the successful creation, in July, 1997, of a new Bank subsidiary, D&N Capital Corporation ("DNCC"). DNCC is a Real Estate Investment Trust ("REIT") that invests in residential and commercial real estate mortgages which it acquires from the Bank. In addition to the $32 million equity investment that the Bank made in DNCC, outside investors purchased preferred stock of the subsidiary for $30.25 million. This preferred stock investment is included in the regulatory capital accounts of D&N Bank. In 1997, the Company made provisions for loan losses of $1.35 million, after making provisions of $1.1 million and $2.4 million in 1996 and 1995, respectively. At December 31, 1997, the allowance for loan losses was $10.5 million, or 0.80% of outstanding loans. D&N's portfolio of nonperforming assets declined during 1997 by $2.8 million or 34% to $5.3 million. At December 31, 1997, the allowance for loan losses was 276% of the loans deemed to be nonperforming. This ratio was 167% in 1996 and 122% in 1995. Noninterest income from operations increased by 19.1% in 1997 after increasing by 14.7% in 1996. The increases in loan related and deposit related fee income experienced in 1996 and 1997 reflect the successful implementation of servicing strategies designed to complement the Company's community banking focus. D&N Bank incurred a one-time charge in 1996 as a result of its mandated contribution to replenish the Federal Deposit Insurance Corporation's ("FDIC") depleted Savings Association Insurance Fund ("SAIF"). The third quarter assessment was $5.5 million before consideration of its impact on federal taxes, and was expected to reduce the Bank's annual deposit insurance premiums by approximately $1.6 million. Also during the third quarter of 1996, the Bank recognized adjustments to its balance of deferred tax assets following the enactment in August of federal legislation which resolved the recapture status of previously allowed accelerated deductions for bad debts. Historically, thrift institutions such as the Bank had been permitted to deduct a portion of their net income as bad debt allowances. This practice was more advantageous than the specific-loss method of deduction which was mandated for other classes of financial institutions. The opportunity to use the percentage-of-income method expired in 1995, but the status of previously accelerated deductions remained 12 3 in question until the 1996 legislation was enacted. Notably, the presence of unresolved prior deductions was felt to be a hindrance to evolution and consolidation of the financial services industry because thrift institutions that had recorded such accelerated deductions were required to repay them before charter conversions or acquisitions by non-thrift institutions could be approved. The new legislation required that accelerated deductions recorded after 1987 would have to be repaid, but forgave that portion of institutions' accelerated loan loss deductions that were recorded before 1988. RESULTS OF OPERATIONS NET INTEREST INCOME The Company's primary source of earnings is its net interest income, defined as the difference between the interest earned on its loans and investments and the interest paid on its deposits and other liabilities. Interest income and interest expense each increased in 1997 as the average size of the Company's earning assets grew substantially. Interest income increased by $21.4 million, or 20.5%, in 1997. The average yield on earning assets decreased by 4 basis points to 7.91% in 1997, from 7.95% in 1996. In 1995, earning assets yielded 7.93%. Driving the interest income gains in 1997 was D&N's 21.1% increase in average earning balances, which followed an increase of 14.7% in 1996 and 11.1% in 1995. Interest expense increased by $15.2 million, or 24.7%, in 1997 as the average balance of interest-bearing liabilities increased by 20.2%, and the average rate paid on those liabilities increased by 19 basis points. In 1997, interest-bearing liabilities had an average cost of 5.12%, compared to 4.93% in 1996 and 5.15% in 1995. Because the average yield on interest-earning assets decreased and the average cost of interest-bearing liabilities increased in 1997, the Company's interest rate spread decreased from 3.02% in 1996 to 2.79% in 1997. In 1995 the spread was 2.79%. Similarly, the Bank's net interest margin, or ratio of net interest income to average interest-earning assets, decreased from 3.26% in 1996 to 3.08% in 1997. In 1995 the net interest margin was 3.04%. Average interest-earning assets exceeded average interest-bearing liabilities by $88.7 million in 1997 compared to $64.5 million in 1996 and $55.3 million in 1995. Average balances of loans outstanding were higher in 1997 than 1996, as the Company's loan originations increased significantly. Average balances of mortgage-backed securities were also sharply higher reflecting loan securitization efforts, while the investment securities category increased modestly. Loans increased by $132 million, or 12%; mortgage-backed securities increased by $120 million, or 82%; and investment securities increased by $24.2 million, or 23%. Average earning rates on investments and mortgage-backed securities were lower in 1997 than 1996, while the average earning rate on the loan portfolio increased. In 1997, loans earned an average yield of 8.25% compared to 8.11% in 1996. Mortgage-backed securities earned an average of 7.15% in 1997, versus an average rate of 7.46% in 1996. Investment securities earned 6.28% in 1997, down from 6.96% in 1996. Even though average loan yields increased from the previous year, overall earning-asset performance decreased slightly as a greater proportion of the earning-asset portfolio was comprised of less profitable mortgage-backed security and investment assets in 1997 than in 1996. The average balances of loan assets and mortgage-backed securities also increased from 1995 to 1996. In 1996, average investment balances fell, reflecting the Company's application of surplus liquidity assets to fund loan growth. Average deposit balances increased 7.9% to $1.012 billion in 1997, from $938 million in 1996. The average cost of deposits increased 7 basis points, to 4.74%, in 1997, from 4.67% in 1996. From 1995 to 1996, average deposit balances increased by $86 million, or 10.1%. In 1995, the average cost of deposits was 4.53%. The average balance of borrowed funds increased by 57.7%, to $488 million in 1997, from $310 million in 1996. In 1995, the average balance of borrowed funds was $236 million. 13 4 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.) The following tables set forth the extent to which the Company's net interest income has been affected by changes in average interest rates and average balances of interest-earning assets and interest-bearing liabilities.
Years Ended December 31, 1997 and 1996 ------------------------------------------------------------------------------------------------ Average balance (1) Average rate Interest Variance due to: (2) ------------------------------------------------------------------------------------------------ Increase 1997 1996 1997 1996 1997 1996 (Decrease) Volume Rate - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Interest-earning assets: Loans (3) $1,194,090 $1,062,108 8.25% 8.11% $98,560 $86,151 $12,409 $10,917 $ 1,492 Mortgage-backed securities (4) 267,010 146,560 7.15 7.46 19,085 10,930 8,155 8,627 (472) Investments and deposits (4) 128,071 103,848 6.28 6.96 8,048 7,228 820 1,562 (742) ------------------------------------------------------------------------------------------------ 1,589,171 1,312,516 7.91 7.95 125,693 104,309 21,384 21,106 278 ------------------------------------------------------------------------------------------------ Interest-bearing liabilities: Deposits 1,012,237 938,484 4.74 4.67 47,961 43,859 4,102 3,469 633 Borrowings 488,251 309,516 5.90 5.71 28,793 17,687 11,106 10,294 812 ------------------------------------------------------------------------------------------------ 1,500,488 1,248,000 5.12 4.93 76,754 61,546 15,208 13,763 1,445 ------------------------------------------------------------------------------------------------ Interest rate spread 2.79 3.02 Excess average earning assets $ 88,683 $64,516 7.91% 7.95% ================================================ Net interest margin 3.08% 3.26% $48,939 $42,763 $6,176 $7,343 $(1,167) ================================================================ Years Ended December 31, 1996 and 1995 ------------------------------------------------------------------------------------------------ Average balance (1) Average rate Interest Variance due to: (2) ------------------------------------------------------------------------------------------------ 1996 1995 1996 1995 1996 1995 Increase Volume Rate (Decrease) - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Interest-earning assets: Loans (3) $1,062,108 $892,364 8.11% 8.13% $86,151 $72,550 $13,601 $13,767 $(166) Mortgage-backed securities(4) 146,560 140,093 7.46 7.55 10,930 10,577 353 484 (131) Investments and deposits (4) 103,848 111,476 6.96 6.85 7,228 7,638 (410) (525) 115 ----------------------------------------------------------------------------------------------- 1,312,516 1,143,933 7.95 7.93 104,309 90,765 13,544 13,726 (182) ----------------------------------------------------------------------------------------------- Interest-bearing liabilities: Deposits 938,484 852,382 4.67 4.53 43,859 38,639 5,220 4,020 1,200 Borrowings 309,516 236,242 5.71 6.29 17,687 14,855 2,832 4,283 (1,451) Interest rate instruments -- -- -- 0.23 -- 2,521 (2,521) -- (2,521) ----------------------------------------------------------------------------------------------- 1,248,000 1,088,624 4.93 5.15 61,546 56,015 5,531 8,303 (2,772) ----------------------------------------------------------------------------------------------- Interest rate spread 3.02 2.79 Excess average earning assets $ 64,516 $55,309 7.95% 7.93% ================================================ Net interest margin 3.26% 3.04% $42,763 $34,750 $8,013 $5,423 $2,590 ===============================================================
(1) Based on average daily balances. (2) Changes to interest income and interest expense attributable to changes in both rate and volume have been attributed proportionately to the change due to rate and the change due to volume. (3) Loans on nonaccrual are included in the average balances shown above. The variance due to rate includes the effect of such loans because no interest is earned on such loans. (4) Average rates on mortgage-backed and investment securities available for sale are based on historical amortized cost balances. 14 5 In 1995, D&N's interest expense included the net costs of interest rate hedging instruments. During 1995, contracts written in the 1980s to exchange fixed interest payments for variable receipts ("swap contracts") resulted in net charges to interest expense of $2.5 million. The swap contracts, originally executed as hedges against rising interest rates, have expired, with the final contract maturing in November of 1995. NONINTEREST INCOME D&N's noninterest income includes recurring fees from loan and deposit-related activities, recurring income from the marketing of assets that are originated for sale, and non-recurring gains and losses from events such as securities sales and sales of non-earning and depreciated assets. D&N's loan and deposit-related fee income totaled $6.0 million in 1997, up $461,000 or 8.3% from 1996, reflecting primarily the Bank's growing core deposit base and the initiation of fees for non-customer usage of the Bank's automatic teller machine network. In 1997, net loan servicing and administrative fees were unchanged from 1996 at $1.9 million. Deposit-related fees, on the other hand, increased by 12.7% in 1997. Gains on sales of loans totaled $1.7 million in 1997, up from $1.0 million in 1996. In 1997, $103 million of D&N's residential mortgages were sold to secondary market investors, compared to $66.1 million in 1996. In each year, D&N Bank retained the rights to service all of these loans. Other income increased from $470,000 in 1996 to $657,000 in 1997 as D&N Bank's subsidiary, Quincy Insurance Agency, continued to successfully expand its offerings of annuities and investment products. NONINTEREST EXPENSE General and administrative expenses totaled $32.6 million in 1997. In 1996, this category included $1.4 million of non-recurring costs associated with the Bank's merger with Macomb Federal Saving Bank. When merger-related costs are excluded from the 1996 total, general and administrative expenses were up in 1997 by $2.5 million, or 8.2%, following an increase of $1.5 million, or 5.1% in 1996. These increases reflect the costs of D&N's expanding retail delivery network, and the variable-based compensation consequences of sharply higher loan production levels. In 1997, net recoveries on sales of other real estate owned ("OREO") exceeded operating costs for such properties by $81,000. In 1996, noninterest expense included $71,000 of net operating costs related to OREO. In 1995, net recoveries on sales of OREO properties exceeded operating costs resulting in a credit in this category of $1.0 million. In 1995, D&N's noninterest expense included amortization costs for goodwill associated with the Company's 1982 merger with First Federal Savings and Loan Association of Flint, Michigan. In 1997, D&N's FDIC insurance premium was $658,000, or $1.76 million less than the adjusted total for 1996. Excluding that year's SAIF recapitalization assessment of $5.5 million, deposit insurance premiums in 1996 were $2.4 million. Similarly, the 1995 premium was $2.4 million. INCOME TAXES The Company's effective income tax rates were 35.09% in 1997, 3.74% in 1996 and (19.16)% in 1995. The tax rates in 1996 and 1995 were effected by reductions in each year of a portion of the valuation allowance for deferred tax assets provided in prior years, when the Company incurred substantial net operating losses. The valuation allowance was eliminated as of December 31, 1996. FINANCIAL CONDITION BALANCE SHEET TRENDS At December 31, 1997, D&N's assets totaled $1.82 billion, an increase of $342 million, or 23%, from the previous year end. The Company's balance sheet growth has been fueled by substantial loan production and increased capitalization. In 1997, net loans receivable increased by $245 million, or 23%, reflecting continued strong demand for the Company's consumer and commercial loan products. Balances of mortgage-backed securities increased $107 million, or 43%, as a consequence of the securitization of $86 million of the Bank's residential mortgage loan production and purchases of collateralized mortgage obligations ("CMOs"). All of the servicing rights for sold and securitized mortgages were retained, resulting in an increase in the balances of loans serviced for others from $415 million to $519 million during the year. The Company's liabilities increased by 22%, or $302 million, to $1.69 billion at December 31, 1997, compared to $1.39 billion at the end of 1996. Overall deposit balances 15 6 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.) increased