-----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, K6JulliUOz89W8Ui5kIM+CQBqKXuZwUFB4GCMEAB/8erDR3IjC5G6WL11tAxVqDk CDXfEF+DY3NSFdVj+hTpbw== 0000950124-99-002236.txt : 19990402 0000950124-99-002236.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950124-99-002236 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL DIRECTIONS INC CENTRAL INDEX KEY: 0000830157 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 382781737 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 033-20417 FILM NUMBER: 99580522 BUSINESS ADDRESS: STREET 1: 322 S JEFFERSON ST CITY: MASON STATE: MI ZIP: 48854 BUSINESS PHONE: 5176760500 MAIL ADDRESS: STREET 2: P O BOX 130 CITY: MASON STATE: MI ZIP: 48854-0130 10-K405 1 FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K 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, 1998 Commission file number 33-20417 Capital Directions, Inc. (Exact name of registrant as specified in its charter) Michigan 38-2781737 -------- ---------- (State of other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 322 South Jefferson St., Mason, Michigan 48854-0130 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (517) 676-0500 Securities registered pursuant to Section 12 (b) of the act: NONE Securities registered pursuant to Section 12 (g) of the act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filer pursuant to item 405 of Registration S-K 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] The registrant estimates that as of March 23, 1999 the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $16,691,890. This is based on a market price of $35.75 per share for the Registrant's stock as of that date. As of March 23, 1999, the registrant had outstanding 596,122 shares of common stock having a par value of $5 per share. 1 2 DOCUMENTS INCORPORATED BY REFERENCE Annual Report to Shareholders for the Year Ended December 31, 1998 (Form 10-K, Part I, Part II, Part III, and Part IV) Proxy Statement for the Annual Meeting of Shareholders to be held April 22, 1999 (Form 10-K, Part III) PART I Item 1. Business Capital Directions, Inc. (the "Registrant") is a one-bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Registrant was incorporated on August 11, 1987 and formed for the purpose of enabling Mason State Bank (the "Bank") to form a one-bank holding company and engage in any other related activity allowed. Mason State Bank was consolidated with Mason Bank on July 22, 1988, thereby causing Mason State Bank to become a wholly-owned subsidiary of the Registrant. Mason State Bank purchased Lakeside Insurance Services, Inc. in 1994 to take advantage of the expanded insurance powers granted to banks in 1994. Lakeside is licensed in Michigan to sell life insurance and variable annuity contracts. The Registrant has no substantial assets except the investments in Mason State Bank. The Registrant and its primary subsidiary, Mason State Bank, operate in the banking industry, which accounts for substantially all of their assets, revenues and operating income. Further discussion of the operations of the Registrant and its subsidiaries is discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1998 Annual Report to the Shareholders, incorporated herein by reference. The Registrant's primary competition is substantially the same as Mason State Bank's as discussed below. The Bank was organized in 1886 under the laws of Michigan and is subject to the Michigan Banking Code of 1969. It is insured by the Bank Insurance Fund through the Federal Deposit Insurance Corporation. The Bank is regulated by the Michigan Financial Institutions Bureau and the Federal Deposit Insurance Corporation. The Federal Reserve Board regulates the Registrant. The Bank's Principal office is located at 322 South Jefferson Street, Mason, Michigan. It operates a branch at 661 North Cedar Street, Mason, Michigan and opened its second branch on October 1, 1998 at 810 W. Bellevue, Leslie, Michigan. Banking services are provided to individuals, businesses, local state and federal governmental units and institutional customers located in Mason and the surrounding areas. Services include demand deposits, savings and time deposits, collections, cash management, night depositories and personal, installment, commercial and real estate loans. The Bank offers a credit card program affiliated with the Visa and MasterCharge Inter-Bank charge card system. The Bank maintains a correspondent relationship with several of the major banks in the Detroit area and elsewhere, in order to provide for the clearance of checks, the transfer of funds, and the periodic purchase and sale of Federal funds, and participation in large loans which would be beyond the Bank's legal lending limit if made by the Bank alone. The Bank has full and part-time employees (40 full-time equivalents) and owns its main office and Cedar Street office. The new facility in Leslie is operated under a lease agreement. The Bank operates primarily within Ingham County. Competing with the Bank in Ingham County are several other commercial banks and financial institutions, some of which have significantly greater total resources than the Bank. 2 3 Item 1. Business-Statistical Disclosure I. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential (A), (B) The following table sets forth average balances for major categories of interest earning assets and interest bearing liabilities, the interest earned (on a fully taxable equivalent basis) or paid on such amounts, and average interest rates earned or paid thereon. 3 4
1998 1997 ----------------------------------- ---------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ------- -------- ------ ------- -------- ------ (Dollars in thousands) ASSETS Loans, including fees(1) $ 69,172 $5,870 8.49% $ 54,870 $4,910 8.95% Taxable investment securities 10,095 662 6.56 12,893 878 6.81 Non-taxable investment securities(2) 4,051 324 8.00 4,545 357 7.85 Federal funds sold 2,487 134 5.39 1,295 68 5.25 -------- ------ ------- ------ Total earning assets 85,805 6,990 8.15% 73,603 6,213 8.44% Cash and due from 2,337 2,710 banks Other assets, net 2,473 3,074 -------- ------- Total non-interest earning assets 4,810 5,784 -------- ------- Total assets $ 90,615 $79,387 ======== ======= LIABILITIES Interest bearing demand deposits $ 10,213 156 1.53% $ 9,299 182 1.96% Savings deposits 17,592 522 2.97 16,586 487 2.94 Time deposits under $100,000 20,923 1,218 5.82 21,133 1,213 5.74 Time deposits of $100,000 or more 10,173 576 5.66 8,551 493 5.77 Other borrowings 10,816 653 6.04 3,501 219 6.26 -------- ------ ------- ------ Total interest bearing liabilities 69,717 3,125 4.48% 59,070 2,594 4.39% ------ ------ Demand deposits 8,870 8,674 Other liabilities 1,381 1,743 Shareholders' equity 10,647 9,900 ------ ------ Total non-interest bearing liabilities and equity 20,898 20,317 -------- ------- Total liabilities and equity $ 90,615 $79,387 ======== ======= Net interest income $3,865 $3,619 ====== ====== Net yield on interest earning assets(2) 4.50% 4.92% ==== =======
(1) Average balances for loans include non-accrual loans. The inclusion of non-accrual loans and fees does not have a material effect on either the average balance or the average interest rate. (2) Interest on non-taxable investment securities is reflected on a fully tax equivalent basis using an effective tax rate of 34% for 1998 and 1997. 4 5 I. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Differential (continued) (C) The following table summarizes the changes in interest income (on a fully taxable equivalent basis) and interest expense resulting from changes in volume and changes in rates:
--------------------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) 1998 COMPARED TO 1997 1997 COMPARED TO 1996 -------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME VOLUME(1) RATE(1) TOTAL VOLUME(1) RATE(1) TOTAL Loans $ 1,225 $ (265) $ 960 $ 480 $ 35 $ 515 Taxable investment securities (185) (31) (216) (92) 31 (61) Non-taxable investment securities (2) (39) 6 (33) (44) 7 (37) Federal funds sold 64 2 66 (45) (2) (47) -------- ----- ----- ------ ----- ----- Total interest income 1,065 (288) 777 299 71 370 INTEREST EXPENSE Interest bearing demand deposits 17 (43) (26) (21) (17) (38) Savings deposits 30 5 35 (15) 13 (2) Time deposits under $100,000 (12) 17 5 (14) 2 (12) Time deposits of $100,000 or more 92 (9) 83 107 6 113 Other borrowings 442 (8) 434 88 2 90 -------- ----- ----- ------ ----- ----- Total interest expense 569 (38) 531 145 6 151 -------- ----- ----- ------ ----- ----- Net interest income $ 496 $(250) $ 246 $ 154 $ 65 $ 219
(1) The change in interest due to both volume and rate has been allocated to volume and rate in proportion to the relationship of the absolute dollar amounts of the change in each. (2) Interest on tax-exempt investment securities is based on a fully taxable equivalent basis. II. Investment Portfolio (A) A table of carrying values of the investment portfolio as of December 31, 1998 and 1997 is set forth in Note 3 on page 14 of the 1998 Annual Report to Shareholders. Such information is incorporated herein by reference. (B) The following table shows the relative maturities and weighted yields of investment securities at December 31, 1998: (dollars in thousands) Held-To-Maturity
1 Year or less 1 Year - 5 Years 5 Years - 10 Years After 10 Years Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------------ U.S. Government agencies(2) $ 713 6.87% $ 690 6.87% $ 0 0.0% $ 395 9.0% State and political subdivisions Non-taxable (1) 1,265 6.31 1,124 7.77 1,090 8.46 999 8.94 ------ ------ ------ ------ Total $1,978 6.51% $1,814 7.43% $1,090 8.46% $1,394 8.96% ====== ====== ====== ======
5 6 II. Investment Portfolio (continued) Available-For Sale
1 Year or less 1 Year - 5 Years Amount Yield Amount Yield ------ ----- ------ ----- U.S. Government agencies (2) $ 959 6.57% $ 577 6.44% State and political subdivisions Taxable 509 6.08 Corporate securities (2) 1,349 6.75 1,926 6.59 ----- ------- Total $2,308 6.68% $ 3,012 6.48% ====== =======
(1) Weighted average yield adjusted to a taxable equivalent basis using a federal income tax rate of 34 percent. (2) Mortgage Backed securities and Corporate securities, as reflected in the above schedules consider anticipated prepayments and calls. (C) The Registrant held no investment securities of a single issuer, except U.S. Government Agency securities, in an amount greater than ten percent of shareholders' equity as of December 31, 1998. III. Loan Portfolio (A) A table of loans outstanding as of December 31, 1998 and 1997 is set forth in Note 4 on page 15 of the 1998 Annual Report to Shareholders. Such information is incorporated herein by reference. The loan portfolio is systematically reviewed and the results reported to the Board of Directors of the Registrant. The purpose of these reviews is to assist in assuring proper loan documentation, to provide for the early identification of potential problem loans and to help ensure the adequacy of the allowance for loan losses. (B) The following table sets forth the remaining maturity of loans outstanding (excluding real estate mortgages, installment and lease financing) at December 31, 1998, according to scheduled payments of principal (in thousands) and considering the banks "rollover policy."(1)
(In thousands) 1 Year 1 Year - After or less 5 Years 5 Years Total ------- -------- -------- -------- Commercial and Agricultural $ 2,739 $ 2,186 $ 622 $ 5,547 ======= ======= ======== ========
The following table sets forth commercial and agricultural loans due after one year, which have predetermined interest rates and/or adjustable interest rates at December 31, 1998.
(In thousands) Fixed Adjustable Rate Rate Total ------- -------- ------- Due after one but within five years $ 1,052 $ 1,134 $ 2,186 Due after five years 274 348 622 ------- -------- ------- Total $ 1,326 $ 1,482 $ 2,808 ======= ======== =======
6 7 III. Loan Portfolio (continued) (1) The "rollover policy" is to generally write terms of these loans for a shorter time then the expected payments. The purpose of this is to re-evaluate the term and credit of the respective borrower. We estimate that this happens on approximately 80% of these borrowings and is reflected as such in this schedule. (C). Risk Elements (1). Nonaccrual, Past Due, Impaired and Restructured Loans. A table and discussion of nonaccrual, past due, impaired and restructured loans for the years ended December 31, 1998 and 1997 is in "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 2, 3, and 4 under Provision and allowance for loans losses, Note 1 under "Loans" and "Allowance for Loan Losses" on page 12 and in Note 5 on page 15 in the 1998 Annual Report to the Shareholders. Such information is incorporated herein by reference. Gross interest income that would have been recorded in 1998 on such loans if the loans had been current in accordance with their original terms and outstanding throughout the period or since origination was $5,172. No income was included in interest income on these loans in 1998. (2). Potential Problem Loans There are no material loans that are current as to which management has serious doubts as to the ability of the borrower to comply with the loan repayment terms, or which are expected to need adjustments in their repayment terms, or which are believed to require additional provisions for loan losses. (3). Foreign Outstandings There were no foreign outstandings as of December 31, 1998 and 1997. (4). Loan Concentrations There were no concentrations of loans exceeding 10% of total loans that have not been already disclosed as a category at December 31, 1998. (D). Other Interest Bearing Assets As of December 31, 1998, there were no other interest bearing assets that would be required to be disclosed under Item III, Parts (C) (1) or (C) (2) of the loan portfolio listing if such assets were loans. 7 8 IV. Summary of Loan Loss Experience (A). The following table sets forth loan allowance balances and summarizes changes in the allowance for loan losses for each of the two years ended December 31.
