FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-22461
O.A.K. FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2817345
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2445 84th Street, S.W., Byron Center, Michigan 49315
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (616) 878-1591
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 par value
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation 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 amendments to
this Form 10-K. _X_
The aggregate market value of the voting and non-voting common stock held by
non-affiliates of the Registrant, based on a per share price of $50.00 as of
March 1, 1999, was approximately $76,829,950 (common stock, $1.00 par value). As
of March 1, 1999, there were outstanding 2,041,779 shares of the Company's
Common Stock ($1.00 par value).
Documents Incorporated by Reference:
Portions of the Company's Proxy Statement for the Annual Meeting of Shareholders
to be held April 22, 1999 are incorporated by reference into Part III of this
report.
<PAGE>
Item 1. Business.
O.A.K. Financial Corporation (the "Company"), a Michigan business
corporation, is a one bank holding company, which owns all of the outstanding
capital stock of Byron Center State Bank (the "Bank"), a Michigan banking
corporation. The Company was formed in 1988 for the purpose of acquiring all of
the common stock of the Bank in a shareholder approved reorganization, which
became effective October 13 of 1988.
The Bank was originally organized in 1921 as a Michigan banking
corporation. As of December 31, 1998, the Bank had approximately 144 full-time
and part-time employees. None of the Bank's employees are subject to collective
bargaining agreements. The Company does not directly employ any personnel. The
principal executive offices of the Company and the Bank are located at 2445 84th
Street, S.W., Byron Center, Michigan 49315. The Bank's main office is located in
Byron Center and it serves other communities with branch offices in Allendale,
Dorr, Grand Rapids, Grandville, Hamilton, Hudsonville, Jamestown, Moline and
Zeeland. The Bank's offices are located in Kent County, Ottawa County and the
northern portion of Allegan County.
The area in which the Bank's offices are located, which is basically south
and west of the city of Grand Rapids, has historically been rural in character
but now has a growing urban population as the Grand Rapids Metropolitan Area
expands south and west. The populations of the cities in which the Bank's
offices are located are approximately as follows: Byron Center - 1,000; Dorr -
1,450; Grand Rapids - 189,125; Grandville - 15,620; Hudsonville - 6,170;
Jamestown - 300; Moline - 800; Hamilton - 600; Zeeland - 6,000; Allendale -
9,600.
Bank Services
The Bank is a full service bank offering a wide range of commercial and
personal banking services. These traditional consumer services include checking
accounts, savings accounts, certificates of deposit, commercial loans, real
estate loans, installment loans, collections, traveler's checks, night
depository, safe deposit boxes and U.S. Savings Bonds. Currently, the Bank does
not offer trust services. The Bank maintains correspondent relationships with
major banks in Detroit and Grand Rapids, pursuant to which the Bank engages in
federal funds sale and purchase transactions, the clearance of checks and
certain foreign currency transactions. In addition, the Bank participates with
other financial institutions to fund certain large commercial loans which would
exceed the Bank's legal lending limit if made solely by the Bank.
The Bank's deposits are generated in the normal course of business, and the
loss of any one depositor would not have a materially adverse effect on the
business of the Bank. No material portion of the Bank's loans is concentrated
within a single industry or group of related industries. As of December 31,
1998, the Bank's certificates of deposits of $100,000 or more constituted
approximately 7% of total deposit liabilities. The Bank's deposits originate
primarily from its service area, and the Bank does, on a very limited basis,
obtain large deposits from outside this area.
The Bank's principal sources of revenue are interest and fees on loans and
interest on investment securities. Interest and fees on loans constituted
approximately 74.1% and 73.7% of total revenues for the years ended December 31,
1998, and December 31, 1997, respectively. Interest on investment securities,
including short-term investments and federal funds sold, constituted
approximately 14.7% and 18.6% of total revenues in 1998 and 1997. Revenues were
also generated from deposit service charges, sales of loans and securities and
other financial service fees.