by 8.2%, or $79.0 million, while core deposits experienced an 8.3% increase from $346.1 million at December 31, 1996, to $374.8 million at year- end 1997. Borrowed funds increased by 53%, or $215 million, in 1997, while advance payments by borrowers and investors held in escrow increased from $11.8 million to $17.6 million. In 1997, D&N's common stockholders' equity rose from $86.1 million to $98.1 million. Profitable operations contributed $14.3 million to the Company's retained earnings while the proceeds from the exercise of options and accompanying tax benefits added $1.2 million to the equity accounts. Cash dividends and purchases of Treasury Stock returned $3.8 million to shareholders in 1997. An additional source of equity in 1997 was $1.5 million of market-value in excess of book-value attributable to investment and mortgage-backed securities held for sale. In accordance with the provisions of the Statement of Financial Accounting Standards ("SFAS") 115, "Accounting for Certain Investments in Debt and Equity Securities", unrealized gains such as these are recorded in the stockholders' equity section of the Company's Statement of Financial Condition, but are not recognized through the Statement of Operations. Under its federal charter, the Bank must maintain adequate levels of capital to assure the safety and soundness of its operations. At December 31, 1997, the Bank had a tangible capital ratio of 6.55%, a core capital ratio of 6.55%, and a risk-based capital ratio of 11.98%. D&N Bank's ratios continue to exceed the levels specified in the Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA" or "the Act") as minimally acceptable standards. At the close of 1997, those minimum standards were tangible capital of 1.50%, core capital of 3.0% (with a proposed regulation which would raise the core capital requirement to between 4.00% and 5.00%), and risk-based capital of 8.00%. The Bank's primary regulator, the Office of Thrift Supervision ("OTS"), prompt corrective action regulations establish five capital categories for thrift institutions: well capitalized, adequately capitalized, undercapitalized, severely undercapitalized and critically undercapitalized. These categories are determined for the supervisory purposes of Section 38 of the Federal Deposit Insurance Act (which establishes a system of mandatory and discretionary supervisory actions which generally become more severe as capital levels decline) and may not necessarily constitute an accurate measure of the Bank's current overall financial condition or its future prospects. A thrift generally will be considered "well capitalized" if it has a core capital (or leverage) ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 10.0%. A thrift generally will be considered "adequately capitalized" if it has a core capital (or leverage) ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0%, and a total risk-based capital ratio of at least 8.0%. The Bank's core (or leverage), Tier 1 risk-based and total risk-based capital ratios at December 31, 1997 of 6.55%, 11.02% and 11.98%, respectively, exceeded the capital ratios established for "well capitalized" institutions. The OTS issued rules adding an interest rate risk component to the total capital that certain rate-sensitive institutions must maintain. The rule requires the OTS to measure an institution's interest rate risk as the percentage change in market value of its portfolio resulting from a hypothetical 200 basis point shift in interest rates. At December 31, 1997, D&N's level of interest rate risk was such that no additional capital was required. LIQUIDITY AND CAPITAL RESOURCES The OTS also requires that institutions maintain liquid assets in the form of cash, U.S. Government securities, mortgage-backed securities and other qualifying assets, in amounts equal to at least 4% of net withdrawable accounts and borrowed funds payable in one year or less. For the month of December 1997, the Bank's average 16 7 liquidity ratio was 13.9%, up from the December 1996 ratio of 6.61%. Borrowing capacity can be viewed as a supplemental source of liquidity for the Bank. D&N's government bond and mortgage-backed securities portfolios include high quality investment securities which are readily acceptable as collateral for additional borrowed funds, obtainable from either the FHLB system or from other financial institutions. Also, much of the Bank's residential mortgage loan portfolio would be acceptable as collateral to support new advances from the FHLB. In the aggregate, by virtue of its inventory of unpledged security and mortgage loan collateral, D&N had approximately $187 million of unused borrowing capacity at December 31, 1997. Loan Portfolio The following table categorizes the Bank's loans receivable for the past five years:
DECEMBER 31 -------------------------------------------------------- 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------- (Dollars in thousands) Residential mortgages $ 703,580 $ 600,923 $597,892 $526,572 $387,252 Mortgages on income-producing property 81,830 85,619 89,176 115,162 131,372 Construction loans 56,446 39,673 41,056 19,900 12,558 Consumer loans 449,551 339,268 239,459 170,939 134,644 Commercial loans 38,435 12,345 7,769 4,748 -- Allowance for losses (10,549) (11,042) (10,081) (8,349) (11,570) Discounts, deferrals and other (18,334) (10,910) (12,912) (7,097) (7,547) ----------------------------------------------------------- $1,300,959 $1,055,876 $952,359 $821,875 $646,709 ===========================================================
D&N's investment in loans increased by $245 million, or 23%, in 1997. Consumer loans and commercial loans experienced the most significant percentage increases, while residential mortgages grew at a more modest rate. The Bank's investment in mortgages on income-producing properties decreased for the seventh consecutive year while the year-end balance of construction loans was up markedly from the previous year. Consumer loans increased by $110 million, or 33% in 1997. Commercial loans increased by $26 million, or 211%, while residential mortgage loans increased during the year by $103 million, or 17%. Mortgages on income-producing properties decreased by $3.8 million, or 4.4%, while construction loan balances increased by $16.8 million, or 42.3%. At the end of 1997, 47% of the Company's loan balances were in consumer or business-related loans, compared to a 44% weighting at the end of 1996. D&N originated $622 million of loans in 1997, up $103 million, or 19.8% from $519 million originated in 1996. Consumer loan production totaled $324 million in 1997, up by $52.1 million, or 19.2%, from 1996. Aggregate mortgage production in 1997 was $261 million, an increase of $33 million, or 14.4%, from 1996. Construction lending accounted for $54.0 million of this total, up 26% from $42.9 million in 1996. Supplementing the Company's mortgage production was $235 million of purchased loans in 1997, up from $148 million in 1996. CREDIT RISK MANAGEMENT AND PROVISION FOR LOSSES ON LOANS AND OTHER ASSETS At December 31, 1997, the Company's nonperforming assets totaled $5.3 million, down from $8.1 million at the end of the previous year and $9.7 million at the end of 1995. The 1997 balance was comprised of $3.8 million of nonperforming loans and $1.5 million of other real estate owned ("OREO"). At the end of 1997, nonperforming loans comprised just 0.29% of the loan portfolio, and the allowance for loan losses stood at 276% of the total balances of nonperforming loans. 17 8 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.) The following table traces the Company's nonperforming asset experience for the last five years.
December 31 ------------------------------------------ 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------ (Dollars in thousands) Nonaccruing loans $3,552 $6,621 $8,225 $17,995 $30,102 Accruing loans delinquent more than 90 days 274 -- 24 5 13 Restructured loans -- -- -- -- 166 ------------------------------------------- Total nonperforming loans 3,826 6,621 8,249 18,000 30,281 Other real estate owned (OREO) 1,474 1,470 1,452 6,520 13,312 ------------------------------------------- Total nonperforming assets $5,300 $8,091 $9,701 $24,520 $43,593 =========================================== Nonperforming loans as a percentage of total loans 0.29% 0.62% 0.86% 2.17% 4.60% =========================================== Nonperforming assets as a percentage of total assets 0.29% 0.55% 0.79% 2.17% 4.04% =========================================== Allowance for loan losses as a percentage of nonperforming loans 275.72% 166.77% 122.21% 46.38% 38.21% =========================================== Allowances for loan and OREO losses as a percentage of nonperforming assets 199.04% 136.47% 105.29% 35.40% 28.03% ===========================================
Allowances for losses on the loan portfolio totaled $10.5 million at December 31, 1997. Losses of $2.18 million were charged off and $340,000 was recovered, as new provisions for loan losses of $1.35 million were recorded during the year. At year-end, the allowance for loan losses represented .80% of the total outstanding loan portfolio balance. The following table details the changes in the Company's allowance for loan losses for the last five years.
Year Ended December 31 --------------------------------------------- 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------ (Dollars in thousands) Balance at beginning of period $11,042 $10,081 $ 8,349 $11,570 $15,611 Charge-offs: Residential mortgages 290 314 169 110 1,136 Mortgages on income-producing property 277 -- 1,019 3,109 2,584 Commercial loans -- -- -- -- -- Consumer loans 1,616 1,216 999 773 681 -------------------------------------------- 2,183 1,530 2,187 3,992 4,401 Recoveries: Residential mortgages -- 3 917 9 25 Mortgages on income-producing property -- 1,098 245 300 8 Commercial loans -- -- -- -- -- Consumer loans 340 290 357 362 327 -------------------------------------------- 340 1,391 1,519 671 360 Net charge-offs 1,843 139 668 3,321 4,041 Provision charged to operations 1,350 1,100 2,400 100 -- -------------------------------------------- Balance at end of period $10,549 $11,042 $10,081 $ 8,349 $11,570 ============================================ Net charge-offs as a percentage of average loans 0.15% 0.01% 0.07% 0.43% 0.59% ============================================ Allowance for loan losses as a percentage of total loans 0.80% 1.03% 1.05% 1.01% 1.76% ============================================
At the end of 1997, $5.4 million of the allowance for loan losses was allocated to the commercial real estate mortgage portfolio while $4.2 million of the allowance was allocated to the consumer loan portfolio. 18 9 The following table summarizes the allocation of the allowance for loan losses among the Company's assets in each of the past five years.
December 31 ------------------------------------------------------------------------------ 1997 1996 1995 ------------------------------------------------------------------------------ Percentage of Percentage of Percentage of Amount loans to total Amount loans to total Amount loans to total - ----------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Residential mortgages $ 569 54% $ 859 57% $ 1,170 63% Mortgages on income-producing property 5,386 9% 6,314 10% 6,115 11% Commercial loans 400 3% 400 1% 400 1% Consumer loans 4,194 34% 3,469 32% 2,396 25% ------------------------------------------------------------------------------- $10,549 100% $11,042 100% $10,081 100% ===============================================================================
---------------------------------------------- 1994 1993 ---------------------------------------------- Percentage of Percentage of Amount loans to total Amount loans to total - -------------------------------------------------------------------------------------- (Dollars in thousands) Residential mortgages $ 813 63% $ 429 60% Mortgages on income-producing property 6,423 17% 9,617 19% Commercial loans -- -- -- -- Consumer loans 1,113 20% 1,524 21% ---------------------------------------------- $8,349 100% $11,570 100% ==============================================
ANALYSIS OF CASH FLOWS The Company's balances of cash and cash equivalents increased from $12.8 million to $20.5 million in 1997. During the year, $326 million of cash was provided from financing activities, primarily from expanded borrowings and increases in customers' deposit balances. Investing activities utilized $378 million of available cash and cash equivalents as loan purchases, mortgage-backed security purchases, and purchases of investment securities exceeded repayments in these categories. Operating activities provided $59.2 million of net cash in 1997. ASSET/LIABILITY MANAGEMENT The Company's objectives for the management of assets and liabilities include achieving and maintaining adequate and stable levels of both net interest income and market value for the Company's net assets. The level of net interest income that can be attained is enhanced by assuming credit, liquidity and interest rate risks and by striving to keep nonearning asset balances to a minimum. Net interest income and market value of portfolio equity ("MVPE") stability is enhanced across various interest rate scenarios by properly matching maturity structures of assets and liabilities. The Company employs various tools, including gap analysis, duration analysis and simulation analysis, to assess the sensitivity of its net interest income and MVPE to changes in interest rates. D&N's cumulative gap analysis for December 31, 1997 is found on the following page. 19 10 Management's Discussion And Analysis (cont.) For each maturity category in the table below, the difference between interest-earning assets and interest-bearing liabilities reflects an imbalance between repricing opportunities for the two sides of the balance sheet. The consequence of a negative cumulative gap at the end of one year suggests that, if interest rates were to fall, the Company's earnings stream would be enhanced as more liability balances would reprice to lower rates than would asset balances. Similarly, the negative cumulative gap suggests that if interest rates were to rise, liability costs would increase more quickly than asset yields, placing negative pressure on earnings. With a cumulative one-year gap of (13.19)%, D&N's balance sheet is liability sensitive. At year-end, however, 42.0% of the Bank's loan portfolio carried variable or adjustable interest rates, and a growing proportion of the fixed-rate loan portfolio was comprised of relatively shorter-term consumer installment loans. The balances presented in the table below reflect contractual repricings for certificates of deposit. Certain demand deposit accounts and regular savings accounts, however, have been classified as repricing beyond one year. While these accounts are subject to immediate withdrawal, experience has shown them to be relatively rate insensitive. If these accounts were included in the 0-3 month category, the gap in that time frame would be negative $376 million and the cumulative gap at twelve months would be negative $426 million.