Analysis of the Allowance For Loan Losses (Dollars in thousands) 1998 1997 ---- ---- Balance, beginning of period $ 1,035 $ 1,020 ------- -------- Loans charged-off Commercial and agricultural 0 7 Real estate-construction 0 0 Real estate-mortgages 0 0 Lease financing 0 0 Installment and others 30 19 -------- -------- Total 30 26 Recoveries of loans charged-off Commercial and agricultural 3 6 Real estate-construction 0 0 Real estate-mortgages 0 0 Lease financing 0 0 Installment and others 26 35 -------- -------- Total 29 41 Net charge-offs (recoveries) 1 (15) Additions charged (credited) to operations (23) 0 -------- -------- Balance at end of period $ 1,011 $ 1,035 ======== ======== Average gross loans outstanding $ 69,172 $54,870 ======== ======= Ratio of net charge-offs(recoveries) during the period to average gross loans outstanding during the period 0.00% -0.03%
Further discussion of the provision and allowance for loan losses as well as non-performing and impaired loans is presented in "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 2, 3, and 4, Note 1 on page 12 and Note 5 on page 15 in the 1998 Annual Report to the Shareholders, incorporated herein by reference. 8 9 IV. Summary of Loan Loss Experience (continued) (B) The following table presents an allocation for loan losses to the various loan categories at December 31:
1998 1997 % of % of (Dollars n thousands) Allowance Loans to Allowance Loans to Amount Total Loans Amount Total Loans ------- ---------- ------- -------- Commercial and agricultural $ 81 6.77% $ 74 6.92% Real estate-mortgages 491 89.12 4 87.21 Installment and other 45 4.11 7 5.87 Unallocated 394 N/A 950 N/A ------- --------- ------- -------- Total $ 1,011 100.00% $ 1,035 100.00% ======= ========= ======= ========
Mason State Bank is committed to the maintenance of an allowance for loan losses in amounts sufficient to absorb loan and lease losses inherent in the loan portfolio. To assure the adequacy of balances and the resulting provision allocations, measurements against historical performance and current analyses of asset quality are undertaken on a periodic basis with consideration for qualitative factors. These evaluations support the budgeted allowance provisions and the traditional philosophy of accounting for losses as they are recognized. On a predetermined basis, a Loan Loss Allowance Model (LLAM) is completed quarterly for the Bank. The results of the LLAM provide a consistent, conservative management tool for quantifying the amount of risk in the loan portfolio. This LLAM computes a suggested allowance balance to be compared to the actual allowance for loan losses. The difference between the suggested and actual allowance is monitored and maintained at an amount considered reasonable to provide for potential losses inherent in the portfolio. To determine the suggested allowance balance, two tests are applied to the various loan categories. The test with the most conservative (greatest) allowance allocation is selected for each category. The two tests are then combined with a separate qualitative factor spread against all loan categories. The first test includes establishment of a minimum allocation percentage for each loan (primarily commercial) based upon its loan grade. The second test involves computing the actual loss experience over the last five years for each of the loan categories (primarily consumer and residential real estate loans). The factor applied to the current outstanding loan balances of these loan categories is equal to at least the five-year average of net charge-offs to average loans for the appropriate loan portfolio. When economic conditions or other factors warrant, a qualitative factor is applied against all loan categories. Management declared that such a factor be instituted for 1998 given the unprecedented seven year expansion of the United States economy and the expection of a reversal of this trend in the near future. The factor applied to the current outstanding of all loan balances is equal to the seven year average of net charge-offs to average loans for the seven year period prior to the start of the current economic expansion (years 1985 through 1991). The allowance allocations above were deemed by management to be amounts reasonably necessary to provide for the inherent losses in the various loan categories as of December 31, 1998 and 1997. 9 10 V. Deposits The following table sets forth average deposit balances and the weighted average rate paid for each of the two years ended December 31:
1998 1997 (Dollars in thousands) Average Average Balance Rate Balance Rate ------- ---- ------- ---- Non interest-bearing demand deposits $ 8,870 $ 8,674 Interest-bearing demand deposits 10,213 1.53% 9,299 1.96% Savings deposits 17,592 2.97 16,586 2.94 Time deposits under $100,000 20,923 5.82 21,133 5.74 Time deposits of $100,000 or more 10,173 5.66 8,551 5.77 ------- ------- Total $67,771 3.65% $64,243 3.70% ======= =======
The following table summarizes time deposits in amounts of $100,000 or more by time remaining until maturity as of December 31, 1998:
(In thousands) Three months or less $ 6,988 Over three months through six months 2,003 Over six months through one year 562 Over one year 1,724 -------- Total $ 11,277 ========
As of December 31, 1998 the registrant had no foreign deposits. VI. Return on Equity and Assets The following table presents the ratios for the year ended December 31:
1998 1997 ---- ---- Net income to average total assets 1.47% 1.56% Net income to average shareholders' equity 12.53 12.47 Cash dividend payout ratio per share 42.63 33.65 Average shareholders' equity to average total assets 11.75 12.47
VII. Short Term Borrowings - Not applicable Item 2. Properties The Bank owns the land on which the Bank's main office is located. The land measures 85' by 170' and bears the municipal address of 322 South Jefferson Street, Mason, Michigan. The permanent building, also owned by Mason State Bank, has approximately 6,800 square feet including banking facilities, storage and personnel lounge areas. This brick structure was built in the mid 1800's and has gone through several remodelings, the last one being in 1986 and is in good general condition. A parking area with spaces to accommodate 20 vehicles occupies part of the property; part is occupied by two drive-in banking stations. The Bank also owns the land used as a Branch office. The land measures 368' by 297' and bears the municipal address of 661 North Cedar Street, Mason, Michigan. The permanent building, built in the 1960's, also owned by Mason State Bank, measures approximately 2,400 square feet, including banking facilities, storage and personnel lounge areas. This building is also in good condition. A parking area with spaces to accommodate 24 vehicles occupies part of the property; part is occupied by 4 drive-in banking stations. 10 11 Item 2. Properties (continued) In October 1998, the Bank established an in-store branch located within the Felpausch Food Center, 810 Bellevue Street, Leslie, Michigan. The Bank entered into a lease arrangement and occupies 709 square feet of the southeast corner of the store. Prior to occupancy, this space was renovated to provide full service banking accommodations. Customer parking is readily available and maintained by Felpausch Food Center. The Registrant operates its business at the same address as Mason State Bank's main office. As of March 19, 1999, the Registrant owned no properties. Item 3. Legal Proceedings There are no material pending legal proceedings to which the Registrant or its subsidiaries is a party or to which any of its property is subject, except for proceedings which arise in the ordinary course of business. In the opinion of management, pending legal proceedings will not have a material effect on the consolidated financial statements of the Registrant or its subsidiaries. Item 4. Submission of Matters to a Vote of Security Holders Not applicable Additional Item - Executive Officers Executive officers of the Registrant are appointed annually by the Board of Directors at the meeting of Directors following the Annual Meeting of Shareholders. There are no family relationships among these officers and/or Directors of the Registrant or any arrangement or understanding between any officer and any other person pursuant to which the officer was elected. The following sets forth certain information with respect to the Registrant's Executive Officers and Directors as of December 31, 1998.
Position With First Elected as an Name (Age) Registrant Officer of the Registrant ---------- ---------- ------------------------- George A. Sullivan (66) Chairman 1988 Gerald W. Ambrose (49) Vice Chairman 1994 Timothy P. Gaylord (44) President and C.E.O. 1995 Douglas W. Dancer (58) Secretary 1990
Mr. Sullivan is a Director of the registrant and Chairman of the Board of Directors of Mason State Bank. Mr. Ambrose is a Director of the registrant and Vice Chairman of the Board of Directors of Mason State Bank. Mr. Gaylord is a Director of the registrant and President and Chief Executive Officer of Mason State Bank. Mr. Dancer is a Director of the registrant and Secretary of the Board of Directors of Mason State Bank. 11 12 PART II I. The information required by this item appears in the Capital Directions, Inc. Annual Report to Shareholders for the year ended December 31, 1998, and is incorporated herein by reference, as follows:
Pages in 1998 Annual Report ------------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 1 Item 6. Selected Financial Data 1 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 2 - 7 Item 7a. Quantitative and Qualitative Disclosures About Market Risk Not required as registrant meets requirements to be a small business filer Item 8. Financial Statements and Supplementary Data 8 - 23 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None
Part III The information required by this item is included in the Capital Directions, Inc. 1999 Proxy Statement, dated March 29, 1999, and is incorporated herein by reference, as follows:
Page in 1999 Proxy Statement --------------- Item 10. Directors and Executive Officers of the Registrant 3 - 4 (In addition, reference is made to additional item - Executive Officers under Part I, Item 4 of this Form 10-K report on page 11) Item 11. Executive Compensation 4 - 6 Item 12. Security Ownership of Certain Beneficial Owners and Management 2 - 3 Item 13. Certain Relationships and Related Transactions 6 - 7
The information appearing in the Corporation's Proxy Statement and in Note 4 on page 15 of the Notes to Consolidated Financial Statements of the 1998 Annual Report to Shareholders is incorporated by reference in response to this item. 12 13 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a). The following documents are filed as part of this report: 1. The following consolidated financial statements of Capital Directions, Inc. included in the 1998 Annual Report to Shareholders for the year ended December 31, 1998, are incorporated herein by reference in Item 8:
Page in 1998 Annual Report ------------- Consolidated balance sheets - December 31, 1998 and 1997 8 Consolidated statements of income for the years ended December 31, 1998, 1997, and 1996 9 Consolidated statements of cash flows for the years ended December 31, 1998, 1997, and 1996 10 Consolidated statements of changes in shareholders' equity for the years ended December 31, 1998, 1997, and 1996 11 Notes to consolidated financial statements 12 - 23 Report of Independent Auditors 7