Maturity ---------------------------------------------------------- 0 to 3 4 to 12 1 to 5 Over 5 Months Months Years Years Total - ---------------------------------------------------------------------------------------------------- (Dollars in thousands) Assets: Cash and due from banks/others $ 20,497 $ -- $ -- $ -- $ 20,497 Investment securities 15,000 52,000 10,000 25,636 102,636 Mortgage-backed certificates 21,835 45,297 174,009 117,155 358,296 Net loans receivable 286,029 385,524 602,582 26,824 1,300,959 Other assets 8,791 1,934 3,831 18,371 32,927 ----------------------------------------------------------- TOTAL ASSETS $ 352,152 $ 484,755 $790,422 $187,986 $1,815,315 =========================================================== Liabilities: Deposits $ 232,098 $ 430,244 $264,633 $116,192 $1,043,167 FHLB advances and other borrowed money 285,317 128,675 204,528 1,003 619,523 Escrow funds -- -- -- 17,585 17,585 Other liabilities -- -- -- 8,239 8,239 ----------------------------------------------------------- TOTAL LIABILITIES 517,415 558,919 469,161 143,019 1,688,514 =========================================================== Preferred Stock of Subsidiary -- -- -- 28,719 28,719 Stockholders' Equity: Common stock -- -- -- 92 92 Additional paid-in capital -- -- -- 76,694 76,694 Retained earnings and other -- -- -- 22,877 22,877 Treasury stock -- -- -- (1,581) (1,581) ----------------------------------------------------------- TOTAL LIABILITIES AND EQUITY $ 517,415 $ 558,919 $469,161 $269,820 $1,815,315 =========================================================== Reprice difference $(165,263) $ (74,164) $321,261 $(81,834) Cumulative gap $(165,263) $(239,427) $ 81,834 $ -- Percent of total assets (9.10)% (13.19)% 4.51% --
20 11 The following table shows the Company's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity, and the instruments' fair values at December 31, 1997.
Maturity ---------------------------------------------------------------------------------------- Total 1998 1999 2000 2001 2002 Thereafter Fair Value ---------------------------------------------------------------------------------------- (Dollars in thousands) Interest sensitive assets: Loans receivable: Real estate mortgages $ 222,294 $152,151 $130,218 $ 88,281 $ 66,332 $187,366 $ 846,642 Average interest rate 8.15% 8.02% 7.94% 8.00% 8.06% 7.80% 7.99% Non-real estate commercial 11,580 6,308 7,037 5,956 3,905 2,920 37,706 Average interest rate 9.55% 9.42% 9.38% 9.36% 9.21% 9.16% 9.40% Consumer 167,875 115,973 77,333 50,261 25,269 12,565 449,276 Average interest rate 9.17% 8.99% 9.03% 9.10% 9.28% 8.95% 9.08% Mortgage-backed securities 49,301 41,754 36,370 31,796 27,918 170,383 357,522 Average interest rate 7.30% 7.21% 7.26% 7.28% 7.35% 7.09% 7.19% Investment securities and interest bearing deposits 61,994 4,040 4 4 -- 39,765 105,807 Average interest rate 5.95% 5.74% 4.80% 4.90% -- 7.85% 6.38% Mortgage servicing assets 358 305 259 220 187 1,060 2,389 ------------------------------------------------------------------------------------- Total interest sensitive assets $ 513,402 $320,531 $257,221 $176,518 $ 123,611 $414,059 $1,799,342 ===================================================================================== Interest sensitive liabilities: Deposits: NOW accounts $ 23,287 $ 12,588 $ 7,553 $ 3,776 $ 3,147 $ 12,588 $ 62,939 Average interest rate 1.51% 1.51% 1.51% 1.51% 1.51% 1.51% 1.51% Savings deposits 27,694 22,816 16,302 12,229 8,156 75,922 163,119 Average interest rate 2.92% 2.99% 3.04% 3.08% 3.16% 3.33% 3.16% Money-market accounts 72,928 6,462 3,693 2,769 1,846 4,616 92,314 Average interest rate 4.02% 4.02% 4.02% 4.02% 4.02% 4.02% 4.02% Certificates of deposit 534,960 78,868 25,766 10,007 8,066 15,647 673,314 Average interest rate 5.86% 6.28% 6.20% 5.93% 6.22% 5.96% 5.93% Borrowings: Securities sold under agreements to repurchase 149,092 -- -- -- -- -- 149,092 Average interest rate 5.80% -- -- -- -- -- 5.80% FHLB Advances and Other borrowed money 215,167 180,767 71,231 621 534 4,169 472,489 Average interest rate 5.86% 6.01% 5.96% 10.04% 10.04% 8.75% 5.97% ------------------------------------------------------------------------------------- Total interest sensitive liabilities $1,023,128 $301,501 $124,545 $ 29,402 $ 21,749 $112,942 $1,613,267 =====================================================================================
Expected maturities are contractual maturities adjusted for prepayments of principal. The Company uses certain assumptions to estimate fair values and expected maturities. For assets, expected maturities are based upon contractual maturity, projected repayments and prepayments of principal. The prepayment assumptions are based on the Company's own historical experience. The assumptions used to present deposit balances are essentially the same as those used in the gap analysis. The actual maturities of these instruments could vary substantially if future prepayments differ from the Company's historical experience. 21 12 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONT.) SIGNIFICANT LITIGATION In 1989, the Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA" or "the Act") was passed, significantly altering the regulatory environment in which depository institutions in general, and the Company in particular, would subsequently operate. A provision of the Act provided for the elimination, over time, of one form of regulatory capital that many institutions, including D&N Bank, had utilized in their capital structures. The phased elimination of supervisory goodwill, an intangible asset previously created when companies such as D&N acquired weaker institutions, resulted in many of the affected companies experiencing capital shortfalls. In D&N's case, $42 million of unamortized supervisory goodwill was permitted to be counted as regulatory capital in 1989 at the time of the Act's passage, while $37 million remained in 1993 when its phase-out as qualifying capital was complete. The loss of this significant portion of D&N's regulatory capital base precipitated drastic changes in the Company's strategic plans, including the 56% shrinkage of the balance sheet from $2.3 billion in 1988 to $1.0 billion in 1993, the closure of the Company's national network of mortgage origination offices, the elimination of many jobs, and the cessation of stockholder dividends. A number of institutions, including D&N Bank, that were adversely affected by the FIRREA legislation subsequently initiated legal actions against the United States Government. The institutions have claimed that the inducements offered by federal regulatory agencies to acquire weakened or insolvent thrifts constituted contractual agreements that the goodwill created through the acquisition transactions would qualify as regulatory capital. FIRREA's mandated phase-out of regulatory capital treatment for supervisory goodwill, then, has been alleged to be a breach of a contract right. The United States Court of Federal Claims has registered approximately 120 similar cases, including D&N's, which seek damages for such breach. Early cases were bifurcated into questions of liability and damages, with the trial courts reasoning that, until the question of the government's liability was unequivocally established, efforts to determine damages or to develop damage theories were potentially irrelevant. Three early cases have proceeded through the Court of Claims, and after consolidation, through the Federal Circuit of the United States Court of Appeals, and the United States Supreme Court. In July of 1996, the Supreme Court found generally that the United States was liable for damages under a theory of contractual breach, and that claims of governmental immunity were not applicable in these cases. The cases were remanded to the Court of Claims where arguments concerning the extent of damages began in 1997. In consideration of the complexities of the pending litigation, the similarity of issues in the various cases, and the potential magnitude of the damage amounts that might ultimately be awarded, the Court of Claims has issued a case management order on the remaining cases, in essence creating an orderly procedure for these lawsuits, including D&N's suit, to proceed. Estimation of potential liability or damages from this action is speculative at this time. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS 130, "Reporting Comprehensive Income", and SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements. It also requires companies to report selected information about operating segments in interim financial reports issued to shareholders. These standards will be adopted effective January 1, 1998 and are not expected to have any material effect on the Company's financial statements. 22 13 OTHER ITEMS D&N utilizes various electronic computer systems for the delivery of its financial services products such as deposit accounts and loans, for the maintenance of its financial and other business records, and for general management purposes. Some of these systems include legacy procedures that may have been designed and historic data that may have been stored in such a manner that inconsistencies or failures might occur when dates from the new millennium are considered. Commonly known as the Year 2000 problem, a myriad of related potential computing difficulties face entities that rely extensively upon computer systems. D&N's major computer systems include deposit accounts, commercial lending, consumer lending, financial control, and sales platform support applications provided by M&I Data Services, Inc.; mortgage lending applications provided by ALLTEL Information Services, Inc. and FiTech, Inc.; and internally maintained micro-computer and network systems which support management functions and communications. D&N is working closely with its data services vendors to ascertain that their applications, upon which the Bank relies, will be certifiable as compliant by the end of 1998. D&N has determined that its internally maintained systems, consisting primarily of a Lotus Notes server array and various workstation-based business suite software, are Year 2000 compliant as currently installed. Costs associated with addressing the Year 2000 issue as it affects D&N's externally vended applications, is implicitly included in the contractual arrangements for those applications. Accordingly, D&N's duty is to monitor the progress of its vendors toward the attainment of compliance and to test for compliance. Where progress is acceptable and timely compliance is deemed likely, no material costs of addressing the Year 2000 issue are imputable to D&N. At this time, D&N deems the progress attained by each of its service bureau vendors to achieve Year 2000 compliance in a timely fashion to be acceptable. Accordingly, the potential cost of addressing the Year 2000 issue is not expected to be material to D&N's business, operations or financial condition. The operations of D&N Financial Corporation, and the financial services industry generally, are influenced by many factors, including the interest rate environment, competition, legislative and regulatory developments and general economic conditions. Except for the historical information contained in this report, certain statements made herein are forward-looking statements that involve risks and uncertainties and are subject to various factors that could cause actual results to differ materially from these statements. Factors that might cause such a difference include, but are not limited to: regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors. 23 14 REPORT OF INDEPENDENT AUDITORS [COOPERS & LYBRAND LETTERHEAD] BOARD OF DIRECTORS AND STOCKHOLDERS D&N FINANCIAL CORPORATION We have audited the Consolidated Statements of Condition of D&N Financial Corporation and Subsidiary as of December 31, 1997 and 1996, and the related Consolidated Statements of Income, Stockholders' Equity and Cash Flows for each of the three years in the period ending December 31, 1997. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit 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 D&N Financial Corporation and Subsidiary at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ending December 31, 1997, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Detroit, Michigan January 22, 1998 24 15 CONSOLIDATED STATEMENTS OF CONDITION D&N FINANCIAL CORPORATION
December 31 -------------------------------- 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) ASSETS Cash and due from banks $ 16,239 $ 2,847 Federal funds sold 300 8,600 Interest-bearing deposits in other banks 3,958 1,342 ------------------------------- Total cash and cash equivalents 20,497 12,789 Investment securities (market value of $56,594,000 in 1997 and $60,783,000 in 1996) 56,524 60,739 Investment securities available for sale (at market value) 46,112 59,038 Mortgage-backed securities (market value of $199,525,000 in 1997 and $213,304,000 in 1996) 198,050 214,690 Mortgage-backed securities available for sale (at market value) 160,246 36,566 Loans receivable (including loans held for sale of $5,275,000 in 1997 and $5,218,000 in 1996) 1,311,508 1,066,918 Allowance for loan losses (10,549) (11,042) ------------------------------- Net loans receivable 1,300,959 1,055,876 Other real estate owned, net 1,474 1,470 Federal income taxes 1,129 6,002 Office properties and equipment, net 16,621 15,764 Other assets 13,703 10,120 ------------------------------- $ 1,815,315 $ 1,473,054 LIABILITIES =============================== Checking and NOW accounts $ 119,412 $ 107,550 Money market accounts 92,314 89,321 Savings deposits 163,119 149,226 Time deposits 667,204 617,102 Accrued interest 1,118 934 ------------------------------- Total deposits 1,043,167 964,133 Securities sold under agreements to repurchase 149,092 58,040 FHLB advances and other borrowed money 470,431 345,997 Advance payments by borrowers and investors held in escrow 17,585 11,808 Other liabilities 8,239 6,955 ------------------------------- Total liabilities 1,688,514 1,386,933 PREFERRED STOCK OF SUBSIDIARY 28,719 -- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value per share (1,000,000 shares authorized; none issued) Common stock, $.01 par value per share (shares authorized - 25,000,000; -- -- shares outstanding - 9,197,224 in 1997 and 8,370,494 in 1996) 92 84 Additional paid-in capital 77,025 55,452 ------------------------------- Total paid-in capital 77,117 55,536 Retained earnings - substantially restricted 21,042 29,568 Less: Cost of treasury stock (98,129 shares in 1997 and 22,339 in 1996) (1,581) (226) Unrealized holding gains on debt securities available for sale, net of tax 1,504 1,243 ------------------------------- Total stockholders' equity 98,082 86,121 ------------------------------- $ 1,815,315 $ 1,473,054 ===============================
See Notes to Consolidated Financial Statements. 25 16 CONSOLIDATED STATEMENTS OF CONDITION D&N FINANCIAL CORPORATION
Year Ended December 31 ------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except earnings per share) INTEREST INCOME Loans $ 98,560 $ 86,151 $ 72,550 Mortgage-backed securities 19,085 10,930 10,577 Investments and deposits 8,048 7,228 7,638 -------------------------------------------- Total interest income 125,693 104,309 90,765 INTEREST EXPENSE Deposits 47,961 43,859 38,639 Securities sold under agreements to repurchase 5,571 2,193 1,450 FHLB advances and other borrowed money 23,222 15,494 13,405 Interest rate instruments -- -- 2,521 -------------------------------------------- Total interest expense 76,754 61,546 56,015 -------------------------------------------- Net interest income 48,939 42,763 34,750 Provision for loan losses 1,350 1,100 2,400 -------------------------------------------- Net interest income after provision for loan losses 47,589 41,663 32,350 NONINTEREST INCOME Loan servicing and administrative fees, net 1,916 1,914 1,882 Deposit related fees 4,080 3,621 3,147 Gain on sale of loans held for sale 1,728 1,031 882 Other income 657 470 222 -------------------------------------------- 8,381 7,036 6,133 Gain (loss) on investment securities available for sale -- 188 (120) Gain on loans and mortgage-backed securities available for sale 539 -- 899 -------------------------------------------- Total noninterest income 8,920 7,224 6,912 NONINTEREST EXPENSE Compensation and benefits 17,881 16,881 15,732 Occupancy 3,110 2,834 2,273 Other expense 11,655 11,863 10,713 -------------------------------------------- General and administrative expense 32,646 31,578 28,718 Other real estate owned, net (81) 71 (999) Amortization of intangibles -- -- 370 FDIC insurance 658 7,894 2,431 -------------------------------------------- Total noninterest expense 33,223 39,543 30,520 -------------------------------------------- Income before income tax expense 23,286 9,344 8,742 Federal income tax expense (credit) 7,743 349 (1,675) -------------------------------------------- Income before preferred stock dividends 15,543 8,995 10,417 Preferred stock dividend of subsidiary 1,218 -- -- -------------------------------------------- NET INCOME $ 14,325 $ 8,995 $ 10,417 ============================================ Earnings per share: Basic $ 1.58 $ 1.08 $ 1.27 ============================================ Diluted $ 1.53 $ 1.01 $ 1.24 ============================================
See Notes to Consolidated Financial Statements. 26 17 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY D&N FINANCIAL CORPORATION
Unrealized Holding Treasury Gains (Losses) Additional Stock & Leveraged on Securities Total Common Paid-In Retained Treasury ESOP Available Stockholders' Stock Capital Earnings Warrants Debt for Sale Equity - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Balance December 31, 1994 $ 74 $ 49,591 $ 10,156 $ (213) $ (99) $ (1,184) $ 58,325 Net income -- -- 10,417 -- -- -- 10,417 Issuance of common stock upon exercise of stock options and warrants - 60,886 shares 1 345 -- -- -- -- 346 Purchase of 11,000 warrants -- -- -- (44) -- -- (44) Reduction of leveraged ESOP debt -- -- -- -- 36 -- 36 Change in value of securities available for sale -- -- -- -- -- 2,899 2,899 ------------------------------------------------------------------------------- Balance December 31, 1995 $ 75 $ 49,936 $ 20,573 $ (257) $ (63) $ 1,715 $ 71,979 Net income -- -- 8,995 -- -- -- 8,995 Issuance of common stock upon exercise of stock options and warrants - 960,508 shares 9 9,046 -- -- -- -- 9,055 Purchase of treasury stock and warrants -- -- -- (3,499) -- -- (3,499) Reissuance of 256,251 treasury shares -- (3,530) -- 3,530 -- -- -- Reduction of leveraged ESOP debt -- -- -- -- 63 -- 63 Change in value of securities available for sale -- -- -- -- -- (472) (472) ------------------------------------------------------------------------------- Balance December 31, 1996 $ 84 $ 55,452 $ 29,568 $ (226) $ -- $ 1,243 $ 86,121 Net income -- -- 14,325 -- -- -- 14,325 Cash dividends, common stock ($0.10 per share) -- -- (826) -- -- -- (826) 10% common stock dividend, at fair market value 8 22,017 (22,025) -- -- -- -- Issuance of common stock upon exercise of stock options - 98,681 shares -- 1,196 -- -- -- -- 1,196 Purchase of treasury stock -- -- -- (2,995) -- -- (2,995) Reissuance of 98,681 treasury shares -- (1,640) -- 1,640 -- -- -- Change in value of securities available for sale -- -- -- -- -- 261 261 ------------------------------------------------------------------------------- Balance December 31, 1997 $ 92 $ 77,025 $ 21,042 $ (1,581) $ -- $ 1,504 $ 98,082 ===============================================================================
See Notes to Consolidated Financial Statements. 27 18 CONSOLIDATED FINANCIAL STATEMENTS D&N FINANCIAL CORPORATION
Year Ended December 31 ----------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) OPERATING ACTIVITIES Net income $ 14,325 $ 8,995 $ 10,417 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,350 1,100 2,400 Depreciation & amortization of office properties & equipment . . 1,987 1,954 1,843 Amortization of net discounts on purchased loans and securities (925) (73) (2,395) Originations and purchases of loans held for sale (47,928) (56,132) (91,203) Proceeds from sales of loans held for sale 89,889 73,658 75,928 (Gain)loss on investment securities available for sale -- (188) 120 Gain on loans and mortgage-backed securities available for sale (539) -- (899) Amortization and writedowns of mortgage servicing rights 543 300 476 Other 519 (2,635) (7,888) ----------------------------------------- Net cash provided (used) by operating activities 59,221 26,979 (11,201) INVESTING ACTIVITIES Proceeds from sales of investment securities available for sale 20 298 10,070 Proceeds from maturities of investment securities 202,066 83,970 44,025 Purchases of investment securities to be held to maturity (184,903) (107,012) (60,309) Proceeds from sales of mortgage-backed securities available for sale 24,094 -- 4,145 Proceeds from sales of loans -- -- 33,535 Principal collected on mortgage-backed securities 64,150 54,951 22,077 Purchases of mortgage-backed securities (107,400) (58,661) -- Loans purchased (234,886) (148,405) (103,524) Net change in loans receivable (137,882) (94,006) (43,299) (Increase) decrease in other real estate owned (4) (151) 4,871 Purchases of office properties and equipment (2,824) (2,868) (2,333) ----------------------------------------- Net cash used by investing activities (377,569) (271,884) (90,742) FINANCING ACTIVITIES Increase in time deposits 50,102 23,058 94,581 Increase in other deposits 28,748 18,666 10,510 Proceeds from notes payable, securities sold under agreements to repurchase and other borrowed money 513,052 309,040 203,000 Payments on maturity of notes payable, securities sold under agreements to repurchase and other borrowed money (297,717) (121,482) (213,851) Net change in advance payments by borrowers and investors held in escrow 5,777 479 (4,022) Common stock cash dividend (826) -- -- Net proceeds from issuance of stock 1,196 9,055 346 Purchases of treasury stock/warrants (2,995) (3,499) (44) Proceeds from issuance of subsidiary preferred stock 28,719 -- -- Reduction of leveraged ESOP debt -- (63) (36) ----------------------------------------- Net cash provided by financing activities 326,056 235,254 90,484 ----------------------------------------- Increase (decrease) in cash and cash equivalents 7,708 (9,651) (11,459) Cash and cash equivalents at beginning of year 12,789 22,440 33,899 ----------------------------------------- Cash and cash equivalents at end of year $ 20,497 $ 12,789 $ 22,440 ========================================= Supplemental disclosures of cash flow information: Interest paid $ 75,416 $ 61,689 $ 60,222 Income taxes paid $ 2,027 $ 299 $ 397 Noncash investing activities: Transfer of loans to other real estate owned $ 961 $ 3,373 $ 1,936 Securitization of loans into mortgage-backed securities $ 86,066 $ 119,717 $ --
See Notes to Consolidated Financial Statements. 28 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS D&N FINANCIAL CORPORATION DECEMBER 31, 1997 NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES D&N Financial Corporation ("the Company") is a financial services holding company whose sole subsidiary is D&N Bank ("the Bank"), a federally-chartered stock savings bank. D&N Financial Corporation's primary business is the delivery of financial services to consumers and businesses through its network of 48 community banking and financial services offices in Michigan. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts and transactions of the Company and the Bank and the Bank's wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. CASH AND CASH EQUIVALENTS: Cash and cash equivalents represent short-term highly liquid investments with original maturities of three months or less and include cash, demand deposits in other banks and interest-bearing deposits in other banks. INVESTMENT CLASSIFICATIONS: Securities are classified as either held to maturity (amortized cost), trading (fair value, with unrealized gains and losses reported in income), or available for sale (fair value, with unrealized gains and losses reported directly in equity, net of taxes). INVESTMENT AND MORTGAGE-BACKED SECURITIES: Investment and mortgage-backed securities which the Company has the ability and the intent to hold until maturity are stated at amortized cost. Investment and mortgage-backed securities available for sale are carried at fair value. Fair value adjustments are included in stockholders' equity, net of tax. Gains or losses realized on the sale of investment and mortgage-backed securities are determined by the specific identification method and are included in securities gains (losses). Interest income is adjusted using the level-yield method for amortization of premiums and accretion of discounts. MORTGAGE DERIVATIVE PRODUCTS: The Bank's interest only certificates are classified as available for sale and are recorded at fair value. Fair value adjustments are included in stockholders' equity and are classified on the Statements of Condition with mortgage-backed securities. ALLOWANCE FOR LOAN LOSSES: A loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The allowance for possible losses on loans is maintained at a level believed adequate by management to absorb potential losses from impaired loans as well as losses from the remainder of the portfolio. Management's determination of the level of the allowance is based upon evaluation of the portfolio, past experience, current economic conditions, size and composition of the portfolio, collateral location and values, cash flow positions, industry concentrations, delinquencies and other relevant factors. MORTGAGE LOANS HELD FOR SALE: The Bank enters into commitments to originate and does originate mortgage loans for sale to investors and in the secondary market. Loans held for sale are carried at the lower of cost or market value, determined on an aggregate basis. Commitment fees are amortized either over the commitment period or the combined commitment and loan period depending upon the probability of performance under the commitment. INTEREST ON LOANS: Interest on loans is credited to income when earned. An allowance for interest on loans is provided when management considers the collection of these loans doubtful and the accrual of interest is usually suspended when a loan becomes more than 90 days past due. LOAN FEES: Loan origination and commitment fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the yields using the level-yield method. 29 20 OTHER REAL ESTATE OWNED: Real estate acquired through foreclosure and similar proceedings is recorded at estimated fair value of the property, less cost to dispose of, at the acquisition date. Operating expenses of such properties, net of any income, are charged to expense. DEPRECIATION: Provisions for depreciation are computed using the straight-line method over the estimated useful lives of office properties and equipment, as follows: buildings - 40 years; leasehold improvements - life of lease; furniture and fixtures - 15 years; and computers - 3 years. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The Company enters into sales of investment and mortgage-backed securities under agreements to repurchase the same or essentially identical securities. The agreements are short-term and are accounted for as secured borrowings. The obligations to repurchase securities sold are reflected as a liability and the securities which collateralize the agreements are reflected as an asset in the Consolidated Statements of Condition. CAPITALIZED MORTGAGE SERVICING RIGHTS: The Company services mortgage loans for investors. Fees earned for and in connection with this activity are recognized as income when the related mortgage payments are received. Mortgage servicing costs are charged to expense as incurred. As the Company acquires mortgage servicing rights through either the purchase or origination of mortgage loans and sells or securitizes those loans with servicing rights retained, it must allocate the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. Capitalized mortgage servicing rights are reported in other assets. The capitalized cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing income (servicing revenue in excess of servicing costs), into noninterest income. Capitalized mortgage servicing rights are periodically assessed for impairment based on the fair value of those rights calculated on a discounted basis. This assessment is performed on a disaggregate basis, stratified by mortgage type, term and rate. Identified impairments are recognized through a valuation allowance. As permitted by Statement of Financial Accounting Standards ("SFAS") 122, "Accounting For Mortgage Servicing Rights", the Company adopted the provisions of the Statement effective July 1, 1995. The effect of adopting SFAS 122 was to increase net income for the year ended December 31, 1995 by $621,000 or $0.07 per share. The Company later adopted SFAS 125, "Accounting For Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", effective January 1, 1997, which had no material effect on the financial statements. INCOME TAXES: The Company uses the liability method in accounting for income taxes. Under this method, deferred income taxes result from temporary differences between the tax bases of assets and liabilities and the bases reported in the consolidated financial statements. The deferred taxes are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. PER SHARE DATA: The Company adopted SFAS 128 "Earnings per Share", for the year ended December 31, 1997. The earnings per share for the years 1996 and 1995 have been restated to comply with these standards. Basic earnings per share is calculated by dividing net income by the average number of shares outstanding during the applicable period. The Company had stock options and warrants which are considered to be potentially dilutive to common stock. Diluted earnings per share is calculated by dividing net income by the average number of shares outstanding during the applicable period adjusted for these potentially dilutive options and warrants. 30 21 The following table sets forth the computation of per share earnings as provided in SFAS 128, and illustrates the dilutive effect of options and warrants outstanding.