2. Financial Statement Schedules Not applicable 3. Exhibits (3a) Articles of Incorporation and (3b) Bylaws (previously filed as Exhibits included in Capital Directions, Inc. Registration Statement Amendment No. 1 to Form S-4, No. 1 to Form S-4, No. 33-20417, Dated March 17, 1988). (10) Material Contracts (a) Incentive Compensation Plans (previously filed as Exhibits included in Capital Directions, Inc.'s 1988 10-K reported dated March 29, 1989 and the 1993 10-K report dated March 29, 1994). (b) Directors Deferred Compensation Plans (previously filed as Exhibits included in Capital Directions, Inc.'s 1988 10-K report dated March 29, 1989). (c) Supplementary Executive Retirement Plan (previously filed as Exhibits included in Capital Directions, Inc.'s 1988 10-K report dated March 29, 1989). (13) Annual Report to Shareholders for the year ended December 31, 1998 (filed herewith). (22) Subsidiaries of registrant (previously filed as Exhibits included in Capital Directions, Inc.'s 1988 10-K report dated March 29, 1989). 13 14 Part IV - Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued) (23) Consents of experts. Consent of Crowe, Chizek and Company LLP. (27) Financial Data Schedule for EDGAR filer. (b). Reports on Form 8-K No reports of Form 8-K were filed during the last quarter of the year covered by this report. 14 15 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, on March 23, 1999. CAPITAL DIRECTIONS, INC. /s/ Timothy P. Gaylord Timothy P. Gaylord - -------------------------- (President and Chief Executive Officer) /s/ Lois A. Toth Lois A. Toth - -------------------------- (Treasurer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed by the following persons in the capacities indicated on March 23, 1999. /s/ George A. Sullivan George A. Sullivan - -------------------------- Chairman of Board of Directors /s/ Gerald W. Ambrose Gerald W. Ambrose - -------------------------- Vice Chairman of Board of Directors /s/ Douglas W. Dancer Douglas W. Dancer - -------------------------- Secretary of Board of Directors /s/ Timothy P. Gaylord Timothy P. Gaylord - -------------------------- President and Chief Executive Officer /s/ Marvin B. Oesterle Marvin B. Oesterle - -------------------------- Director /s/ Paula Johnson Paula Johnson - -------------------------- Director 15 16 Index to Exhibits The following exhibits are filed or incorporated by reference as part of this report: 3(A) Articles of Incorporation of the Registrant as currently in effect and any amendments thereto (Incorporated herein by reference to exhibit 3(A) of the Registrants' Form S-4 Registration Statement dated March 17, 1988 No. 33-20417). 3(B) Bylaws of the Registrant as currently in effect and any amendments thereto (Incorporated herein by reference to exhibit 3(B) of the Registrants' Form S-4 Registration Statement dated March 17, 1988 No. 33-20417). 10(A) Incentive Compensation Plans (Incorporated herein by reference to exhibit 10(A) to Registrants' Report on Form 10-K for the year ended December 31, 1988 and December 31, 1988 and December 31, 1993 [1988 and 1993 10-K Report]). 10(B) Directors Deferred Compensation Plan (Incorporated herein by reference to exhibit 10(B) to Registrants' Report on Form 10-K for the year ended December 31, 1988 [1988 10-K Report]). 10(C) Supplementary Executive Retirement Plan (Incorporated herein by reference to exhibit 10(C) to Registrants' Report on Form 10-K for the year ended December 31, 1988 [1988 10-K Report]). 13 Annual Report to Shareholders for the year ended December 31, 1998 (filed herewith). 22 List of Subsidiaries (Incorporated herein by reference to exhibit 22 to Registrants' Report on Form 10-K for the year ended December 31, 1988 [1988 10-K Report]). 23 Consents of experts. Consent of Crowe, Chizek and Company LLP. 27 Financial Data Schedule for EDGAR filer. 16 EX-13 2 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 A MESSAGE FROM THE PRESIDENT AND CEO [GRAPHIC OF PRESIDENT AND CEO] Timothy P. Gaylord President and CEO Capital Directions, Inc. and Mason State Bank It's my pleasure to report another excellent year for Capital Directions, Inc. Nineteen ninety-eight is the ninth consecutive year the Corporation reports increased earnings. Net income of $1,334,000 grew 8% over 1997 and represents the highest earnings in corporate history. Basic earnings per share were $2.24 in 1998 compared with $2.08 in 1997. Return on total assets (ROA) of 1.47% is off slightly from 1997 levels, but represents strong performance when coupled with a 25% growth in assets. Return on average shareholders' equity (ROE) of 12.53% improved over 1997 as a result of improved leverage of capital and increased earnings. The objective to grow the Bank has been extremely successful in 1998. Our strategy concentrated on entering new markets, expanding market share, and enhancing current products. Mason State Bank opened a new location in Leslie, Michigan approximately 10 miles south of Mason. The new facility is a state-of-the-art in-store branch located in the Leslie Felpausch Food Center. The branch offers full service and provides a high level of convenience for our clients. The greater Lansing economy has been extremely strong in 1998. This has stimulated the demand for new construction and mortgage lending. An aggressive approach to expand market share in mortgage lending has resulted in closing $40,000,000 in mortgages in 1998. Our Personal Bankers do not subscribe to the old adage of "Banker's Hours". They take appointments when and where it's convenient for the client. We continue to develop new sources of fee income and service enhancement. The Bank entered into an agreement with a local insurance agency and the AutoOwners Insurance Group to provide the benefit of group insurance rates for our clients. This benefit has allowed the Bank to differentiate its product from our competitors and enhance customer loyalty. Our investment in the Michigan Banker's Title Company of Mid Michigan, LLC continues to exceed expectations and complements our mortgage lending activity. The overall loan portfolio remains strong. The Bank recorded $400 of net loan charge-offs in 1998. This is the first year the Bank has experienced net loan charge-offs in a six year period. Mason State Bank continues to adhere to strict underwriting standards. Mason State Bank is recognized for consistent earnings improvement, excellent asset quality, and a strong capital base by investment analysts and bank rating services. The Bank operates at an efficiency ratio of 56.17%, which compares favorably with statewide peer of 62.96%. Capital Directions, Inc. continues to strive to improve shareholder value over time. During 1998 dividends declared increased by 37%. An investment in Capital Directions utilizing the dividend reinvestment program in 1993 would have returned an annually compounded rate of return of 27.59%. As the following chart illustrates an investment in Capital Directions has provided excellent returns over time. We look for 1999 to be another record year. Preparation for the Year 2000 is almost complete and our new location is well on its way to meeting our plan objectives. The industry continues to change and through the dedication and planning of our directors, management, and staff we are able to consistently improve our performance. Thank you for your support in 1998. Sincerely, /s/ Timothy Gaylord Timothy Gaylord CONTENTS Selected financial data .............................................. 1 Market for common stock and related security holder matters .......... 1 Management's discussion and analysis of financial condition and results of operations ................................................ 2-7 Report of independent auditors ....................................... 7 Capital Directions, Inc. consolidated balance sheets ................. 8 Capital Directions, Inc. consolidated statements of income ........... 9 Capital Directions, Inc. consolidated statements of cash flows ....... 10 Capital Directions, Inc. consolidated statements of changes in shareholders' equity ................................................. 11 Notes to consolidated financial statements ........................... 12-23 Management, officers, and directors .................................. 24 1998 highlights ...................................................... 24-25 STOCK PERFORMANCE CAPITAL DIRECTIONS, INC. Shareholders taking advantage of the dividend reinvestment program experienced an overall annual compounded rate of return of 27.59% since December of 1993. 12/31/93 $10,000 12/31/98 $37,963 2 SHAREHOLDER RETURNS 1992-1998
1992 1993 1994 1995 1996 1997 1998 Net Income (In Thousands) $835 $869 $930 $1,050 $1,136 $1,235 $1,334 Return On Equity 13.10% 12.62% 12.48% 12.71% 12.67% 12.47% 12.53% Return On Assets 1.10% 1.14% 1.24% 1.40% 1.49% 1.56% 1.47% Book Value Per Share $11.14 $12.17 $12.86 $14.45 $15.80 $17.17 $18.48 (Retroactively adjusted for stock splits) Stockholders' Equity to Total Assets 8.47% 9.52% 10.05% 11.04% 11.91% 12.78% 10.97%
STOCK & SHAREHOLDER INFORMATION STOCK TRANSFER AGENT AND REGISTRAR American Stock Transfer and Trust Company 40 Wall Street, 46th Floor New York, New York 10005 AUTOMATIC DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN Participating Capital Directions, Inc. shareholders take the opportunity to reinvest the cash dividends paid on their shares to purchase additional shares of Capital Directions, Inc. common stock. Participants may also purchase additional shares through cash payment without paying fees or commissions. DIRECT DEPOSIT The Corporation continues to provide convenient services to meet your needs. For quick transfer and availability, your cash dividends may be deposited directly into your Mason State Bank checking, savings, or money market account. To learn more about the Automatic Dividend Reinvestment and Stock Purchase Plan, or to initiate direct deposit of your cash dividends, please contact Kimberly A. Dockter, CPS, Executive Secretary, at (517) 676-0500. THE 1-YEAR ANNUALIZED RETURN ON CAPITAL DIRECTIONS, INC. STOCK WAS 6.63% THE 5-YEAR ANNUALIZED RETURN ON CAPITAL DIRECTIONS, INC. STOCK WAS 27.59% ANNUAL MEETING OF SHAREHOLDERS The annual meeting for the year ended December 31, 1998 will be held at the Ingham County Community Building, 700 East Ash Street, Mason, Michigan on Thursday, April 22, 1999 at 5:30 p.m. HOW TO ORDER FORM 10-K The Corporation's 1998 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, can be found on the Internet. It is also available, without charge, to shareholders upon request. Send requests to Lois A. Toth, Treasurer, Capital Directions, Inc., P.O. Box 130, Mason, MI 48854-0130 or call (517) 676-0500. 3 SELECTED FINANCIAL DATA (In thousands, except per share data)
SUMMARY OF OPERATIONS 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Interest and dividend income.......................... $ 6,880 $ 6,092 $ 5,709 $ 5,740 $ 5,262 Interest expense...................................... 3,125 2,594 2,443 2,441 2,135 - --------------------------------------------------------------------------------------------------------------------------- Net interest income................................... 3,755 3,498 3,266 3,299 3,127 Provision for loan losses............................. (23) -- -- 193 25 Non interest income................................... 565 568 783 1,046 735 Non interest expense.................................. 2,461 2,340 2,479 2,714 2,580 - --------------------------------------------------------------------------------------------------------------------------- Income before income tax expense...................... 1,882 1,726 1,570 1,438 1,257 Income tax expense.................................... 548 491 434 388 327 - --------------------------------------------------------------------------------------------------------------------------- Net income............................................ $ 1,334 $ 1,235 $ 1,136 $ 1,050 $ 930 =========================================================================================================================== PER SHARE(1) Average shares outstanding............................ 595,064 594,926 594,856 594,856 594,856 Basic earnings(2)..................................... $ 2.24 $ 2.08 $ 1.91 $ 1.77 $ 1.56 Diluted earnings(2)................................... 2.22 2.07 1.90 1.76 1.56 Dividends declared.................................... 0.96 0.70 0.57 0.52 0.50 Book value............................................ 18.48 17.17 15.80 14.45 12.86 RATIOS BASED ON NET INCOME Net income to average shareholders' equity............ 12.53% 12.47% 12.67% 12.71% 12.48% Net income to average assets.......................... 1.47 1.56 1.49 1.40 1.24 BALANCE SHEET Assets................................................ $ 100,229 $ 79,957 $ 78,920 $ 77,835 $ 76,112 Net loans............................................. 80,904 60,299 50,772 48,689 50,550 Short-term investments................................ 626 188 2,800 6,050 800 Securities............................................ 12,383 14,118 19,497 16,055 17,713 Deposits.............................................. 72,389 64,421 66,509 66,208 66,880 Long-term Federal Home Loan Bank borrowings........... 15,593 3,670 1,913 1,880 430 Shareholders' equity.................................. 10,997 10,216 9,397 8,594 7,648
1 A 2-for-1 stock split was declared on the common stock November 3, 1997 and paid December 1, 1997. Earnings, dividends, book value and price per share figures have been restated to give retroactive effect to this split. 2 Restated to reflect adoption of SFAS No. 128 on December 31, 1997. MARKET FOR COMMON STOCK AND RELATED SECURITY HOLDER MATTERS Capital Directions, Inc. stock is not listed on any exchange. Its shares are traded through the local brokers of Everen Securities, Morgan Stanley Dean Witter, and Roney & Co. Management has not verified the accuracy of their bid reporting, nor will the price be reflective if the stock was listed on an active exchange. At December 31, 1998, there were approximately 421 holders of the Company's common stock. Dividends are declared on a quarterly basis with a total of $568,000 declared in 1998 and $415,000 in 1997.