Year Ending December 31 ------------------------------------------------------------------------------ 1997 1996 1995 ------------------------------------------------------------------------------ Earnings Earnings Earnings Shares Per Share Shares Per Share Shares Per Share - ------------------------------------------------------------------------------------------------------------------------------------ (In thousands, except per share earnings) Basic EPS: 9,094 $ 1.58 8,337 $ 1.08 8,172 $ 1.27 Net dilutive effect of: Stock options outstanding 271 (0.05) 167 (0.02) 134 (0.02) Warrants outstanding -- -- 402 (0.05) 97 (0.01) ----------------------------------------------------------------------------- Diluted EPS: 9,365 $ 1.53 8,906 $ 1.01 8,403 $ 1.24 =============================================================================
Options to purchase 107,800 shares of common stock at $19.26 to $24.37 per share were outstanding at December 31, 1997. These options were not included in the computation of diluted earnings per share, because the exercise prices were greater than the average annual market price of the comon stock in 1997. RECLASSIFICATIONS: Certain amounts in previously issued consolidated financial statements have been reclassified to conform with the current year presentation. All per share amounts have been restated to include the effects of a 10% stock dividend and adoption of SFAS 128 in 1997. NOTE B: BUSINESS COMBINATION On April 10, 1996, Macomb Federal Savings Bank ("Macomb") was merged into the Company. The Company issued 716,497 shares of common stock and cash in lieu of fractional shares for all of the outstanding shares of Macomb. At the time of the merger, Macomb had assets and stockholders' equity (unaudited) of $41,932,000 and $6,268,000, respectively. The merger was accounted for as a pooling-of-interests and accordingly, the financial statements have been restated to include the results of Macomb. A reconciliation of previously reported net interest income and net income is as follows:
Three Months Ended Twelve Months Ended March 31, 1996 December 31, 1995 - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars In thousands) Net interest income (as previously reported) $ 9,465 $ 33,632 Macomb Federal Savings Bank - net interest income 217 1,118 --------------------------------------- Total net interest income $ 9,682 $ 34,750 ======================================= Net income (as previously reported) 3,497 10,140 Macomb Federal Savings Bank - net income (9) 277 --------------------------------------- Total net income $ 3,488 $ 10,417 =======================================
A reconciliation of per share income is as follows:
Three Months Ended Twelve Months Ended March 31, 1996 December 31, 1995 - ----------------------------------------------------------------------------------------------------------------------------------- Basic earnings per share: Net income (as previously reported) $ 0.47 $ 1.37 Macomb Federal Savings Bank (0.05) (0.10) --------------------------------------- Basic earnings per share $ 0.42 $ 1.27 Diluted earnings per share: ======================================= Net income (as previously reported) $ 0.44 $ 1.33 Macomb Federal Savings Bank (0.04) (0.09) --------------------------------------- Diluted earnings per share $ 0.40 $ 1.24 =======================================
31 22 NOTE C: NEW BANK SUBSIDIARY D&N Capital Corporation ("D&N Capital") is a Delaware corporation incorporated on March 18, 1997 for the purpose of acquiring and holding real estate assets and is a Real Estate Investment Trust ("REIT"). All shares of common stock of D&N Capital are owned by D&N Bank. On July 17, 1997, D&N Capital sold 1.21 million shares of its 9.0% noncumulative preferred stock, Series A with a liquidation preference of $25.00 per share (totaling $30,250,000). As part of this transaction, D&N Capital received $28,719,000 in net proceeds, after offering costs of $1,531,000. The Series A Preferred Shares are generally not redeemable prior to July 1, 2002. On or after July 1, 2002, the Series A Preferred Shares may be redeemed for cash at the option of the Bank, in whole or in part, at a redemption price of $25.00 per share. The preferred shares are treated as Tier-1 Capital by the Bank, and are traded on Nasdaq as DNFCP. During 1997, D&N Capital declared and paid preferred dividends totaling $1,217,563. NOTE E: INVESTMENT SECURITIES Investment securities consisted of the following: NOTE D: RESTRICTIONS ON CASH AND NONINTEREST-BEARING BALANCES The Company is required to maintain reserve balances with the Federal Reserve Bank. The average amounts of those reserve balances for the years ended December 31, 1997 and December 31, 1996 were $452,000 and $418,000, respectively.
December 31 -------------------------------------------------------------- 1997 1996 -------------------------------------------------------------- Book Market Book Market Value Value Value Value - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) U.S. Treasury securities $ 33,299 $ 33,369 $ 40,737 $ 40,781 Investment in Federal Home Loan Bank stock 23,200 23,200 19,959 19,959 Other securities 25 25 43 43 -------------------------------------------------------------- Held to maturity 56,524 56,594 60,739 60,783 U.S. Treasury securities 44,764 44,860 57,996 58,000 Municipal bonds 148 148 -- -- Other securities 1,088 1,104 1,032 1,038 Valuation allowances 112 -- 10 -- -------------------------------------------------------------- Available for sale 46,112 46,112 59,038 59,038 -------------------------------------------------------------- $102,636 $102,706 $119,777 $119,821 ==============================================================
32 23 An analysis of gross unrealized gains and losses is as follows:
December 31 ---------------------------------------------------------------------- 1997 1996 ---------------------------------------------------------------------- Gross Gross Gross Gross Unrealized Unrealized Unrealized Unrealized Gains Losses Gains Losses - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Held to maturity U.S. Treasury securities $ 70 $ -- $ 79 $ (35) ------------------------------------------------------------------ 70 -- 79 (35) Available for sale U.S. Treasury securities 97 (1) 31 (27) Other securities 16 -- 6 -- ------------------------------------------------------------------ 113 (1) 37 (27) ------------------------------------------------------------------ $ 183 $ (1) $ 116 $ (62) ==================================================================
There were no sales of investment securities during 1997. Proceeds from sales of investment securities available for sale during 1996 were $298,000. Gross gains of $188,000 were realized on those sales. Proceeds from sales of investment securities available for sale during 1995 were $10,070,000. Gross losses of $120,000 were realized on those sales. The book value and market value of investment securities at December 31, 1997, by contractual maturity, were as follows:
Less than one year 1 - 5 Years ------------------------------------------------------------------------ Book Market Avg. Book Market Avg. Value Value Yield Value Value Yield - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) U.S. Treasury securities held to maturity $33,299 $33,369 5.95% $ -- $ -- --% U.S. Treasury securities available for sale 34,560 34,618 5.94 10,204 10,242 6.04 ------------------------------------------------------------------------- $67,859 $67,987 5.95% $10,204 $ 10,242 6.04% ==========================================================================
NOTE F: MORTGAGE-BACKED SECURITIES Mortgage-backed securities consisted of the following:
December 31 ----------------------------------------------------------------- 1997 1996 ----------------------------------------------------------------- Book Market Book Market Value Value Value Value - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Government agency securities $ 112,156 $ 113,253 $ 127,677 $ 126,576 Collateralized mortgage obligations 84,788 84,987 85,755 85,311 Accrued interest receivable 1,285 1,285 1,417 1,417 Net discounts (179) -- (159) -- -------------------------------------------------------------------- Held to maturity 198,050 199,525 214,690 213,304 Government agency securities 86,658 88,145 18,815 19,255 Collateralized mortgage obligations 69,104 69,715 14,767 15,005 Interest-only certificates 378 1,422 639 2,023 Accrued interest receivable 964 964 283 283 Net premiums 940 -- 160 -- Valuation allowances 2,202 -- 1,902 -- -------------------------------------------------------------------- Available for sale 160,246 160,246 36,566 36,566 -------------------------------------------------------------------- $ 358,296 $ 359,771 $ 251,256 $ 249,870 ====================================================================
Mortgage-backed securities with a carrying value of $20,851,000 are specifically pledged as collateral for advances from the Federal Home Loan Bank of Indianapolis and other borrowings. 33 24 (Note F: continued...) An analysis of gross unrealized gains and losses is as follows:
December 31 ----------------------------------------------------------------- 1997 1996 ----------------------------------------------------------------- Gross Gross Gross Gross Unrealized Unrealized Unrealized Unrealized Gains Losses Gains Losses - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Government agency securities $ 1,238 $ (368) $ 764 $(2,119) Collateralized mortgage obligations 675 (70) 294 (325) ----------------------------------------------------------------- Held to maturity 1,913 (438) 1,058 (2,444) Government agency securities 743 (1) 287 (11) Collateralized mortgage obligations 424 (8) 270 (28) Interest only certificates 1,044 -- 1,384 -- ----------------------------------------------------------------- Available for sale 2,211 (9) 1,941 (39) ----------------------------------------------------------------- $ 4,124 $ (447) $ 2,999 $(2,483) =================================================================
Proceeds from sales of mortgage-backed securities available for sale during 1997 were $30,154,000. Gross gains of $543,000 and gross losses of $4,000 were realized on those sales. There were no sales of mortgage-backed securities during 1996. Proceeds from sales of mortgage-backed securities available for sale during 1995 were $4,145,000. Gross gains of $267,000 were realized on those sales, and there were no losses. The book value and market value of mortgage-backed securities at December 31, 1997, by contractual maturity, were as follows:
Held to Maturity Available For Sale ---------------------------------------------------------------------------------------- Book Market Average Book Market Average Value Value Yield Value Value Yield - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Government agency securities Less than one year $ -- $ -- --% $ -- $ -- -- % One to five years 731 737 7.00 -- -- -- Five to ten years 1,530 1,542 7.14 -- -- -- After ten years 110,121 110,974 7.04 87,403 88,145 7.08 ---------------------------------------------------------------------------------------- 112,382 113,253 7.04 87,403 88,145 7.08 Collateralized mortgage obligations Less than one year -- -- -- -- -- -- One to five years -- -- -- -- -- -- Five to ten years -- -- -- -- -- -- After ten years 84,383 84,987 6.98 69,298 69,715 6.95 ---------------------------------------------------------------------------------------- 84,383 84,987 6.98 69,298 69,715 6.95 Interest-only certificates Less than one year -- -- -- -- -- -- One to five years -- -- -- -- -- -- Five to ten years -- -- -- 3 12 139.66 After ten years -- -- -- 375 1,410 132.90 ---------------------------------------------------------------------------------------- -- -- -- 378 1,422 132.96 ---------------------------------------------------------------------------------------- $ 196,765 $198,240 7.02% $157,079 $ 159,282 7.33% ========================================================================================
Mortgage-backed securities will mature according to the repayment characteristics of the underlying mortgage loans which collateralize the securities. Expected maturities for the mortgage-backed securities will differ from contractual maturities because borrowers have the right to prepay. The aggregate book value and aggregate market value of the securities of any one issuer, other than U.S. Government agencies, did not exceed 10% of stockholders' equity at December 31, 1997 or 1996. 34 25 NOTE G: LOANS RECEIVABLE The carrying amounts and fair values of loans receivable consisted of the following:
December 31 ---------------------------------------------------------------------- 1997 1996 ---------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Residential mortgages $ 694,902 $ 706,459 $ 592,712 $ 598,390 Residential mortgages held for sale 5,275 5,275 5,218 5,218 Mortgages on income producing property 81,304 79,007 84,983 79,704 Construction loans 56,176 55,901 39,535 39,404 Consumer loans 446,710 449,276 337,178 338,180 Commercial loans 38,164 37,706 12,262 11,959 Accrued interest receivable 7,311 7,311 5,940 5,940 ---------------------------------------------------------------------- 1,329,842 1,340,935 1,077,828 1,078,795 Less: Discounts on purchased loans (2,356) -- (2,035) -- Allowance for loan losses 10,549 -- 11,042 -- Undisbursed portion of loan proceeds 20,315 -- 12,085 -- Deferred income 375 -- 860 -- ---------------------------------------------------------------------- $ 1,300,959 $ 1,340,935 $ 1,055,876 $ 1,078,795 ======================================================================
Credit is extended based on evaluation of the borrower's financial condition, the value of the collateral and, in the case of income producing property, the sufficiency of net cash flows from the property's operation to service the debt. When loans are made to businesses, personal guarantees may also be required of owners or partners. Loans collateralized by income producing property are categorized as follows:
December 31 --------------------------- 1997 1996 - ------------------------------------------------------------------------------- (Dollars in thousands) Shopping centers $22,185 $23,582 Multi-family apartments 19,913 25,404 Motels/hotels 11,491 13,540 Offices 6,905 6,667 Nursing homes 5,291 5,528 Industrial 4,774 4,565 Condominium development 4,240 1,826 Mobile home parks 2,118 3,625 Other 4,387 246 ----------------------- $81,304 $84,983 =======================
35 26 (Note G: continued...) Loans collateralized by income producing property categorized by state are as follows:
December 31 ------------------------- 1997 1996 - ---------------------------------------------------------------- (Dollars in thousands) Michigan $65,697 $65,645 California 11,008 11,738 New York 805 2,037 Pennsylvania 405 607 Other 3,389 4,956 ------------------------- $81,304 $84,983 =========================
Changes in the allowance for loan losses are summarized as follows:
1997 1996 1995 - -------------------------------------------------------------------------------------- (Dollars in thousands) Balance at beginning of year $ 11,042 $ 10,081 $ 8,349 Provisions for loan losses 1,350 1,100 2,400 Net charge-offs (1,843) (139) (668) ------------------------------------- Balance at end of year $ 10,549 $ 11,042 $ 10,081 =====================================
At December 31, 1997 and 1996, the total recorded investment in impaired loans, as defined by SFAS 114 "Accounting by Creditors for Impairment of a Loan", was $4,779,000 and $7,241,000, respectively. In 1997 and 1996 the amount of the recorded investment for which there is a related allowance for loan losses is $145,000, and the amount of the recorded investment for which there is no related allowance for loan losses is $4,634,000 and $7,096,000, respectively. Interest income on impaired loans is recognized primarily on a cash basis. During 1997 and 1996, the amount of interest income recognized on impaired loans was insignificant. Changes in capitalized mortgage servicing rights, included in other assets in the Consolidated Statements of Condition, are summarized as follows:
1997 1996 1995 - --------------------------------------------------------------------------------------- (Dollars in thousands) Balance at beginning of year $ 1,443 $ 1,113 $ 968 Originations and acquisitions 1,236 630 621 Amortizations, sales, and writedowns (543) (300) (476) ----------------------------------------- Balance at end of year $ 2,136 $ 1,443 $ 1,113 =========================================
Changes in the valuation allowance for mortgage servicing rights are summarized as follows:
1997 1996 1995 - --------------------------------------------------------------------------------------- (Dollars in thousands) Balance at beginning of year $221 $291 $ -- Additions: Purchased mortgage servicing rights 38 151 222 Originated mortgage servicing rights 154 55 77 -------------------------------------- Total additions 192 206 299 Reductions: Purchased mortgage servicing rights 69 158 8 Originated mortgage servicing rights 23 118 -- -------------------------------------- Total reductions 92 276 8 -------------------------------------- Balance at end of year $321 $221 $291 ======================================
36 27 At December 31, 1997, and 1996, the fair value of capitalized mortgage servicing rights were $2,389,000 and $1,770,000, respectively. Loans serviced for others amounted to $518,877,000, $415,156,000, and $278,051,000 at December 31, 1997, 1996 and 1995, respectively. NOTE H: OTHER REAL ESTATE OWNED Other real estate owned ("OREO") consisted of the following:
December 31 ----------------------- 1997 1996 - --------------------------------------------------------------------------------------- (Dollars in thousands) Real estate acquired through foreclosure $ 742 $1,365 Real estate in judgment 732 105 ------------------- $1,474 $1,470 ===================
Changes in the allowance for possible losses on OREO are summarized as follows:
1997 1996 1995 - ----------------------------------------------------------------------------------------- (Dollars in thousands) Balance at beginning of year $-- $ 133 $ 330 Provision for losses -- -- 150 Net charge-offs -- (133) (347) ------------------------------ Balance at end of year $-- $ -- $ 133 ==============================
The Company recorded writedowns of other real estate owned amounting to $75,000 during 1996. The Company did not record any writedowns of other real estate owned in 1997 or 1995. The Company recognized net gains on sale of OREO amounting to $132,000, $164,000 and $1,139,000 during 1997, 1996 and 1995, respectively. NOTE I: OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized as follows:
December 31 ---------------------- 1997 1996 - ----------------------------------------------------------------------- (Dollars in thousands) Cost: Land $ 2,565 $ 2,634 Buildings and improvements 17,653 17,174 Furniture and equipment 18,749 16,839 ------------------------ 38,967 36,647 Less accumulated depreciation 22,346 20,883 ------------------------ $ 16,621 $ 15,764 ========================
Depreciation and amortization expense was $1,987,000, $1,954,000 and $1,843,000 in 1997, 1996 and 1995, respectively. Rental expense for leased properties and equipment was $1,150,000, $938,000 and $643,000 in 1997, 1996 and 1995, respectively. The aggregate minimum annual rental commitments under these leases are approximately $1,105,000 in 1998, $955,000 in 1999, $877,000 in 2000, $787,000 in 2001, $605,000 in 2002 and $1,266,000 thereafter. 37 28 NOTE J: DEPOSITS The carrying amounts and fair values of deposits and the nominal rate of interest paid were as follows:
December 31 --------------------------------------------------------------------------------------- 1997 1996 --------------------------------------------------------------------------------------- Weighted Weighted Carrying Fair Average Carrying Fair Average Amount Value Rate Amount Value Rate - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Checking accounts $ 56,473 $ 56,473 --% $ 46,882 $ 46,882 --% NOW accounts 62,939 62,939 1.51 60,668 60,668 1.52 Money market accounts 92,314 92,314 4.02 89,321 89,321 4.01 Savings deposits 163,119 163,119 3.16 149,226 149,226 2.82 Certificates of deposit 667,204 673,314 5.93 617,102 622,040 5.79 Accrued interest 1,118 1,118 -- 934 934 -- --------------------------------------------------------------------------------------- $1,043,167 $1,049,277 4.74% $ 964,133 $ 969,071 4.61% =======================================================================================
Included in deposits are $144,426,000 and $107,386,000 of deposit accounts with balances in excess of $100,000 as of December 31, 1997 and 1996, respectively. Certificates of deposit had the following maturities at December 31, 1997:
Weighted Amount Average Rate - ---------------------------------------------------------------------------- (Dollars in thousands) 1998 $531,631 5.86% 1999 77,811 6.28 2000 25,230 6.20 2001 9,698 5.93 2002 and beyond 22,834 6.05 ---------------------------------------- $667,204 5.93% ========================================
The average balance, interest expense and average rate on deposits were as follows:
1997 1996 1995 --------------------------------------------------------------------------------------------- Average Interest Avg. Average Interest Avg. Average Interest Avg. Balance Expense Rate Balance Expense Rate Balance Expense Rate --------------------------------------------------------------------------------------------- (Dollars in thousands) Checking accounts $ 47,680 $ -- --% $ 40,349 $ -- --% $ 36,886 $ -- --% NOW and money market accounts 152,615 4,547 2.98 146,863 4,490 3.06 137,867 4,261 3.09 Savings deposits 154,541 4,623 2.99 153,701 4,446 2.89 139,685 3,723 2.67 Certificates of deposit 657,401 38,791 5.90 597,571 34,923 5.84 537,944 30,655 5.70 ---------------------------------------------------------------------------------------------- $1,012,237 $ 47,961 4.74% $938,484 $ 43,859 4.67% $ 852,382 $ 38,639 4.53% ==============================================================================================
38 29 NOTE K: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Securities sold under agreements to repurchase, in which the Company will repurchase identical securities, consisted of the following:
December 31 ---------------------------------------------------- 1997 1996 ---------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Collateral pledged: Mortgage-backed securities and Treasury notes with a book value including accrued interest of $151,761,000 and a market value of $152,766,000 in 1997, and a book value including accrued interest of $59,835,000 and a market value of $59,750,000 in 1996. $149,092 $149,092 $58,040 $58,040 =====================================================
Securities sold under agreements to repurchase averaged $98,471,000 and $40,095,000 during 1997 and 1996, respectively, and the maximum amounts outstanding at any month-end during 1997 and 1996 were $181,055,000 and $74,621,000, respectively. The securities underlying the agreements were delivered to the dealers who arranged the transactions. The dealers may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and have agreed to resell to the Company essentially identical securities at the maturities of the agreements. Agreements to repurchase as of December 31, 1997, are as follows:
Broker Borrowing Average Rate Maturity Date - ------------------------------------------------------------------------------------------------------- (Dollars in thousands) Bear Stearns $ 26,755 5.80% January 1998 Federal National Mortgage Association 49,955 5.75 January 1998 Merrill Lynch 36,805 5.82 January 1998 Morgan Stanley 35,577 5.88 January 1998 -------------------------- $149,092 5.80% ==========================
NOTE L: FHLB ADVANCES AND OTHER BORROWED MONEY The carrying amounts and fair values of Federal Home Loan Bank of Indianapolis ("FHLB") advances and other borrowed money consisted of the following:
December 31 ----------------------------------------------------------------------------------- 1997 1996 1997 1996 ----------------------------------------------------------------------------------- Year of Weighted Weighted Carrying Fair Carrying Fair Maturity Avg. Rate Avg. Rate Amount Value Amount Value -------- --------- ------------------ ----- -------- ------ (Dollars in thousands) Advances from FHLB: Variable rate of interest: 5.47 - 6.80% 1997 --% 5.58% $ -- $ -- $206,000 $206,047 5.69 - 5.88 1998 5.76 -- 61,000 61,001 -- -- Fixed rate of interest: 5.20 - 5.42% 1997 -- 5.25 -- -- 45,000 44,977 5.47 - 5.98 1998 5.88 5.77 153,000 153,190 43,000 42,566 5.81 - 6.20 1999 5.99 5.84 179,000 179,927 43,000 42,233 5.85 - 5.97 2000 5.92 -- 70,000 70,509 -- -- 4.00 2005 4.00 4.00 1,003 888 1,003 802 ----------------------------------------------------------------------------------- 464,003 465,515 338,003 336,625 Other borrowed money: Collateralized mortgage obligation 6,428 6,974 7,994 8,606 ------------------------------------------ $ 470,431 $472,489 $345,997 $345,231 ==========================================
39 30 (Note L: continued...) The Company is required to maintain qualifying loans, investments and mortgage-backed securities as collateral for the FHLB advances. The collateralized mortgage obligation ("CMO") was issued through a special purpose finance subsidiary established in 1986. The CMO is secured by mortgage-backed securities with unpaid principal balances of $7,154,000 and $9,160,000 at December 31, 1997 and December 31, 1996, respectively. The notes underlying the obligations bear interest, payable quarterly, at rates varying from 7.27% to 7.33%, with contractual maturity dates ranging from 2008 to 2010. NOTE M: FEDERAL INCOME TAXES Federal income tax expense (credit) consisted of the following:
1997 1996 1995 - ----------------------------------------------------------------------------------- (Dollars in thousands) Current $4,634 $ -- $ 100 Deferred 3,109 3,228 3,959 Change in valuation allowance for deferred tax assets -- (2,879) (5,734) ------------------------------------ $7,743 $ 349 $ (1,675) ====================================
Deferred income tax expense (credit) included in stockholders' equity related to the change in unrealized holding gains (losses) on securities available for sale for 1997, 1996 and 1995 amounted to $141,000, $(181,000), and $850,000, respectively. A reconciliation of the statutory federal income tax rate to the effective income tax rate follows:
1997 1996 1995 - ----------------------------------------------------------------------------------- Statutory tax rate 35.0% 35.0% 35.0% Effect of: Change in valuation allowance for deferred tax assets -- (30.8) (68.5) Adjustment to net operating loss carryforward -- -- 12.5 Other, net 0.1 (0.5) 1.9 ----------------------------------- Effective tax rate 35.1% 3.7% (19.1)% ===================================
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 the Company's deferred and other tax assets and liabilities are as follows:
December 31 ------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Deferred tax assets: Allowance for loan losses $ 3,086 $ 3,036 Net deferral required by SFAS 91 79 229 Pension and other benefit obligations 700 695 Tax effect of net of operating loss carryforward -- 3,258 Other, net 398 381 ------------------------------ Total deferred tax assets 4,263 7,599 Deferred tax liabilities: Securities marked to market for tax purposes* (13) 289 Fixed assets 588 662 FHLB stock 1,075 1,075 Valuation adjustment on CMO residuals 1,431 1,408 Other, net 53 68 ------------------------------ Total deferred tax liabilities 3,134 3,502 ------------------------------ Total net deferred tax assets 1,129 4,097 Current income tax receivable due to net operating loss carrybacks and other overpayments -- 1,905 ------------------------------ Total net federal income tax assets $ 1,129 $ 6,002 ==============================
* The amount shown is net of the $810,000 and $669,000 tax effect of SFAS 115 unrealized holding gains at December 31, 1997 and December 31, 1996, respectively. 40 31 NOTE N: STOCKHOLDERS' EQUITY AND REGULATORY MATTERS OTS regulations governing the payment of dividends by savings institutions provide that an institution may only pay dividends with regulatory approval. Unlike the Bank, the Company is not subject to these regulatory restrictions on the payment of dividends to its stockholders. However, the source of future dividends may depend upon the payment of dividends from the Bank to the Company. In December 1993, the Company issued 1,003,219 units in the shareholder rights offering. Each unit consisted of three shares of common stock and one warrant. Each warrant entitled the holder thereof to purchase one share of common stock at an exercise price of $8.25 at any time no later than December 31, 1996. During 1996, 1995 and 1994, 996,369, 2,553 and 390 warrants were exercised, respectively. The warrant period ended with 3,907 warrants unexercised. During 1996, the Company paid a one-time charge of $5.5 million pretax, ($3.6 million after tax) as the mandated contribution of D&N Bank, to replenish the Federal Deposit Insurance Corporation's depleted Savings Association Insurance Fund ("SAIF"). This charge is the result of federal legislation passed and signed into law on September 30, 1996, which required all thrifts to pay a one-time assessment to restore the SAIF fund to its statutory reserve level. The assessment was 65.7 basis points (b.p.) of the institution's deposits as of March 31, 1995. Macomb had a leveraged Employee Stock Ownership Plan ("ESOP"), which was terminated subsequent to the merger with the Company. The related ESOP debt was paid in full in 1996. On December 7, 1989, new capital standards were imposed on the thrift industry as a result of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"). Regulatory standards impose the following capital requirements: a risk-based capital standard expressed as a percent of risk-adjusted assets, a leverage ratio of core capital to total adjusted assets, and a tangible capital ratio expressed as a percent of total adjusted assets. As of December 31, 1997, the Bank exceeded all regulatory capital standards. In December, 1996, D&N Financial Corporation's Board of Directors authorized a program to acquire up to 440,000 shares of D&N Financial Corporation common stock for the Company's treasury. In 1996, 257,222 shares were acquired and 256,251 were reissued as holders of D&N Financial Corporation Warrants (issued in 1993) presented their maturing warrants for conversion to common stock. In 1997, the authorized program was completed when an additional 182,050 shares were acquired for general corporate purposes, including the satisfaction of its obligation to issue shares upon the exercise of employees' and directors' stock options. By December 31, 1997, 98,681 of these shares had been reissued upon the exercise of stock options. On December 10, 1997, the Company declared a $.05 per share cash dividend and a 10% stock dividend. Both were paid on January 13, 1998, to holders of record on December 23, 1997. The liability for the cash dividend is shown in Other Liabilities on the accompanying financial statements. All per share data have been adjusted to include the effect of the stock dividend. The table below summarizes as of December 31, 1997, the Bank's capital requirements under FIRREA and its actual capital ratios at that date.