1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER 1998 High................................................................ $ 33.00 $ 33.00 $ 33.38 $ 31.25 Low................................................................. 25.00 31.25 28.00 30.00 Dividend per share declared......................................... 0.19 0.23 0.27 0.27 1997 High................................................................ $ 21.88 $ 22.07 $ 24.25 $ 30.00 Low................................................................. 20.75 20.75 21.50 21.50 Dividend per share declared......................................... 0.16 0.17 0.18 0.19
A 2-for-1 stock split was declared on the common stock November 3, 1997 and paid December 1, 1997. Earnings, dividends, book value and price per share figures have been restated to give retroactive effect to this split. 1 4 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis provides additional information concerning the consolidated financial condition and results of operations for Capital Directions, Inc. and its wholly owned subsidiaries. It should be read in conjunction with the consolidated financial statements and supplemental data contained elsewhere in this report. Capital Directions, Inc., a one-bank holding company, commenced operations on July 22, 1988. This was facilitated by the acquisition of 100% of the outstanding shares of Mason State Bank in an exchange of common stock. The Corporation is not aware of any market or institutional trends, events, or circumstances that will have or are reasonably likely to have a material effect on liquidity, capital resources, or operations except as discussed herein. Also, the Corporation is not aware of any current recommendations by regulatory authorities that will have such effect if implemented. PERFORMANCE SUMMARY In 1998, Capital Directions, Inc. and its subsidiaries reported record net earnings of $1,334,000. This is an increase of 8.02% over the previous year. Basic earnings per share were $2.24 in 1998 compared to $2.08 in 1997. In 1998, return on average assets decreased to 1.47% from 1.56% in 1997. This decrease is attributable to the rapid growth in the total assets of the Corporation. Return on shareholders' equity was 12.53%, up from 12.47% in 1997. As of December 31, 1998 the leveraged capital ratio, which excludes the net unrealized gain or loss on securities available for sale, was 11.2%, down from 12.6% the prior year but well in excess of the minimum required by regulatory authorities of 4.0%. The following table provides a summary of the factors impacting net income in 1998 compared to the same components in 1997:
(In thousands) 1997 Net income.............................. $ 1,235 Increase (decrease) in net income: Interest income............................. 788 Interest expense............................ (531) Provision for loan losses................... 23 Non interest income......................... (3) Non interest expense........................ (121) Income taxes................................ (57) ----------- 1998 NET INCOME $ 1,334 ===========
In 1997, net income for the Corporation was $1,235,000, which was an increase of 8.71% over net earnings of $1,136,000 for 1996. Basic earnings per share increased to $2.08 in 1997 compared to $1.91 in 1996. The 1997 return on average assets increased to 1.56% from 1.49% in 1996. Return on average shareholders' equity was 12.47% down from 12.67% in 1996. The leveraged capital ratio for the year ending December 31, 1997 was 12.6%, up from 12.1% the prior year. The operations of our Holding Corporation did not materially affect the consolidated financial results for 1998, 1997, or 1996. NET INTEREST INCOME The largest segment of the Corporation's operating income is net interest income. Net interest income is determined by adding interest and certain fees from earning assets, then subtracting the interest paid on deposits and other funding sources. This may be impacted by changes in volume and mix of earning assets, funding sources, deposits, interest rates, loan demand, and other market factors. Net interest income for 1998, on a fully taxable equivalent basis, was $3,865,000, an increase of $246,000 over 1997. For 1997, net interest income, on a fully taxable equivalent basis, increased $219,000 over 1996. Average balances and rates on major categories of interest earning assets and interest bearing liabilities appear in Table 1 on the following page. The effect on net interest income from changes in average balances ("volume") and yields, and rates ("rate") are quantified in Table 2 on the following page. As shown, net interest income improved in 1998 and 1997 generally due to volume increases in earning assets. Yields on assets were lower and rates on funding were slightly higher in 1998 than 1997, reflecting a decreasing interest rate environment, with customers moving to higher priced deposit products. Average yields on earning assets decreased to 8.15% in 1998 from 8.44% in 1997. Interest bearing liability rates increased to 4.48% in 1998 from 4.39% in 1997. Despite an increase in net interest income related primarily to an increase of 16.58% in average earning assets, net interest margin decreased by 42 basis points primarily related to a 29 basis point decline in the average rate on earning assets. PROVISION AND ALLOWANCE FOR LOAN LOSSES Provision for losses on loans is charged to operations based on management's evaluation of potential losses in the portfolio. Provision is based upon regular review of the level and trend of non-performing assets; loans 90 days past due, but not considered non-performing; charge-offs and recoveries; the mix of loans in the portfolio; and anticipated economic conditions. Based on positive trends in the Bank's portfolio in 1998 related to such factors, the provision for loan losses was ($23,000) in 1998. No provision was recorded in 1997 when a net recovery of $15,000 was achieved. Net charge-offs for 1998 totaled less than $500. This was preceded by five consecutive years of net recoveries. Excellent loan portfolio performance indicates a continued strong mid-Michigan business climate 2 5 MANAGEMENT'S DISCUSSION & ANALYSIS... (continued) and reflects attention to underwriting standards as well as consistent monitoring of the portfolio. Mason State Bank management rates the overall quality of the loan portfolio as good and concludes the $1,011,000 allowance or 1.23% allowance to total loans appropriate to cover inherent losses in the portfolio at year-end 1998. Non-performing loans are defined as all loans which are accounted for as non-accrual; loans 90 days or more past due and still accruing interest; or loans which have been renegotiated due to the borrowers' inability to comply with the original terms. As of December 31, 1998, non-performing loans totaled $373,000 or .46% of total loans. This represents an increase of $164,000
TABLE 1 1998 1997 1996 -------------------------------- -------------------------------- ------------------------------- (Dollars in INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE thousands) AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE* RATE* BALANCE EXPENSE* RATE* BALANCE EXPENSE* RATE* ------- -------- ----- ------- -------- ----- ------- -------- ----- Loans...... $ 69,172 $ 5,870 8.49% $ 54,870 $ 4,910 8.95% $ 49,507 $ 4,395 8.88% Other earning assets..... 16,633 1,120 6.73 18,733 1,303 6.96 21,521 1,448 6.73 ---------- -------- --------- -------- ---------- -------- Total earning assets..... 85,805 6,990 8.15 73,603 6,213 8.44 71,028 5,843 8.23 Other Assets..... 4,810 5,784 5,084 ---------- --------- ---------- TOTAL...... $ 90,615 $ 79,387 $ 76,112 ========== ========= ========== Interest bearing liabilities $ 69,717 $ 3,125 4.48% $ 59,070 $ 2,594 4.39% $ 57,578 $ 2,443 4.24% -------- ------- ------- Non interest bearing liabilities and equity..... 20,898 20,317 18,534 ---------- --------- ---------- TOTAL...... $ 90,615 $ 79,387 $ 76,112 ========== ========= ========== Net interest income..... $ 3,865 $ 3,619 $ 3,400 ======== ======== ======== Net interest margin on earning assets..... 4.50% 4.92% 4.79%
*Fully taxable equivalent basis.
TABLE 2 1998 COMPARED TO 1997 1997 COMPARED TO 1996 (In thousands) VOLUME RATE TOTAL VOLUME RATE TOTAL ------ ---- ----- ------ ---- ----- Change due to: Earning assets*.................................. $ 1,065 $ (288) $ 777 $ 299 $ 71 $ 370 Interest bearing liabilities..................... 569 (38) 531 145 6 151 --------- -------- ------- ---------- -------- ------- TOTAL NET INTEREST INCOME......................... $ 496 $ (250) $ 246 $ 154 $ 65 $ 219 ========= ======== ======= ========== ======== =======
*Fully taxable equivalent basis. 3 6 MANAGEMENT'S DISCUSSION & ANALYSIS... (continued) in non-performing loans from 1997 levels. Non-performing loans totaled .34% of total loans in 1997. This was a slight increase of $37,000 from the 1996 levels.
DECEMBER 31, 1998 1997 ---------- ---------- Non-accrual.................... $ 243,000 $ 48,000 90 days or more past due....... 130,000 161,000 Renegotiated................... -- -- ---------- ---------- TOTAL $ 373,000 $ 209,000 ========== ==========
A loan is considered impaired when full collection of principal and interest is not expected under the original terms of the loan. There were no impaired loans in the portfolio at December 31, 1998, 1997, or 1996. NON INTEREST INCOME Non interest income decreased slightly by $3,000 from the previous year. Investment commission fees as well as surcharges on foreign ATM transactions increased in 1998. These increases were offset by an increase in net losses on securities of $13,000 in 1998, a result of securities called prior to maturity. The change in non interest income from 1997 to 1996 was a decline of $215,000. This was largely the result of the closing of operations in December 1996 of Monex Investment Corporation. Excluding Monex, the $32,000 decrease in non interest income was primarily the result of decreased service charge income and decreased gains on the sale of loans. NON INTEREST EXPENSE Non interest expense increased $121,000 during 1998. This increase is a result of several factors, including increased salary and benefit costs, as well as data processing costs. In addition, premises and equipment costs increased in 1998 as a result of the completion of our new branch in Leslie, Michigan that opened in October 1998. Non interest expense decreased by $139,000 from 1996 to 1997. Excluding the expenses related to Monex in 1996, non interest expenses increased $83,000. These increases were related to decreased salary and benefit costs, which were offset by, increased director expenses, marketing expenses, and shareholder related expenses. INCOME TAX EXPENSE The 1998 provision for income tax was $548,000, up from $491,000 in 1997. The 1997 provision was up $57,000 from the $434,000 provision in 1996. This figure reflects a higher taxable income in 1998 and 1997. LIQUIDITY AND INTEREST RATE SENSITIVITY MANAGEMENT The primary objective of asset/liability management is to assure adequate liquidity and net interest income by maintaining appropriate maturities and balances between interest sensitive earning assets and interest bearing liabilities. Liquidity management insures sufficient funds are maintained to meet the cash withdrawal requirements of depositors and the credit demands of borrowers. Sources of liquidity include: federal funds sold, investment security maturities and pay downs. The Bank maintained an average balance of $2,487,000 in federal funds sold in 1998. The Bank is a member of the Federal Home Loan Bank system for several reasons: access to an alternative funding source, lower costs for credit services, and an alternative tool to manage interest rate risk. Throughout 1996, 1997, and 1998 the Bank used this source of funding (see Note 8) to directly offset loans of like terms and conditions. Other sources of liquidity include: internally generated cash flow, repayments and maturities of loans, other borrowings, and growth in core deposits. At December 31, 1998 the securities available for sale were valued at $5,320,000. It is not anticipated that management will use these funds due to the optional sources that may be available in 1999. Interest rate sensitivity management seeks to maximize net interest margins through periods of changing interest rates. The Bank develops strategies to assure that desired levels of interest sensitive assets and interest bearing liabilities mature or reprice within selected time frames. Strategies include the use of variable rate loan products as well as managing deposit accounts and maturities in the investment portfolio. The chart on the following page, using recommended regulatory standards, reflects "the rate sensitive position" or the difference between loans and investments, and liabilities that mature or reprice within the next year and beyond. The financial industry has generally referred to this difference as the "GAP" and its handling as "GAP Management." At year-end 1998, the percentage of rate sensitive assets to rate sensitive liabilities within the one-year time horizon was 86%. The chart on the following page shows the Bank's GAP position as of December 31, 1998. The Bank has a liability sensitive position within one year of approximately $5,532,000, which indicates higher net interest income may be earned if rates decrease during the period. Due to the limitations of GAP analysis, modeling is also used to enhance measurement and control. CAPITAL RESOURCES The adequacy of the Corporation's capital is reviewed regularly to ensure that sufficient capital is available to meet current and future funding needs and comply with regulatory requirements. Shareholders' equity, excluding the net unrealized gain on securities available for sale, increased $767,000 or 7.53% to $10,955,000 at year-end 1998, which represented 10.93% of total assets. At December 31, 1997, the similar ratio of shareholders' equity to total assets was 12.74%. Dividends declared per common share increased by 37.14% to $ .96 in 1998 compared to $.70 in 1997. The Corporation has a strong capital position that will meet our needs in 1999. Regulators established "risk-based" capital guidelines 4 7 MANAGEMENT'S DISCUSSION & ANALYSIS... (continued) that became effective December 31, 1990. Under the guidelines, minimum capital levels, which may include all or a portion of the allowance for loan losses, are based on the perceived risk in asset categories and certain off-balance-sheet items, such as loan commitments and standby letters of credit. On December 31, 1998, the Bank has a "risk-based" total capital to asset ratio of 17.68%. The ratio exceeds the requirements established by regulatory agencies as shown at right.
CAPITAL DECEMBER 31, 1998 (Dollars in thousands) RISK-BASED LEVERAGE ---------- ---------- Actual amount.................. $ 11,718 $ 10,887 Actual percentage.............. 17.7% 11.2% Required amount................ $ 5,303 $ 3,898 Required percent............... 8.0% 4.0% EXCESS AMOUNT $ 6,415 $ 6,989
GAP MEASUREMENT (Dollars in thousands)
0-30 31-90 2ND 3RD 4TH ANNUAL 1-3 3-5 OVER 5 DAYS DAYS QUARTER QUARTER QUARTER TOTAL YEARS YEARS YEARS TOTAL ---- ---- ------- ------- ------- ----- ----- ----- ------ ----- ASSETS Loans.......... $ 12,972 $ 4,536 $ 4,691 $ 3,986 $ 2,448 $ 28,633 $ 10,173 $ 13,256 $35,992 $88,054 Loan repayment offset -- -- -- -- -- -- -- -- -- -6,139 Allowance for loan losses.......... -- -- -- -- -- -- -- -- -- -1,011 Federal funds sold..... 600 -- -- -- -- 600 -- -- -- 600 Investments(1)... 1,912 158 2,700 200 1,191 6,161 3,168 1,384 3,070 13,783 Mortgage- backed repayments..... -- -- -- -- -- -- -- -- -- -1,400 Other non-earning assets -- -- -- -- -- -- -- -- -- 6,342 --------- -------- --------- --------- --------- -------- --------- --------- --------- --------- TOTAL $ 15,484 $ 4,694 $ 7,391 $ 4,186 $ 3,639 $ 35,394 $ 13,341 $ 14,640 $ 39,062 $ 100,229 ========= ======== ========= ========= ========= ======== ========= ========= ========= ========= LIABILITIES Non interest bearing deposits $ 383 $ 755 $ 1,241 $ 1,138 $ 1,138 $ 4,655 $ 2,586 $ 2,586 $ 461 $ 10,288 Interest bearing deposits....... 8,271 10,150 7,764 5,165 4,189 35,539 13,400 7,102 6,060 62,101 Long-term FHLB borrowings..... 23 65 500 -- 144 732 1,936 11,977 948 15,593 Other liabilities.... -- -- -- -- -- -- -- -- -- 1,250 Capital........ -- -- -- -- -- -- -- -- -- 10,997 --------- -------- --------- --------- --------- -------- --------- --------- --------- --------- TOTAL $ 8,677 $ 10,970 $ 9,505 $ 6,303 $ 5,471 $ 40,926 $ 17,922 $ 21,665 $ 7,469 $ 100,229 ========= ======== ========= ========= ========= ======== ========= ========= ========= ========= GAP............ $ 6,807 $- 6,276 $ - 2,114 $ - 2,117 $ - 1,832 $- 5,532 $ - 4,581 $ - 7,025 $ 31,593 Cumulative GAP. $ 6,807 $ 531 $ - 1,583 $ - 3,700 $ - 5,532 $- 5,532 $ -10,113 $ -17,138 $ 14,455 GAP ratio...... 178% 43% 78% 66% 67% 86% 74% 68% 523%
(1) Maturities reflect probable prepayments and calls. 5 8 MANAGEMENT'S DISCUSSION & ANALYSIS... (continued) Federal and State banking laws and regulations place certain restrictions on the amount of dividends and loans that a bank could pay its parent Corporation. Of the $11,718,000 in risk-based capital, $6,415,000 is available for dividends to the parent Corporation in 1999 (before considering 1999 net income and any changes in risk-based assets). The remaining $5,303,000 is restricted based on the minimum risk-based capital requirements now in effect. IMPACT OF INFLATION AND CHANGING PRICES The majority of assets and liabilities of the Corporation are monetary in nature and therefore the Corporation differs greatly from most commercial and industrial companies that have significant investments in fixed assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation significantly affects other expenses, which tend to rise during periods of general inflation. Management believes the most significant impact on financial results is the Corporation's ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities and actively manage the amount of securities available for sale in order to protect against the effects of wide interest rate fluctuations on net income and shareholders' equity. IMPACT OF YEAR 2000 COMPLIANCE The approach of the Year 2000 presents potential problems to businesses that utilize computer systems in their daily operations. Some computer systems may not be able to properly interpret dates after December 31, 1999, as they may use only two digits to indicate the year. Thus, a date using "00" as the year may be recognized as the year 1900 rather than the year 2000. Addressing the potential problem related to the year 2000 has been a top priority at Capital Directions, Inc. since 1997. At that time, a Year 2000 Plan was developed and a committee, consisting of officers and employees was formed which meets on a regular basis and provides regular reports to the Board of Directors on the status of the Bank's implementation. As outlined in the Plan, the scope of the Year 2000 project includes the compliance of all operating systems and hardware on all platforms in the areas of both information and non-information technology. The phases of this project include the assessment phase where we identify all software and hardware systems we anticipate running as of the Year 2000; the renovation phases where all systems affected by the Year 2000 issue are changed either through code enhancements, upgrades, or replacements; the validation phase where all changes made in the renovation phase and systems certified as Year 2000 compliant are tested to ensure compliance; and finally, the implementation phase where we continue to monitor the progress of certified systems through business use. Capital Directions expects to spend approximately $35,000 associated with the Year 2000; 20% of this amount is attributed to software and hardware upgrades, and 80% attributed to salaries. To date, 80% of the update costs have been expensed. The Corporation's earnings have been adequate to handle Year 2000 expenditures with no delay to other capital expenditures. It is difficult to predict exact expenses associated with the Year 2000 issue and additional funds may be needed for unknown expenses that may occur. We have successfully concluded the assessment phase of the project and fully expect the renovation of all systems to be complete by the first quarter of 1999. The validation of systems began in June of 1998 and is targeted for completion by June 1999. Our overall target for all phases of this project is no later than the third quarter of 1999; however, 90% of our mission critical systems were compliant by the end of 1998. The core processing system software is key to the continued operations of Capital Directions, Inc. The third-party provider of this system was certified as compliant at the time we entered into an agreement with them. While this system is certified as compliant, we have continued to perform numerous validation tests utilizing test dates in the Year 2000, including leap year. All testing will be complete by April 1999. The mainframe operating system software Year 2000 upgrade was installed prior to year-end 1998. Testing will be complete by the first quarter of 1999. We consider our PC-based loan document processing software to be key to loan processing. We purchased the Year 2000 upgrade for this software prior to year-end 1998; testing to be completed by the first quarter 1999. PC and network inventories were completed in July 1998. Testing of both hardware and software was completed at that time. Non-compliant PCs were either upgraded or replaced and have been retested. Word processing and spreadsheet software found to be non-compliant were brought into compliance in 1998. The network was upgraded to a certified Year 2000 compliant version and was tested prior to year-end 1998. We fully expect compliance of all PC-based hardware and software by first quarter of 1999. Included in the assessment phase of all operating systems was the inventorying of all environmental, non-information technology systems - those systems with embedded chips. The third-party vendors to those systems have all been contacted and to date, no Year 2000 concerns have arisen. 6 9 MANAGEMENT'S DISCUSSION & ANALYSIS... (continued) In conjunction with the implementation of the Plan noted above, all information and non-information systems (hardware, software, and environmental) vendors have been assigned risk factors based on the current validation status of their service or product, their responsiveness to Year 2000 issues, company history, and financial strength. All vendors in this analysis have been found to be "on target" with their plans and at the present time we have no known material concerns to report. All customers that have a borrowing or deposit relationship in excess of $250,000 have also been interviewed and an evaluation of their Year 2000 preparedness has been completed. Most material customers are progressing satisfactory with their Year 2000 plans. The Corporation does not expect to experience credit deterioration due to the Year 2000 issue. The Corporation may face a liquidity risk if the public perceives liquidity risk involved with the Year 2000 and withdraws funds from the banking system. The Corporation has established lines of credit to handle this uncertainty. Despite careful planning, we recognize there may be circumstances beyond our control that may prohibit us from operating "as usual" after December 31, 1999. As such, for each mission critical system within the Corporation we have developed contingency plans. These contingency plans will provide us with directions should any of these systems fail after the Year 2000. Contingency plans will continue to be revised as testing of each system is completed and implementation takes place. REPORT OF INDEPENDENT AUDITORS [LOGO CROWE CHIZEK] Board of Directors and Shareholders Capital Directions, Inc. Mason, Michigan We have audited the accompanying consolidated balance sheets of Capital Directions, Inc. as of December 31, 1998 and 1997 and the related consolidated statements of income, changes in shareholders' equity and cash flows for the years ended December 31, 1998, 1997 and 1996. 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 the 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Capital Directions, Inc. as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the years ended December 31, 1998, 1997 and 1996 in conformity with generally accepted accounting principles. /s/ Crowe, Chizek and Company LLP ----------------------------------- Crowe, Chizek and Company LLP Grand Rapids, Michigan February 4, 1999 7 10 CAPITAL DIRECTIONS, INC. CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) DECEMBER 31, 1998 1997 ASSETS Cash and non interest bearing deposits.......................................................... $ 2,695 $ 2,000 Interest bearing deposits....................................................................... 26 188 Federal funds sold.............................................................................. 600 -- --------- ---------- Total cash and cash equivalents......................................................... 3,321 2,188 Securities available for sale................................................................... 5,320 6,271 Securities held to maturity (fair value of $6,484 in 1998 and $7,705 in 1997)................... 6,276 7,483 Federal Home Loan Bank (FHLB) stock............................................................. 787 364 Total loans..................................................................................... 81,915 61,334 Less allowance for loan losses.................................................................. (1,011) (1,035) --------- ---------- Net loans............................................................................... 80,904 60,299 Premises and equipment, net..................................................................... 784 618 Accrued interest receivable..................................................................... 509 544 Other assets.................................................................................... 2,328 2,190 --------- ---------- TOTAL ASSETS $ 100,229 $ 79,957 ========= ========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits Non interest bearing.......................................................................... $ 10,288 $ 8,322 Interest bearing.............................................................................. 62,101 56,099 --------- ---------- Total deposits.......................................................................... 72,389 64,421 Accrued interest payable....................................................................... 232 193 Other liabilities.............................................................................. 1,018 1,007 Federal funds purchased........................................................................ -- 450 Long-term FHLB borrowings...................................................................... 15,593 3,670 --------- ---------- Total liabilities....................................................................... 89,232 69,741 SHAREHOLDERS' EQUITY Common stock: $5 par value, 1,300,000 shares authorized; 595,123 and 595,056 shares outstanding in 1998 and 1997........................................ 2,976 2,975 Additional paid-in capital..................................................................... 2,561 2,561 Retained earnings.............................................................................. 5,418 4,652 Net unrealized gain on securities available for sale, net of tax of $22 in 1998 and $14 in 1997................................................................................ 42 28 --------- ---------- Total shareholders' equity.............................................................. 10,997 10,216 --------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 100,229 $ 79,957 ========= ==========
See accompanying notes to consolidated financial statements. 8 11 CAPITAL DIRECTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data) YEARS ENDED DECEMBER 31, 1998 1997 1996 INTEREST AND DIVIDEND INCOME Loans, including fees............................................................ $ 5,870 $ 4,910 $ 4,395 Federal funds sold............................................................... 134 68 115 Securities: Taxable - available for sale......................................... 422 552 621 Taxable - held to maturity........................................... 188 295 269 Tax exempt - held to maturity........................................ 214 236 260 Dividends on FHLB stock.......................................................... 45 29 29 Other interest income............................................................ 7 2 20 --------- --------- ---------- TOTAL INTEREST AND DIVIDEND INCOME 6,880 6,092 5,709 INTEREST EXPENSE Deposits......................................................................... 2,472 2,375 2,314 Federal funds purchased.......................................................... 1 12 1 Long-term FHLB borrowings........................................................ 652 207 128 --------- --------- ---------- TOTAL INTEREST EXPENSE 3,125 2,594 2,443 --------- --------- ---------- NET INTEREST INCOME............................................................... 3,755 3,498 3,266 Provision for loan losses......................................................... (23) -- -- --------- --------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,778 3,498 3,266 NON INTEREST INCOME Service charges on deposits...................................................... 260 260 271 Merchant charge card fees........................................................ 23 27 25 Net gain (loss) on securities.................................................... (18) (5) 6 Net gain on sales of loans....................................................... 3 7 37 Investment commission fees....................................................... 47 14 197 Other income..................................................................... 250 265 247 --------- --------- ---------- TOTAL NON INTEREST INCOME 565 568 783 NON INTEREST EXPENSE Salaries and wages............................................................... 1,101 1,048 1,175 Pension and other employee benefits.............................................. 325 314 269 Net occupancy expense of premises................................................ 144 139 155 Equipment rentals, depreciation, and maintenance................................. 162 194 208 Other operating expense.......................................................... 729 645 672 --------- --------- ---------- TOTAL NON INTEREST EXPENSE 2,461 2,340 2,479 --------- --------- ---------- INCOME BEFORE INCOME TAX EXPENSE.................................................. 1,882 1,726 1,570 Income tax expense............................................................... 548 491 434 --------- --------- ---------- NET INCOME $ 1,334 $ 1,235 $ 1,136 ========= ========= ========== BASIC EARNINGS PER COMMON SHARE $ 2.24 $ 2.08 $ 1.91 ========= ========= ========== DILUTED EARNINGS PER COMMON SHARE $ 2.22 $ 2.07 $ 1.90 ========= ========= ==========