Regulatory Bank Actual Requirements Capital ----------------------------------------------- Amount Percent Amount Percent - --------------------------------------------------------------------------------------------- (Dollars in thousands) Risk-based capital $86,758 8.00% $129,878 11.98% Core capital 54,742 3.00 119,474 6.55 Tangible capital 27,371 1.50 119,474 6.55
41 32 (Note N: continued...) The FDIC Improvement Act of 1992 ("FDICIA") requires each federal banking agency to implement prompt corrective actions for institutions that it regulates. The OTS has adopted rules, based upon FDICIA's five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under FDICIA, the OTS is required to take supervisory action against institutions that are not deemed either "well capitalized" or "adequately capitalized". The rules generally provide that a savings institution is "well capitalized" if its total risk-based capital ratio is 10% or greater, its ratio of core capital to risk-based assets ("tier 1 risk-based capital") is 6% or greater, its core capital ("leverage") ratio is 5% or greater, and the institution is not subject to a capital directive. The Bank's tier 1 risk-based capital ratio at December 31, 1997 was 11.02%. At December 31, 1997, the Bank was considered well capitalized. NOTE O: EMPLOYEE BENEFIT PLANS The Company sponsors an employee savings and investment plan in which all employees may participate after completing a minimum of 1,000 hours in an eligibility period. The plan allows participants to make contributions by salary deductions equal to 15% or less of their salary pursuant to Section 401(k) of the Internal Revenue Code. Employee contributions are matched by the Company at the rate of 100 cents per dollar, up to 6% of the employee's salary. Employees vest immediately in their own contributions and over a five-year period in the Company's contributions. Employee contributions may be invested in a variety of instruments, including the Company's common stock and the preferred stock of D&N Capital Corporation. The Company's matching contribution is invested at the direction of the participant. The Company's contributions to the plan were $653,000, $621,000 and $273,000 in 1997, 1996, and 1995, respectively. The Company terminated its noncontributory defined benefit retirement plan during 1996, with all assets being distributed to participants. No gain or loss was recorded on this transaction. The following table sets forth the market value of assets and distribution thereof on December 16, 1996 the date of distribution.
Before Effect of After Termination Termination Termination - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Assets and obligations: Accumulated benefit obligation $ (8,419) $ 8,419 $ -- Plan assets at fair value 11,238 (11,238) -- --------------------------------------------------- Excess assets $ 2,819 $ (2,819) $ -- ===================================================
Benefits under the plan were based on years of service and the employee's compensation during the last five years of employment. Pension expense included the following components:
1997* 1996* 1995* - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Service cost-benefits earned during the period $ -- $ -- $ 620 Interest cost on projected benefit obligation -- -- 1,071 Return on plan assets -- -- (2,030) Net amortization -- -- 512 -------------------------------------------------- $ -- $ -- $ 173 ==================================================
*Benefits were frozen as of September 30, 1995; therefore, no cost or amortization was subsequently recorded. 42 33 NOTE P: POSTRETIREMENT BENEFITS The Company has a contributory unfunded benefit plan which provides postretirement medical benefits to certain employees who have retired prior to September 30, 1995. The Company is recognizing its accumulated postretirement benefit obligation over a prospective 20-year period. The following table sets forth the plan's status and amounts recognized in the Company's Consolidated Statement of Condition.
December 31 ---------------------------- 1997 1996 - ------------------------------------------------------------------------------------- (Dollars in thousands) Accumulated postretirement benefit obligation $ 1,187 $ 1,358 Unrecognized net loss (141) (233) Unrecognized transition obligation (780) (829) ----------------------------- Accrued postretirement benefit cost $ 266 $ 296 =============================
Postretirement benefit expense included the following components:
1997 1996 1995 - --------------------------------------------------------------------------------------------- (Dollars in thousands) Service cost $ -- $ -- $ -- Interest cost 84 97 99 Amortization of transition obligation 48 48 49 --------------------------------- $132 $ 145 $ 148 =================================
A weighted average discount rate of 7.25% in 1997 and 7.00% in 1996 was used in determining the accumulated postretirement benefit obligation. The 1997 health care trend rate was projected to be 9.0% for participants under the age of 65, and this rate is assumed to trend downward until it reaches 5.5% and remains at that level thereafter. This trend rate assumption does not have a significant effect on the plan; therefore, a one percent change in the trend rate is not material in the determination of the accumulated postretirement benefit obligation or the ongoing expense. 43 34 NOTE Q: STOCK OPTION PLAN The Company has stock option plans in which 1,487,000 shares of common stock have been reserved for issuance as of December 31, 1997. Under the plans, the exercise price of any option will not be less than the fair market value of the common stock on the date of grant. The dates on which the options are first exercisable is determined by the Stock Option Committee of the Board of Directors and have generally vested over a two year period from the date of grant. The term on any option may not exceed ten years from the date of grant. The Company has elected to continue to measure compensation cost using the intrinsic value method, in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, since all options are granted at a fixed price not less than the fair market value of the Company's common stock on the date of grant, no compensation cost has been recognized for its stock option plans. Had stock option costs of these plans been determined based on the fair value at the 1997, 1996 and 1995 grant dates for awards under those plans consistent with the methodology of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation", the pro forma effects on the Company's net income and earnings per share would be as follows:
1997 1996 1995 - ---------------------------------------------------------------------------------------------------- (Dollars in thousands, except earnings per share) Net income (as reported) $ 14,325 $ 8,995 $10,417 Stock option compensation cost (761) (396) (74) ----------------------------------------- Pro forma net income $ 13,564 $ 8,599 $10,343 ========================================= Basic earnings per share (as reported) $ 1.58 $ 1.08 $ 1.27 Stock option compensation cost (0.08) (0.05) (0.00) ----------------------------------------- Pro forma basic earnings per share $ 1.50 $ 1.03 $ 1.27 ========================================= Diluted earnings per share (as reported) $ 1.53 $ 1.01 $ 1.24 Stock option compensation cost (0.08) (0.04) (0.01) ----------------------------------------- Pro forma diluted earnings per share $ 1.45 $ 0.97 $ 1.23 =========================================
The fair value of each option grant in 1997, 1996 and 1995 was estimated using the Black-Scholes option pricing model with the following assumptions used:
1997 1996 1995 - ------------------------------------------------------------------------------------------------- Estimated weighted average fair value per share of options granted $ 7.63 $ 4.61 $ 2.63 Assumptions: Annualized dividend yield 0.8% -- -- Common-stock price volatility 32.5% 25.1% 25.1% Weighted average risk-free rate of return 6.5% 5.9% 7.4% Weighted average expected option term (in years) 5 5 4
44 35 The following table sets forth changes in options outstanding.
1997 1996 1995 ------------------------------------------------------------------------------------ Weighted Weighted Weighted Amount Avg. Price Amount Avg. Price Amount Avg. Price - --------------------------------------------------------------------------------------------------------------------------- Shares under option: Outstanding at beginning of year 820,943 $ 9.31 653,956 $ 7.56 702,463 $7.43 Granted 261,087 19.55 315,929 12.26 82,368 7.28 Forfeited (34,003) 12.27 (21,836) 9.45 (4,432) 7.15 Canceled -- -- (6,353) 14.60 (68,365) 7.73 Exercised (98,681) 9.05 (120,753) 7.22 (58,078) 5.51 ---------------------------------------------------------------------------------- Outstanding at end of year 949,346 12.07 820,943 9.31 653,956 7.56 ---------------------------------------------------------------------------------- Exercisable at end of year 738,092 $ 11.25 590,858 $ 8.40 563,268 $7.64 ----------------------------------------------------------------------------------
The following table sets forth details of options outstanding at December 31, 1997.
Options Outstanding Options Exercisable - ---------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding Contractual life Price Exercisable Price - ---------------------------------------------------------------------------------------------------------- $ 5.45 - 7.62 366,737 5.2 Years $ 6.99 357,937 $ 7.03 10.17 - 12.05 262,122 7.0 Years 11.38 193,082 11.26 12.95 - 14.04 67,650 8.1 Years 13.92 52,250 13.89 16.36 - 24.38 252,837 9.5 Years 19.65 134,824 21.42 - ---------------------------------------------------------------------------------------------------------- $ 5.45 - 24.38 949,346 7.0 Years $ 11.82 738,093 $ 11.25 ==========================================================================================================
45 36 NOTE R: LITIGATION The Company is a defendant in a number of matters of litigation, substantially all of which have arisen in the ordinary course of business. It is the opinion of management that the resulting liabilities, if any, from these actions will not materially affect the Consolidated Financial Statements. D&N Bank is a plaintiff, like approximately 120 other institutions, in a currently pending claim in the United States Court of Federal Claims seeking substantial damages as a result of the 1989 Financial Institutions Reform, Recovery and Enforcement Act's mandatory phase-out of the regulatory capital treatment of supervisory goodwill. The ultimate outcome of these matters cannot be ascertained at this time. NOTE S: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is party to financial instruments with off-balance sheet risk (in the normal course of its business) to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments may include commitments to originate or purchase loans, standby letters of credit, recourse arrangements on sold assets, and forward commitments. The instruments involve, to varying degrees, elements of credit and interest rate risk in addition to the amounts recognized in the Consolidated Statements of Condition. The contract amounts of those instruments reflect the extent of the Company's involvement in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments, standby letters of credit and recourse arrangements is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. For forward commitments, the contract amounts do not represent exposure to credit loss. The Company controls the credit risk of those instruments through credit approvals, limits and monitoring procedures. The following table sets forth financial instruments with off-balance sheet risk and their contract amounts and fair values.