See accompanying notes to consolidated financial statements. 9 12 CAPITAL DIRECTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) YEARS ENDED DECEMBER 31, 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES Net income....................................................................... $ 1,334 $ 1,235 $ 1,136 Adjustments to reconcile net income to net cash from operating activities Depreciation.................................................................... 120 120 114 Provision for loan losses....................................................... (23) -- -- Net amortization/(accretion) on securities...................................... (14) 52 83 Loans originated for sale....................................................... (1,051) -- (288) Proceeds from sales of loans originated for sale................................ 1,053 -- 290 Net (gain) loss on securities................................................... 18 5 (6) Net gain on sales of loans originated for sale.................................. (2) -- (2) Net gain on sales of non-residential loans...................................... (1) (7) (35) Changes in assets and liabilities: Accrued interest receivable.................. 35 (42) (9) Accrued interest payable..................... 39 (2) (12) Other assets................................. (146) (82) 65 Other liabilities............................ (36) 77 (49) --------- --------- ---------- NET CASH FROM OPERATING ACTIVITIES 1,326 1,356 1,287 CASH FLOWS FROM INVESTING ACTIVITIES Securities available for sale: Purchases....................................... (6,437) (1,446) (4,328) Maturities, calls, and principal payments....... 7,408 3,548 2,382 Sales .......................................... -- 1,674 -- Securities held to maturity: Purchases....................................... (1,246) (180) (4,236) Maturities, calls, and principal payments....... 2,451 1,719 2,535 Purchase of FHLB stock........................................................... (423) -- -- Cash management funds, net sales................................................. -- -- 138 Proceeds from sales of non-residential loans..................................... 68 188 1,099 Net change in loans.............................................................. (20,649) (9,708) (3,147) Premises and equipment expenditures.............................................. (286) (171) (32) --------- --------- ---------- NET CASH FROM INVESTING ACTIVITIES (19,114) (4,376) (5,589) CASH FLOWS FROM FINANCING ACTIVITIES Net change in deposits........................................................... 7,968 (2,088) 301 Net change in federal funds purchased............................................ (450) 450 -- Proceeds from long-term FHLB borrowings.......................................... 12,150 2,000 262 Repayment of long-term FHLB borrowings........................................... (227) (243) (229) Proceeds from shares issued upon exercise of stock options....................... 1 3 -- Dividends paid................................................................... (521) (391) (330) --------- --------- ---------- NET CASH FROM FINANCING ACTIVITIES 18,921 (269) 4 --------- --------- ---------- Net change in cash and cash equivalents........................................... 1,133 (3,289) (4,298) Cash and cash equivalents at beginning of year.................................... 2,188 5,477 9,775 --------- --------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,321 $ 2,188 $ 5,477 ========= ========= ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest.......................................... $ 3,086 $ 2,596 $ 2,455 Income taxes - federal............................ 571 524 529
See accompanying notes to consolidated financial statements. 13 CAPITAL DIRECTIONS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except share and per share data) NET UNREALIZED GAIN ON SECURITIES TOTAL ADDITIONAL AVAILABLE SHARE- COMMON PAID-IN RETAINED FOR SALE, HOLDERS' YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 STOCK CAPITAL EARNINGS NET OF TAX EQUITY -------- ---------- -------- ---------- -------- BALANCES, JANUARY 1, 1996 $ 1,487 $ 2,559 $ 4,522 $ 26 $ 8,594 Net income for the year ....................... -- -- 1,136 -- 1,136 Other comprehensive income, net: Net change in unrealized gain on securities available for sale, net of tax of $4 ......... -- -- -- 6 6 -------- Comprehensive income .......................... 1,142 Cash dividends ($.57 per share) ............... -- -- (339) -- (339) -------- -------- -------- -------- -------- BALANCES, DECEMBER 31, 1996 1,487 2,559 5,319 32 9,397 Net income for the year ....................... -- -- 1,235 -- 1,235 Other comprehensive income, net: Net change in unrealized gain on securities available for sale, net of tax of ($3) ....... -- -- -- (4) (4) -------- Comprehensive income .......................... 1,231 Issuance of 100 shares of common stock upon exercise of stock options ............... 1 2 -- -- 3 Issuance of 297,528 shares of common stock for two-for-one stock split .................. 1,487 -- (1,487) -- -- Cash dividends ($.70 per share) ............... -- -- (415) -- (415) -------- -------- -------- -------- -------- BALANCES, DECEMBER 31, 1997 2,975 2,561 4,652 28 10,216 Net income for the year ....................... -- -- 1,334 -- 1,334 Other comprehensive income, net: Net change in unrealized gain on securities available for sale, net of tax of $8 ......... -- -- -- 14 14 -------- Comprehensive income .......................... 1,348 Issuance of 67 shares of common stock upon exercise of stock options ............... 1 -- -- -- 1 Cash dividends ($.955 per share) .............. (568) (568) -------- -------- -------- -------- -------- BALANCES, DECEMBER 31, 1998 $ 2,976 $ 2,561 $ 5,418 $ 42 $ 10,997 ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 11 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DECEMBER 31, 1998, 1997, AND 1996) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF REPORTING: Capital Directions, Inc. (the "Company") is a holding company whose wholly-owned subsidiaries include Mason State Bank (the "Bank") and Monex Financial Services, Inc. ("Monex"). Lakeside Insurance Agency is a wholly-owned subsidiary of the Bank. The accounting policies of the Company and its subsidiaries conform with generally accepted accounting principles and prevailing practices within the banking and securities industry. The accrual basis of accounting is followed for all major items in the preparation of the consolidated financial statements. All material intercompany balances and transactions are eliminated in consolidation. NATURE OF OPERATIONS AND LINES OF BUSINESS: The Company and its subsidiaries provide a broad range of banking and financial services in the banking industry. Substantially all revenues and services are derived from banking products and services. The Bank operates predominantly in Central Michigan as a commercial bank. The Bank's primary services include accepting retail deposits and making residential, consumer, and commercial loans. CONCENTRATION OF CREDIT RISK: The Company grants loans to and accepts deposits from customers located primarily in its delineated community. The Company also invests in securities issued by local governmental units. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. Actual results could differ from those estimates. The allowance for loan losses and fair values of securities and other financial instruments are particularly susceptible to change in the near term. SECURITIES: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs, or other factors. Securities classified as available for sale are reported at their fair value and the unrealized holding gain or loss is reported, net of related income tax effects, as a separate component of other comprehensive income and shareholders' equity, until realized. Securities are written down to fair value when a decline in fair value is not temporary. Gains and losses resulting from the sale of securities are computed by the specific identification method. Premium amortization is deducted from, and discount accretion is added to, interest income from securities using the level-yield method. LOANS HELD FOR SALE: Loans held for sale are reported at the lower of cost or market value in the aggregate. LOANS: Loans are reported at the principal balance outstanding, net of deferred loan fees and costs, the allowance for loan losses, and charge-offs. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. When full loan repayment is in doubt, interest income is not reported. Payments received on such loans are reported as principal reductions. ALLOWANCE FOR LOAN LOSSES: Because some loans may not be repaid in full, an allowance for loan losses is recorded. Increases to the allowance are recorded by a provision for loan losses charged to expense. Estimating the risk of the loss and amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on its regular review of nonperforming assets, as well as loans 90 days or more past due but not considered nonperforming, charge-offs and recoveries, growth and portfolio mix of loans, general economic conditions, and other factors and estimates which are subject to change over time. While management may periodically allocate portions of the allowance for specific problem loan situations, the whole allowance is available for any loan charge-offs that occur. A loan is charged-off against the allowance by management as a loss when deemed uncollectible, although collection efforts may continue and future recoveries may occur. Loan impairment is reported when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of the collateral if repayment is expected solely from collateral. Loans totaling $75,000 or more are evaluated for impairment when payments are delayed, typically 90 days or more, or when it is probable that all principal and interest will not be collected according to the original terms of the loan. 12 15 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PREMISES AND EQUIPMENT: Asset cost is reported net of accumulated depreciation. Depreciation expense is calculated on both accelerated and straight-line methods over asset useful lives. These assets are reviewed for impairment when events indicate the carrying amount may not be recoverable. OTHER REAL ESTATE: Real estate acquired in settlement of loans is initially reported at estimated fair value at acquisition. After acquisition, a valuation allowance reduces the reported amount to the lower of the initial amount or fair value less costs to sell. Expenses, gains and losses on disposition, and changes in the valuation allowance are reported in other operating expense. There were no properties held as other real estate at December 31, 1998 and 1997. STOCK OPTIONS: No expense for stock options is recorded, as the grant price approximates the market price of the stock at the date of grant. Proforma disclosures in a separate note shows the effect on net income and earnings per common share had the options' fair value been recorded using an option pricing model. INCOME TAXES: Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are computed based on the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. CASH FLOW REPORTING: Cash and cash equivalents are defined to include cash on hand, non interest bearing deposits in other institutions, short-term interest bearing deposits in other institutions, and federal funds sold. Customer loan and deposit transactions, cash management funds, long-term interest bearing deposits made with other financial institutions, and short-term borrowings with an original maturity of 90 days or less are reported on a net cash flow basis. EARNINGS AND DIVIDENDS PER COMMON SHARE: Basic earnings per common share is based on net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share shows the dilutive effect of any additional potential common shares. Earnings and dividends per common share are restated for all stock splits and stock dividends, including the December 1, 1997 two-for-one stock split. COMPREHENSIVE INCOME: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, net of tax, which are also recognized as a separate component of shareholders' equity. The accounting standard that requires reporting comprehensive income first applies for 1998, with prior information restated to be comparable. NEW ACCOUNTING PRONOUNCEMENTS: Beginning January 1, 2000, a new accounting standard will require all derivatives to be recorded at fair value. Unless designated as hedges, changes in these fair values will be recorded in the income statement. Fair value changes involving hedges will generally be recorded by offsetting gains and losses on the hedge and on the hedged item, even if the fair value of the hedged item is not otherwise recorded. This is not expected to have a material effect but the effect will depend on derivative holdings when this standard applies. Mortgage loans originated in mortgage banking are converted into securities on occasion. A new accounting standard for 1999 will allow classifying these securities as available for sale, trading, or held to maturity, instead of the current requirement to classify as trading. This is not expected to have a material effect but the effect will vary depending on the level and designation of securitizations as well as on market price movements. RECLASSIFICATIONS: Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform with the 1998 presentation. NOTE 2 - RESTRICTIONS ON CASH AND NON INTEREST BEARING DEPOSITS To satisfy legal reserve and clearing requirements, non interest bearing balances are required to be maintained as deposits with the Federal Reserve or as cash on hand. The total required reserve and clearing balances were $424,000 and $402,000 at year-end 1998 and 1997, respectively. 13 16 NOTE 3 - SECURITIES Year-end securities were as follows:
(In thousands) GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- --------- ---------- ------- AVAILABLE FOR SALE 1998 Obligations of U.S. Government agencies ........ $ 1,520 $ 16 $ -- $ 1,536 Obligations of states and political subdivisions 501 8 -- 509 Corporate securities ........................... 3,235 40 -- 3,275 ------- ------- ------- ------- $ 5,256 $ 64 $ -- $ 5,320 ======= ======= ======= ======= 1997 Obligations of U.S. Government agencies ........ $ 3,490 $ 22 $ (15) $ 3,497 Corporate securities ........................... 2,739 35 -- 2,774 ------- ------- ------- ------- $ 6,229 $ 57 $ (15) $ 6,271 ======= ======= ======= ======= HELD TO MATURITY 1998 Obligations of U.S. Government agencies ........ $ 1,798 $ 49 $ -- $ 1,847 Obligations of states and political subdivisions 4,478 159 -- 4,637 ------- ------- ------- ------- $ 6,276 $ 208 $ -- $ 6,484 ======= ======= ======= ======= 1997 Obligations of U.S. Government agencies ........ $ 2,908 $ 71 $ -- $ 2,979 Obligations of states and political subdivisions 4,539 151 -- 4,690 Collateralized mortgage obligations ............ 36 -- -- 36 ------- ------- ------- ------- $ 7,483 $ 222 $ -- $ 7,705 ======= ======= ======= =======
The amortized cost and fair values of securities at year-end 1998 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
(In thousands) AVAILABLE FOR SALE HELD TO MATURITY -------------------- -------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- ------ --------- ------ Due in one year or less ..................... $1,840 $1,850 $1,265 $1,270 Due from one to five years .................. 2,395 2,435 1,124 1,155 Due from five to ten years .................. -- -- 1,090 1,144 Due after ten years ......................... -- -- 999 1,068 ------ ------ ------ ------ $4,235 $4,285 $4,478 $4,637 U.S. Government mortgage-backed securities Fixed rate ................................. 572 577 1,485 1,520 Variable rate .............................. 449 458 313 327 ------ ------ ------ ------ TOTALS $5,256 $5,320 $6,276 $6,484 ====== ====== ====== ======
During 1998 and 1997 there were no sales or purchases of mutual funds. Net sales of mutual funds were $138,000 in 1996. No gains or losses were realized on mutual fund sales in 1998, 1997, or 1996. There were no sales of securities in 1998. Net losses on calls of securities totaled $18,000 in 1998. During 1997, $1,674,000 of securities classified as available for sale were sold at a gross gain of $29,000 and a gross loss of $2,000. Net losses on calls of securities totaled $32,000 in 1997. In 1996, $324,000 of securities classified as held to maturity were sold under the safe harbor provision rules of SFAS No. 115. Gross gains of $6,000 were realized on these sales. For purposes of the Consolidated Statements of Cash Flows, these sales have been included as part of the maturities of securities held to maturity. Securities with a carrying value of approximately $1,927,000 and $1,863,000 at year-end 1998 and 1997 were pledged to secure public deposits, and for other purposes as required or permitted by law. Additional securities are pledged as collateral to secure FHLB borrowings as disclosed in a separate note. 14 17 NOTE 4 - LOANS Year-end loans were as follows:
(In thousands) 1998 1997 ------- ------- Commercial and agricultural . $ 5,547 $ 4,241 Real estate mortgage ........ 73,000 53,492 Installment ................. 3,368 3,601 ------- ------- TOTAL $81,915 $61,334 ======= =======
Certain directors, executive officers, and principal shareholders of the Company, including associates of such persons, were loan customers of the Company. A summary of activity related to these loans follows:
(In thousands) 1998 1997 ----- ----- Balance, January 1 .......... $ 609 $ 590 New loans ................... 419 100 Repayments .................. (398) (73) Other changes, net .......... -- (8) ----- ----- BALANCE, DECEMBER 31 $ 630 $ 609 ===== =====
Other changes include adjustments for loans applicable to one reporting period that are excludable from the other reporting period. NOTE 5 - ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses was as follows:
(In thousands) 1998 1997 1996 ------- ------- ------- Balance, beginning of period ..... $ 1,035 $ 1,020 $ 995 Loans charged-off ................ (30) (26) (68) Recoveries ....................... 29 41 93 Provision for loan losses ........ (23) -- -- ------- ------- ------- BALANCE, END OF PERIOD $ 1,011 $ 1,035 $ 1,020 ======= ======= =======
During 1998, 1997, and 1996, the Company had no loans which were considered impaired. NOTE 6 - PREMISES AND EQUIPMENT, NET Year-end premises and equipment were as follows:
(In thousands) 1998 1997 ------- ------- Land ............................. $ 86 $ 86 Buildings and improvements ....... 1,062 914 Furniture and equipment .......... 2,369 2,237 ------- ------- TOTAL COST 3,517 3,237 Less accumulated depreciation .... (2,733) (2,619) ------- ------- PREMISES AND EQUIPMENT, NET $ 784 $ 618 ======= =======
15 18 NOTE 7 - INTEREST BEARING DEPOSITS Year-end interest bearing deposits were as follows:
(In thousands) 1998 1997 ------- ------- Interest bearing demand .............. $11,934 $ 9,976 Savings .............................. 18,201 16,008 Time In denominations less than $100,000 . 20,689 20,837 In denominations of $100,000 or more 11,277 9,278 ------- ------- TOTAL $62,101 $56,099 ======= =======
At year-end 1998, stated maturities of time deposits were as follows: (In thousands) 1999.......... $ 21,278 2000.......... 5,279 2001.......... 2,698 2002.......... 2,256 2003.......... 455 -------- TOTAL $ 31,966 ========
Related party deposits totaled approximately $1,283,000 and $267,000 at year-end 1998 and 1997. NOTE 8 - LONG-TERM FEDERAL HOME LOAN BANK (FHLB) BORROWINGS At year-end, advances from the Federal Home Loan Bank were as follows:
(In thousands) 1998 1997 ------- ------- Maturities May 1999 through January 2003, primarily fixed rate at rates from 5.67% to 6.72%, averaging 6.41% in 1998 and 6.39% in 1997 $ 3,443 $ 3,670 Maturities January 2003 through November 2008, primarily fixed rate at rates from 4.86% to 6.02%, averaging 5.66% ......................... 12,150 -- ------- ------- TOTAL $15,593 $ 3,670 ======= =======
Each advance has a prepayment penalty which is determined based upon the lost cash flow to the FHLB. In addition to FHLB stock, the advances were collateralized by approximately $58,082,000 of first mortgage loans and securities under a blanket lien arrangement at year-end 1998 and approximately $4,588,000 of securities at year-end 1997. At year-end 1998, scheduled principal reductions on these advances were: (In thousands) 1999............. $ 732 2000............. 1,222 2001............. 714 2002............. 723 2003............. 11,254 Thereafter....... 948 -------- TOTAL $ 15,593 ========
16 19 NOTE 9 - BENEFIT PLANS A retirement and savings plan has been established for all full-time employees. Annual matching contributions are made based on a percentage of participants' compensation plus a discretionary amount determined by the Board of Directors. The expense for the plan was approximately $43,000 in 1998, 1997, and 1996. An incentive compensation plan is also maintained for certain employees and is based upon key performance factors. The expense for the plan was approximately $47,000 in 1998, $42,000 in 1997, and $37,000 in 1996. An incentive stock option plan was approved in 1994 to provide officers and other key employees an opportunity to acquire a proprietary interest in the Company with an incentive to their continued employment and efforts to promote the Company's success. Under the plan, up to 40,000 unauthorized and newly issued shares of common stock may be issued upon exercise of stock options granted under the plan. The plan provides for stock options to be granted at prices that approximate the fair value of the stock at the respective dates of grant. Accordingly, no compensation cost for stock options was recognized in 1998, 1997, and 1996. The vesting of stock options does not start until two years from the date of grant. After two years, the options will vest evenly over a three year period. The plan terminates on May 20, 2003. All shares and per share amounts have been restated for stock splits. A summary of activity in the plan is as follows:
WEIGHTED WEIGHTED AVERAGE AVERAGE AVAILABLE OPTIONS EXERCISE GRANT DATE FOR GRANT OUTSTANDING PRICE FAIR VALUE --------- ----------- -------- ---------- Balance at January 1, 1996 ....... 36,000 4,000 $12.75 Granted .......................... (4,000) 4,000 18.00 $ 1.70 ------ ------ ------ Balance December 31, 1996 ........ 32,000 8,000 15.38 Granted .......................... (4,000) 4,000 21.88 2.17 Exercised ........................ -- (200) 12.75 Forfeited ........................ 400 (400) 12.75 ------ ------ ------ Balance December 31, 1997 ........ 28,400 11,400 17.80 Granted .......................... (4,400) 4,400 32.00 3.21 Exercised ........................ -- (67) 18.00 Cancelled ........................ 66 (66) 18.00 Forfeited ........................ 867 (867) 24.19 ------ ------ ------ BALANCE DECEMBER 31, 1998 24,933 14,800 $21.64 ====== ====== ======
For the options outstanding at December 31, 1998, the range of exercise prices was $12.75 to $32.00 per share with a weighted average remaining contractual life of 7.8 years. At December 31, 1998 and 1997, 3,466 and 1,133 options were exercisable at a weighted average price of $14.57 and $12.75 per share, respectively. No options were exercisable at December 31, 1996. Had compensation cost for stock options been measured using FASB Statement No. 123, net income and earnings per share would have been the pro forma amounts indicated below. The pro forma effect may increase in the future if more options are granted.
(In thousands, except per share data) 1998 1997 1996 ------- ------- ------- Net income as reported ............... $ 1,334 $ 1,235 $ 1,136 Pro forma net income ................. 1,327 1,231 1,134 Basic earnings per share as reported . 2.24 2.08 1.91 Pro forma basic earnings per share ... 2.23 2.07 1.91 Diluted earnings per share as reported 2.22 2.07 1.90 Pro forma diluted earnings per share . 2.21 2.06 1.90
17 20 NOTE 9 - BENEFIT PLANS (CONTINUED) The pro forma effects are computed using option pricing models, using the following weighted average assumptions as of the grant date.
1998 1997 1996 ------- ------- ------- Risk-free interest rate ....... 5.47% 6.17% 5.23% Expected option life .......... 5 YEARS 5 years 5 years Expected stock price volatility 7.57% 7.57% 7.57% Dividend yield ................ 3.56% 4.19% 3.55%
A deferred compensation plan has been adopted to provide retirement benefits to the directors, at their option, in lieu of annual directors' fees. The present value of future benefits are accrued annually over the period of active service of each participant. The expense for the plan was $104,000 in 1998, $85,000 in 1997, and $105,000 in 1996. Insurance on the lives of the participants has also been purchased with the Bank as owner and beneficiary of the policies. NOTE 10 - OTHER OPERATING EXPENSE Other operating expense consists of:
(In thousands) 1998 1997 1996 ---- ---- ---- Supplies ............... $ 54 $ 53 $ 51 State taxes ............ 65 66 68 Deferred compensation .. 104 85 105 Other expense .......... 506 441 448 ---- ---- ---- TOTAL $729 $645 $672 ==== ==== ====
NOTE 11 - INCOME TAX Income tax expense consists of:
(In thousands) 1998 1997 1996 ----- ----- ----- Taxes currently payable . $ 602 $ 517 $ 477 Deferred benefit ........ (54) (26) (43) ----- ----- ----- TOTAL $ 548 $ 491 $ 434 ===== ===== =====
Year-end deferred tax assets and liabilities consist of:
(In thousands) 1998 1997 1996 ----- ----- ----- Deferred tax assets Allowance for loan losses ........................... $ 222 $ 230 $ 230 Deferred compensation ............................... 301 299 273 Deferred loan fees .................................. 2 5 7 Other ............................................... 2 3 4 ----- ----- ----- 527 537 514 Deferred tax liabilities Fixed assets ........................................ (37) (37) (40) Net unrealized gain on securities available for sale (22) (14) (17) Deferred gain on installment sale ................... -- (43) (45) Other ............................................... (6) (27) (25) ----- ----- ----- (65) (121) (127) ----- ----- ----- TOTAL $ 462 $ 416 $ 387 ===== ===== =====
18 21 NOTE 11 - INCOME TAX (CONTINUED) An allowance against deferred tax assets has not been recorded for 1998, 1997, or 1996. The difference between the financial statement income tax expense and the amounts computed by applying the federal income tax rate to pretax income is reconciled as follows:
(In thousands) 1998 1997 1996 ----- ----- ----- Statutory rate ........................ 34% 34% 34% Income tax computed at statutory rate . $ 640 $ 587 $ 534 Tax effect of Nontaxable income .................... (70) (72) (78) Other ................................ (22) (24) (22) ----- ----- ----- TOTAL $ 548 $ 491 $ 434 ===== ===== =====
NOTE 12 - EARNINGS PER COMMON SHARE A reconciliation of the numerators and denominators of the basic earnings per common share and diluted earnings per common share computations for the years ended is presented below:
(In thousands, except per share data) 1998 1997 1996 ------ ------ ------ Basic earnings per common share: Net income available to common shareholders .................... $1,334 $1,235 $1,136 Weighted average common shares outstanding ..................... 595 595 595 ------ ------ ------ BASIC EARNINGS PER COMMON SHARE $ 2.24 $ 2.08 $ 1.91 ====== ====== ====== Diluted earnings per common share: Net income available to common shareholders .................... $1,334 $1,235 $1,136 Weighted average common shares outstanding for basic earnings per common share .............................................. 595 595 595 Add: dilutive effect of assumed exercise of stock options ...... 5 3 2 ------ ------ ------ Weighted average common shares outstanding for diluted earnings per common share .............................................. 600 598 597 ------ ------ ------ DILUTED EARNINGS PER COMMON SHARE $ 2.22 $ 2.07 $ 1.90 ====== ====== ======
Stock options for 4,100 shares of common stock were not considered in computing diluted earnings per common share for 1998 because they were antidilutive. NOTE 13 - OTHER COMPREHENSIVE INCOME Other comprehensive components and related taxes were as follows:
(In thousands) 1998 1997 1996 ---- ---- ---- Net change in unrealized gain (loss) on securities available for sale Unrealized gain (loss) on securities available for sale ............... $ 4 $(12) $ 16 Reclassification adjustments for (gains) losses included in net income 18 5 (6) ---- ---- ---- Net change in unrealized gain (loss) on securities available for sale . 22 (7) 10 Tax effects ............................................................ (8) 3 (4) ---- ---- ---- TOTAL OTHER COMPREHENSIVE INCOME, NET $ 14 $ (4) $ 6 ==== ==== ====
19 22 NOTE 14 - COMMITMENTS AND CONTINGENCIES Periodically, in the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit and guarantees, which are not reflected in the accompanying consolidated financial statements. The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unused lines of credit, commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The same credit policy to make commitments is followed for those loans recorded in the consolidated financial statements. The contract amounts of these financial instruments are as follows at year-end:
(In thousands) 1998 1997 Unused lines of credit .. ................................. $7,216 $6,227 Commitments to make loans ................................. 752 342 Standby letters of credit ................................. 479 269