December 31 --------------------------------------------------- 1997 1996 --------------------------------------------------- Contract Fair Contract Fair Amount Value Amount Value - --------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Financial instruments whose contract amounts represent credit risk: Commitments to originate and purchase loans $78,710 $(787) $69,383 $(694) Unused lines of credit 93,709 (937) 78,303 (783) Standby letters of credit 3,907 (39) 367 (4) Loans sold with recourse 2,155 (108) 3,004 (150) Financial instruments whose contract amounts exceed the amount of credit risk: Forward commitments to sell loans 6,400 (64) 4,000 (40)
46 37 Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn on, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's evaluation of the borrower's creditworthiness. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Additionally, the Company has retained credit risk on certain residential and commercial mortgage loans sold with recourse with outstanding balances at December 31, 1997 of $1,310,000 and $845,000, respectively. These balances as of December 31, 1996 were $1,430,000 and $1,574,000, respectively. The maximum amount of loss to which the Company is subject, under the recourse provisions, is $1,395,000 at December 31, 1997. Management does not believe the recourse provisions subject the Company to any material risk of loss. This credit risk is considered to be no more onerous than that existing on similar loans in the Company's loan portfolio. Forward commitments to sell loans are contracts the Company negotiates for the purpose of reducing the market risk associated with rate lock agreements with customers for new loan applications that have not yet been closed. In order to fulfill a forward commitment, the Company typically exchanges through FNMA, FHLMC or GNMA, its current production of loans for mortgage-backed securities which are then delivered to a national securities firm at a future date at prices or yields specified by the contracts. Risks may arise from the possible inability of the Company to originate loans to fulfill the contracts, in which case the Company would normally purchase securities in the open market to deliver against the contracts. NOTE T: FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and fair values of financial instruments at the dates indicated. SFAS 107, "Disclosures about Fair Value of Financial Instruments", defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
December 31 -------------------------------------------------------------------- 1997 1996 -------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - ------------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Cash and cash equivalents $ 20,497 $ 20,497 $ 12,789 $ 12,789 Investment securities (Note E) 102,636 102,706 119,777 119,821 Mortgage-backed securities (Note F) 358,296 359,771 251,256 249,870 Loans receivable (Note G) 1,300,959 1,340,935 1,055,876 1,078,795 Deposits (Note J) (1,043,167) (1,049,277) (964,133) (969,071) Securities sold under agreement to repurchase (Note K) (149,092) (149,092) (58,040) (58,040) Debt (Note L) (470,431) (472,489) (345,997) (345,231) Commitments to originate and purchase loans (Note S) -- (787) -- (694) Unused lines of credit (Note S) -- (937) -- (783) Standby letters of credit (Note S) -- (39) -- (4) Loans sold with recourse (Note S) -- (108) -- (150) Forward commitments to sell loans (Note S) -- (64) -- (40)
47 38 (Note T: continued...) ESTIMATION OF FAIR VALUES: SFAS 107 requires disclosure of fair value information about financial instruments, whether or not recognized in the Statement of Condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts reported in the Statement of Condition for cash and cash equivalents approximate those assets' fair value. Fair values for investment securities and mortgage-backed securities 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. Fair values for the Company's loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value. The fair values of checking and NOW accounts, money market accounts and savings deposits are the amounts payable on demand at the reporting date. The fair value for fixed-maturity time deposits is estimated using a discounted cash flow analyses using the rates currently offered for deposits with similar remaining maturities. The fair values of securities sold under agreement to repurchase and the Company's debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for debt with similar terms and remaining maturities. Fair values for the Company's off-balance sheet instruments (guarantees and credit commitments) are based on current settlement or termination values and on fees currently charged to enter into similar agreements, given the remaining terms of the agreements and the counterparties' credit standing. NOTE U: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Income (Loss) Before Gain on Income Income Net Provision Securities Tax Tax Net Stock Price Interest Interest Interest For Loan & Other Expense Expense Income Earnings Per Share(2) Range(2) Income Expense Income Losses Assets (Credit) (Credit) (Loss) Basic Diluted High Low - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in thousands, except earnings per share and stock price) 1st Quarter 1997 $ 28,335 $17,000 $11,335 $ 300 $ -- $ 5,075 $1,781 $ 3,294 $0.36 $0.35 16 15/16 14 57/64 1996 24,000 14,318 9,682 300 -- 2,689 (799) 3,488 0.42 0.40 12 1/2 10 29/32 2nd Quarter 1997 30,293 18,484 11,809 300 539 5,505 1,926 3,579 0.39 0.38 17 1/2 15 33/64 1996 25,426 14,886 10,540 300 188 2,824 (537) 3,361 0.40 0.38 12 47/64 10 29/32 3rd Quarter 1997 32,142 19,626 12,516 300 -- 6,262 2,003 3,722 0.41 0.40 19 49/64 16 13/16 1996 27,105 15,863 11,242 300 -- (1,127)(1) (42) (1,085)(1) (0.13) (0.12) 12 61/64 11 9/64 4th Quarter 1997 34,923 21,644 13,279 450 -- 6,444 2,033 3,730 0.41 0.40 26 3/4 19 13/64 1996 27,778 16,479 11,299 200 -- 4,958 1,727 3,231 0.38 0.36 16 9/64 12 1/2 Year 1997 125,693 76,754 48,939 1,350 539 23,286 7,743 14,325 1.58 1.53 26 3/4 14 57/64 1996 104,309 61,546 42,763 1,100 188 9,344 349 8,995 1.08 1.01 16 9/64 10 29/32
(1)Included in this loss is the one-time charge of $5.5 million to replenish the Federal Deposit Insurance Corporation's Savings Association Insurance Fund (see Note N). (2)All per share amounts have been adjusted to include the effect of the 10% stock dividend in 1997. 48 39 NOTE V: D&N FINANCIAL CORPORATION - PARENT COMPANY ONLY FINANCIAL INFORMATION CONDENSED STATEMENTS OF CONDITION
December 31 1997 1996 ---------------------- (Dollars in thousands) - ------------------------------------------------------------------------------------------ ASSETS Cash and cash equivalents $ 2 $ 2 Amounts receivable from subsidiary 3,523 6,104 Investments in subsidiary 94,994 80,014 Other assets -- 65 -------------------------- $ 98,519 $ 86,185 ========================== LIABILITIES AND STOCKHOLDERS' EQUITY Dividends payable $ 414 $ -- Other liabilities 23 64 Stockholders' equity 98,082 86,121 -------------------------- $ 98,519 $ 86,185 ==========================
CONDENSED STATEMENTS OF INCOME
Year Ended December 31 ---------------------------------------- 1997 1996 1995 - --------------------------------------------------------------------------------------------------------- (Dollars in thousands) Interest income from subsidiary $ 228 $ 64 $ 40 Equity in undistributed net income of subsidiary 14,388 9,378 10,618 Noninterest expense: Compensation and benefits 10 13 9 Other 281 434 232 ---------------------------------------- Total noninterest expense 291 447 241 ---------------------------------------- Income before income tax expense 14,325 8,995 10,417 Federal income tax expense -- -- -- ---------------------------------------- Net income $ 14,325 $ 8,995 $ 10,417 ======================================== CONDENSED STATEMENTS OF CASH FLOWS Year Ended December 31 ------------------------------------ 1997 1996 1995 - --------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating activities Net income $ 14,325 $ 8,995 $ 10,417 Items not affecting cash: Equity in undistributed net income of subsidiary (14,388) (9,378) (10,618) Other 438 115 37 -------------------------------------- Net cash provided (used) by operating activities 375 (268) (164) Investing activities Change in intercompany receivable 2,581 (5,225) (102) Financing activities Proceeds from exercise of stock options 865 9,055 346 Purchases of treasury stock (2,995) (3,499) (44) Common stock cash dividends (826) -- -- Payment of ESOP debt -- (63) (36) -------------------------------------- Net cash provided (used) by financing activities (2,956) 5,493 266 Net change in cash and cash equivalents -- -- -- Cash and cash equivalents at beginning of year 2 2 2 -------------------------------------- Cash and cash equivalents at end of year $ 2 $ 2 $ 2 ======================================
49 40 STOCKHOLDER INFORMATION D&N FINANCIAL CORPORATION 400 Quincy Street Hancock, Michigan 49930 (906) 482-2700 363 W. Big Beaver, Ste. 100 Troy, Michigan 48084 (248) 528-0704 COMMON STOCK D&N's common stock is listed on The Nasdaq Stock Market under the symbol DNFC. The stock quotations appear in major daily newspapers under the listing D&N Fncl. At December 31, 1997, there were approximately 7,100 holders of D&N common stock. SHAREHOLDER ASSISTANCE Shareholders with questions concerning their records, change of name, address or ownership of stock and lost or stolen certificates may contact the transfer agent: Illinois Stock Transfer Company 223 West Jackson Blvd., Suite 1210 Chicago, Illinois 60606 (800) 757-5755 DIRECT INVESTMENT PLAN Registered holders of D&N Financial Corporation common stock are eligible to participate in the Company's Direct Investment Plan. The Plan provides a convenient method for making direct cash investments for the purchase of additional shares of D&N stock without fees or commissions. Purchases are made on or about the first working day of each month on the open market. The minimum investment is $25; the maximum is $12,000 annually. Cash investments must be received by the transfer agent no less than five working days prior to month end to be included in the monthly purchase. FORM 10-K The 1997 Annual Report and Form 10-K are available to shareholders at no cost upon written request to the Company at the address above. INVESTOR RELATIONS CONTACT Analysts, investment professionals, shareholders and others seeking information about the Company should contact Mary Jo Kristapovich, Director of Investor Relations. She may be reached at the address above, by phone at (906) 487-6225 or by e-mail at mjkrist@portup.com. ANNUAL MEETING The 1998 Annual Meeting of Stockholders will be held on April 30, 1998 at 2 p.m. Eastern Daylight Time at the Franklin Square Inn in Houghton, Michigan. OTHER COMPANY INFORMATION To find out more about D&N--its history, management, products and services--visit our web site at http://www.dn.portup.com. INDEPENDENT AUDITORS Coopers & Lybrand, L.L.P., Detroit, Michigan 52 EX-21 3 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF REGISTRANT
Percentage State of of Incorporation Parent Subsidiary Ownership or Organization - -------------------------- -------------------------- ---------- --------------- D&N Financial Corporation D&N Bank 100% Federal D&N Bank D&N Enterprises, Inc. 100% Michigan D&N Bank D&N Holdings, Inc. 100% Michigan D&N Bank D&N Funding I Corp. 100% Delaware D&N Bank D&N Mortgage Corporation 100% Michigan D&N Bank D&N Capital Corporation 100% Delaware D&N Holdings, Inc. Quincy Insurance Co. 100% Michigan
EX-23 4 EXHIBIT 23 1 EXHIBIT 23 [COOPERS & LYBRAND LETTERHEAD] CONSENT OF INDEPENDENT ACCOUNTANTS The Board of Directors D&N Financial Corporation 400 Quincy Street Hancock, MI 49930 Gentlemen: We consent to the incorporation by reference in the Registration Statement of D&N Financial Corporation on Form S-8 (Registration No. 33-94076) of our report dated January 22, 1998 on our audits of the financial statements of D&N Financial Corporation and Subsidiary as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, which report is incorporated by reference in this Annual Report on Form 10-K of D&N Financial Corporation for the year ended December 31, 1997. COOPERS & LYBRAND L.L.P. Coopers & Lybrand L.L.P. Detroit, Michigan March 25, 1998 EX-27.1 5 EXHIBIT 27.1
9 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 16,239 3,958 300 0 206,358 254,574 256,119 1,311,508 10,549 1,815,315 1,043,167 149,092 25,824 470,431 0 28,719 77,117 20,965 1,815,315 98,560 27,133 0 125,693 47,961 76,754 48,939 1,350 0 33,223 23,286 14,325 0 0 14,325 1.58 1.53 3.08 3,552 274 0 14,100 11,042 2,183 340 10,549 10,549 0 0
EX-27.2 6 EXHIBIT 27.2
9 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 9,264 13,176 0 0 96,238 127,907 129,015 962,440 10,081 1,228,497 922,932 0 17,291 216,295 50,011 0 0 21,968 1,228,497 72,550 18,215 0 90,765 38,639 56,015 34,750 2,400 147 30,520 8,742 10,417 0 0 10,417 1.27 1.24 3.04 8,249 0 0 14,462 8,349 2,187 1,519 10,081 10,081 0 0
EX-27.3 7 EXHIBIT 27.3
9 1,000 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 21,175 14,273 0 0 84,115 97,841 98,408 1,035,790 10,141 1,273,859 936,321 26,876 15,642 219,388 0 0 50,381 25,251 1,273,859 19,980 4,020 0 24,000 11,050 14,318 9,682 300 0 8,424 2,689 3,488 0 0 3,488 .42 .40 3.19 6,144 0 0 16,662 10,081 306 66 10,141 10,141 0 0
EX-27.4 8 EXHIBIT 27.4
9 1,000 3-MOS DEC-31-1996 APR-01-1996 JUN-30-1996 12,512 938 0 0 70,536 152,288 152,235 1,105,958 (10,150) 1,095,808 934,831 46,852 18,143 285,244 0 0 50,626 28,328 1,364,024 21,435 3,991 0 25,426 10,856 14,886 10,540 300 188 9,468 2,824 3,361 0 0 3,361 .40 .38 3.27 6,626 2,425 0 18,119 10,141 372 81 10,150 10,150 0 0
EX-27.5 9 EXHIBIT 27.5
9 1,000 3-MOS DEC-31-1996 JUL-01-1996 SEP-30-1996 5,738 4,532 0 0 72,399 201,601 200,226 1,100,094 10,390 1,408,131 944,733 61,690 23,030 300,529 0 0 50,805 27,344 1,408,131 22,466 4,639 0 27,105 10,917 15,863 11,242 300 0 13,749 (1,127) (1,085) 0 0 (1,085) (.13) (.12) 3.37 7,962 0 0 15,131 10,150 329 269 10,390 10,390 0 0
EX-27.6 10 EXHIBIT 27.6
9 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 2,847 1,342 8,600 0 95,604 275,429 274,087 1,066,918 11,042 1,473,054 964,133 58,040 18,763 345,997 55,536 0 0 30,585 1,473,054 86,151 18,158 0 104,309 43,859 61,546 42,763 1,100 0 39,543 9,344 8,995 0 0 8,995 1.08 1.01 3.26 6,621 0 0 15,900 10,081 1,530 1,391 11,042 11,042 0 0
EX-27.7 11 EXHIBIT 27.7
9 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 1,800 747 1,300 0 74,064 338,903 334,347 1,092,824 10,987 1,528,468 1,007,508 71,886 14,703 345,599 0 0 55,497 33,275 1,528,468 21,937 6,398 0 28,335 11,288 17,000 11,335 300 0 7,568 5,075 3,294 0 0 3,294 0.36 0.35 3.13 4,292 0 0 12,168 11,042 434 79 10,987 10,987 0 0
EX-27.8 12 EXHIBIT 27.8
9 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 7,363 3,833 800 0 62,863 330,700 329,479 1,184,271 10,978 1,608,837 1,020,312 88,840 19,781 390,177 0 0 55,467 34,260 1,608,837 23,598 6,695 0 30,293 11,987 18,484 11,809 300 539 8,349 5,505 3,579 0 0 3,579 0.39 0.38 3.13 3,877 0 0 10,845 10,987 397 88 10,978 10,978 0 0
EX-27.9 13 EXHIBIT 27.9
9 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 7,050 40 0 0 107,506 303,424 304,656 1,314,797 10,850 1,754,069 1,032,841 156,276 20,985 421,573 0 28,719 54,960 38,715 1,754,069 25,453 6,689 0 32,142 12,279 19,626 12,516 300 0 8,303 6,262 3,722 0 0 3,722 0.41 0.40 3.13 3,872 280 0 11,691 10,978 524 96 10,850 10,850 0 0
-----END PRIVACY-ENHANCED MESSAGE-----