Commitments are generally made at variable rates, primarily tied to NBD's prime rate, with maximum commitment periods generally around 365 days. Since many of the commitments to make loans expire without being used, the amount does not necessarily represent future cash commitments. Collateral obtained upon the exercise of the commitments is determined using management's credit evaluation of the borrower and may include real estate, vehicles, business assets, deposits, and other items. In management's opinion, these commitments represent normal banking transactions and no material losses are expected to result. NOTE 15 - REGULATORY MATTERS The Bank is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the consolidated financial statements. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The minimum requirements are:
TIER 1 CAPITAL TO CAPITAL TO RISK-WEIGHTED ASSETS AVERAGE TOTAL TIER 1 ASSETS Well capitalized............................ 10% 6% 5% Adequately capitalized...................... 8 4 4 Undercapitalized............................ 6 3 3
20 23 NOTE 15 - REGULATORY MATTERS (CONTINUED) At year-end, Bank actual capital levels and minimum required levels were:
(Dollars in thousands) MINIMUM REQUIRED TO BE MINIMUM REQUIRED WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO 1998 Total capital (to risk weighted assets) ....... $11,718 17.7% $5,303 8.0% $6,628 10.0% Tier 1 capital (to risk weighted assets) ....... 10,887 16.4 2,651 4.0 3,977 6.0 Tier 1 capital (to average assets) 10,887 11.2 3,898 4.0 4,873 5.0 1997 Total capital (to risk weighted assets) ....... $10,799 19.7% $4,375 8.0% $5,468 10.0% Tier 1 capital (to risk weighted assets) ....... 10,111 18.5 2,187 4.0 3,281 6.0 Tier 1 capital (to average assets) 10,111 12.6 3,213 4.0 4,017 5.0
The Bank was considered well capitalized at year-end 1998 and 1997. Federal and state banking laws and regulations place certain restrictions on the amount of dividends and loans a bank can pay to its parent company. Under the most restrictive of these regulations, as of year-end 1998, the Bank could pay approximately $6,415,000 in dividends to the parent company without prior regulatory approval. NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate fair values for financial instruments. The carrying amount is considered to estimate fair values for cash and cash equivalents, demand and savings deposits, short-term borrowings, accrued interest, FHLB stock, and variable rate loans or deposits that reprice frequently and fully. Securities fair values are based on quoted market prices or, if no quotes are available, on the rate and term of the security and on information about the issuer. For fixed rate loans or time deposits and for variable rate loans or time deposits with infrequent repricing or repricing limits, the fair value is estimated by discounted cash flow analysis using current market rates for the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. Fair value of loans held for sale is based on market estimates. The fair value of debt is based on currently available rates for similar financing. The fair value of off-balance-sheet items is based on the fees or costs that would currently be charged to enter into or terminate such arrangements and are not material to this presentation. The estimated year-end fair values of financial instruments were as follows:
(In thousands) 1998 1997 CARRYING ESTIMATED CARRYING ESTIMATED VALUE FAIR VALUE VALUE FAIR VALUE Financial assets Cash and cash equivalents ............... $ 3,321 $ 3,321 $ 2,188 $ 2,188 Securities available for sale ........... 5,320 5,320 6,271 6,271 Securities held to maturity ............. 6,276 6,484 7,483 7,705 FHLB stock .............................. 787 787 364 364 Loans, net of allowance for loan losses.. 80,904 82,211 60,299 61,162 Accrued interest receivable ............. 509 509 544 544 Financial liabilities Deposits ................................ (72,389) (72,680) (64,421) (64,597) Federal funds purchased ................. -- -- (450) (450) Long-term FHLB borrowings ............... (15,593) (15,824) (3,670) (3,704) Accrued interest payable ................ (232) (232) (193) (193)
21 24 NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) While these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of such items at year-end 1998 or 1997, the estimated fair values would necessarily have been achieved at that date, since the market values may differ depending on various circumstances. Also, the use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair values at year-end 1998 and 1997 should not necessarily be considered to apply at subsequent dates. In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as premises and equipment. Also, non-financial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the trained workforce, customer goodwill, and similar items. NOTE 17 - CAPITAL DIRECTIONS, INC. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) The following condensed financial information is for Capital Directions, Inc. (parent company only):
CONDENSED BALANCE SHEETS (In thousands) DECEMBER 31, 1998 1997 ASSETS Cash, due from banks, and other cash equivalents ........................ $ 52 $ 4 Investment in Mason State Bank .......................................... 10,928 10,139 Investment in Monex Financial Services, Inc. ............................ 4 4 Other assets ............................................................ 173 182 ------- -------- TOTAL ASSETS $11,157 $ 10,329 ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Dividends payable ....................................................... $ 160 $ 113 Shareholders' equity .................................................... 10,997 10,216 ------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $11,157 $ 10,329 ======= ========
CONDENSED STATEMENTS OF INCOME (In thousands) YEARS ENDED DECEMBER 31, 1998 1997 1996 OPERATING INCOME Dividends from Mason State Bank ........................................ $ 583 $ 338 $ 420 Dividends from Monex Financial Services, Inc. .......................... -- 148 -- ------- -------- ------- 583 486 420 OPERATING EXPENSES Wages and benefits ..................................................... 4 68 68 Other expenses and income tax benefit .................................. 19 (3) (6) ------- -------- ------- 23 65 62 INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES ........ 560 421 358 Equity in undistributed net income of Mason State Bank .................. 774 961 791 Equity in excess distributed net income of Monex Financial Services, Inc. -- (147) (13) ------- -------- ------- 774 814 778 ------- -------- ------- NET INCOME $ 1,334 $ 1,235 $ 1,136 ======= ======== =======
Other comprehensive income and comprehensive income for the Parent Company are equal to the amounts reported for the Consolidated Company for 1998, 1997, and 1996 as disclosed in the Consolidated Statements of Changes in Shareholders' Equity. 22 25 NOTE 17 - CAPITAL DIRECTIONS, INC. CONDENSED FINANCIAL INFORMATION (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS (In thousands) YEARS ENDED DECEMBER 31, 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES Net income ................................................. $ 1,334 $ 1,235 $ 1,136 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed net income of subsidiaries ........ (774) (814) (778) Change in other assets .................................... 8 (43) (19) ------- ------- ------- Net cash from operating activities 568 378 339 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from shares issued upon exercise of stock options . 1 3 -- Dividends paid ............................................. (521) (391) (330) ------- ------- ------- Net cash from financing activities (520) (388) (330) ======= ======= ======= Net change in cash and cash equivalents ..................... 48 (10) 9 Cash and cash equivalents at beginning of year .............. 4 14 5 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 52 $ 4 $ 14 ======= ======= =======
23 26 CAPITAL DIRECTIONS, INC. DIRECTORS BOARD OF DIRECTORS George A. Sullivan Chairman, Capital Directions, Inc. Private Practice Attorney Gerald W. Ambrose Vice Chairman, Capital Directions, Inc. County Controller, Ingham County Timothy P. Gaylord President & Chief Executive Officer Capital Directions, Inc. Douglas W. Dancer Secretary, Capital Directions, Inc. Realtor, CB Richard Ellis Martin Marvin B. Oesterle Partner, Golden Acres Farms and Oesterle Brothers Seed Corn Paula Johnson Co-owner, Vision Real Estate Company and Developer, PAL, LLC OFFICERS George A. Sullivan, Chairman Gerald W. Ambrose, Vice Chairman Timothy P. Gaylord, President & Chief Executive Officer Douglas W. Dancer, Secretary Lois A. Toth, Treasurer MASON STATE BANK MANAGEMENT Timothy P. Gaylord President & Chief Executive Officer Thomas L. Peterson Senior Vice President, Retail Banking Kathleen Baker Vice President, Mortgage Loans Jeff Kumfer Vice President, Commercial Loans Joanne Bowerman Assistant Vice President, Operations Melanie J. Greene Assistant Vice President, Director of Marketing Elizabeth J. Luttrell Assistant Vice President, Human Resources & Security Thelma Hines Customer Services Officer Lois A. Toth Controller & Cashier Virginia Taylor Auditor & Compliance Officer Lea Ammerman Branch Manager 1998 HIGHLIGHTS THE MISSION OF MASON STATE BANK IS TO OPERATE AS A FINANCIAL SERVICES ORGANIZATION IN A SAFE, SECURE, AND ETHICAL MANNER AND TO PRODUCE SUPERIOR RETURNS FOR OUR SHAREHOLDERS. THIS WILL BE ACCOMPLISHED BY BEING CUSTOMER FOCUSED AND PROVIDING QUALITY SERVICES AND PRODUCTS DELIVERED THROUGH A STAFF OF HIGHLY TRAINED AND MOTIVATED PROFESSIONALS. [PRESTIGE CLUB PAPER] In 1998, Mason State Bank entered into an agreement with a local insurance company and AutoOwners Insurance Group to offer all MSB checking account holders membership in the Mason State Bank Prestige Club. Prestige Club members are eligible for exceptional group discounts on private passenger automobile insurance, homeowners insurance, and executive umbrella insurance. This free benefit resulted in substantial annual savings for qualified Mason State Bank checking customers! You've heard about it in all the media, it goes by different names...the new millenium...Y2K... it's the Year 2000. [GRAPHIC] Mason State Bank has a Year 2000 team that is working on issues related to the Year 2000. Both hardware and software are inventoried and mission critical systems have been identified. Our core operating system software and hardware was certified as Year 2000 compliant. Testing of all mission critical systems started in June 1998 with completion expected by June 1999. The Bank contacted both commercial and retail customers to inform them of issues related to the Year 2000, and assist them in preparing for the change. 24 27 1998 HIGHLIGHTS (CONTINUED) [GRAPHIC] In late 1997, the directors, management, and staff of Mason State Bank and G & R Felpausch Company of Hastings announced an upcoming Mason State Bank supermarket branch inside the Leslie Felpausch. The beautiful new branch opened in October of 1998. [GRAPHIC] The best source of growth is not always new customers; but often selling additional products to existing customers. This is called growing the share of wallet and it has been a successful strategy for our Commercial Loan Department. MSB increased the number of profitable products per customer by providing clients with unparalleled, personalized service and innovative product upgrades at very competitive prices. [GRAPHIC] MSB began its Leslie branch grand opening celebrations on October 23rd. A ribbon cutting ceremony was conducted by Felpausch and Mason State Bank representatives with community leaders and residents attending. [GRAPHIC] The Bank hosted a grand opening event for the entire community on Saturday the 24th. Clowns painted faces and did balloon tricks, there was a huge hot dog roast, and many valuable prizes. Everyone involved had a great time, and the weather was perfect! [GRAPHIC] During 1998, Mason State Bank promoted Lea Ammerman to Officer and made her Branch Manager of the new Leslie location. Additionally, Lea was elected in 1998 to the Leslie Area Chamber of Commerce Board of Directors. [GRAPHIC] The staff of Mason State Bank bid a fond farewell to Virginia Taylor in 1998. Virginia retired after 12 years of dedicated service to the Bank as auditor and compliance officer. She will be missed by everyone! Mortgage loan outstandings showed extensive growth in 1998. The Bank marketed mortgage, refinance, construction, and home equity loans through personal sales at home shows, sales contacts with Realtors, direct mail, and referrals from satisfied Mason State Bank customers. [GRAPHIC] In addition to increased sales proficiency, quick and efficient processing of the loans is necessary for such an explosion in mortgage loan outstandings. During 1998, Deb Whited was promoted to Loan Processing Supervisor. Pairing increased sales effort with the talent of the loan processing staff allowed the Bank to process more loans than ever before. This dedication to success led to Deb Whited being named employee of the year by the staff of Mason State Bank! [GRAPHIC] In 1998, Mason State Bank installed a Marketing Customer Information File (MCIF) program which combines customer, product, and account level information into one source accessed on a personal computer. [GRAPHIC] The Bank now has a complete picture of the relationships any member of a household has with us. This provides immediate and accurate analysis of the customer base and allows us to compare, summarize, analyze, segment, research, or even add information to any or all of the records. This strategic action has been and will continue to be instrumental to future sales planning and implementation. 25 28 FINANCIAL HIGHLIGHTS
CHANGE CHANGE 1998 1997 AMOUNT PERCENT INCOME STATEMENT Net interest income ........................ $ 3,755,000 $ 3,498,000 $ 257,000 7.35% Net income ................................. 1,334,000 1,235,000 99,000 8.02 Basic earnings per share ................... 2.24 2.08 0.16 7.69 Cash dividend declared per share ........... 0.96 0.70 0.26 37.14 RATIOS Return on average shareholders' equity ..... 12.53% 12.47% Return on average assets ................... 1.47 1.56 Average shareholders' equity as a percentage of average assets ......................... 11.78 12.47 BALANCE SHEET Total assets ............................... $100,229,000 $79,957,000 $20,272,000 25.35% Total earning assets ....................... 94,924,000 75,640,000 19,284,000 25.49 Total loans, net ........................... 80,904,000 60,299,000 20,605,000 34.17 Total deposits ............................. 72,389,000 64,421,000 7,968,000 12.37
EX-23 3 CONSENTS OF EXPERTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference and use of our report, dated February 4, 1999, on the consolidated financial statements of Capital Directions, Inc. which appears on Page 7 of Capital Directions, Inc.'s 1998 Annual Report to Shareholders and is incorporated by reference in the Capital Directions, Inc. Annual Report on Form 10-K for the year ended December 31, 1998, in the registration statement on Form S-8 for the Capital Directions, Inc. Incentive Stock Option Plan. /s/ Crowe, Chizek and Company LLP ------------------------------------ Crowe, Chizek and Company LLP Grand Rapids, Michigan March 26, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 1998 ANNUAL REPORT 1000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 2695 26 600 0 5320 6276 6484 81915 1011 100229 72389 0 1250 15593 0 0 2976 8021 100229 5870 824 186 6880 2472 3125 3755 (23) (18) 2461 1882 1334 0 0 1334 2.24 2.22 4.50 243 130 0 0 1035 30 29 1011 617 0 394
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