The Bank provides real estate, consumer and commercial loans to customers
in its market. 79.3 percent of the Bank's loan portfolio is held in fixed rate
loans as of December 31, 1998. Most of these loans, approximately 93.8%, mature
within five years of issuance. Approximately $13,842,000 of loans (or 6.2% of
the Bank's total loan portfolio) have fixed rates with maturities exceeding five
years. 44.4 percent of the Bank's interest-bearing deposits are held in savings,
NOW and MMDAs, all of which are variable rate products. Of the $101,118,000 in
certificates, approximately $74,853,000 mature within one year, with the balance
maturing within a five year period.
Requests to the Bank for credit are considered on the basis of credit
worthiness of each applicant, without consideration to race, color, religion,
national origin, sex, marital status, physical handicap, age, or the receipt of
income from public assistance programs. Consideration is given to the
applicant's capacity for repayment, collateral, capital and alternative sources
of repayment. Loan applications are accepted at all the Bank's offices and are
approved within
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the limits of each lending officer's authority. Loan requests in excess of
$750,000 are required to be presented to the Board of Directors or the Executive
Committee of the Board for its review and approval.
As described in more detail in Table 20 on page 28, the Bank's ratio of
rate sensitive assets to rate sensitive liabilities as of December 31, 1998, was
a 20% positive gap, compared to a 23 % positive gap at December 31, 1997. As
indicated on page 28, the entire balance of savings, NOW, and MMDAs are not
categorized as 0 to 3 months, although they are variable rate products. Some of
these balances are core deposits which are not considered rate sensitive based
on the Bank's historical experiences.
The Bank sells participations in commercial loans to other financial
institutions approved by the Bank, for the purpose of meeting legal lending
limit requirements or loan concentration considerations. The Bank has also sold
student loans and regularly sells fixed rate and conforming adjustable rate
residential mortgages to the Federal Home Loan Mortgage Corporation ("Freddie
Mac"). Those residential real estate mortgage loan requests that do not meet
Freddie Mac criteria are reviewed by the Bank for approval and, if approved, are
retained in the Bank's loan portfolio. The Bank has the ability to purchase
loans which meet its normal credit standards.
The Bank's investment policy is considered to be generally conservative. It
provides for unlimited investment in U.S. government bonds, with the maximum
size of a single purchase limited to $3,000,000 and a maximum maturity of
fifteen years. Municipal bonds with an A rating or better may be purchased to
provide nontaxable income, with the maximum life of municipal bonds limited to
ten years. Nonrated bonds may be purchased from local communities that are
familiar to the Bank, with a maximum block size of a single purchase limited to
$250,000. Investments in states other than Michigan may not exceed 10% of the
municipal portfolio, and investments in a single issuer may not exceed 5% of
equity capital. Mortgage backed securities, which are fully collateralized by
securities issued by government sponsored agencies, may be purchased in block
sizes of up to $3,000,000, provided the average life expectancy does not exceed
ten years.
In addition, certain collateralized mortgage obligations may be purchased
if their average life does not exceed five years. In addition to these
referenced thresholds affecting the acquisition of investment securities,
holdings of approved "non high-risk mortgage securities" are required to be
"stress tested" at least annually. The acquisition of "high-risk mortgage
securities" is prohibited. In no case may the Bank participate in such
activities as "gains trading," "when-issued" trading, "pair offs," corporate
settlement of government and agency securities, repositioning repurchase
agreements, and short sales. All securities dealers effecting transactions in
securities held or purchased by the Bank must be approved by the Bank's Board of
Directors.
Bank Competition
The Bank has ten offices, one within each of the communities it serves. See
"Properties" below for more detail on these facilities. Within these
communities, its principal competitors are Comerica Bank, NBD Bank, Old Kent
Bank, National City Bank, Huntington Bank, Michigan National Bank and United
Bank of Michigan. Each of these financial institutions, which are headquartered
in larger metropolitan areas, have significantly greater assets and financial
resources than the Company, with the exception of United Bank of Michigan. Based
on deposit information as of June 30, 1996, the Bank holds approximately 1.8% of
deposits in the Kent County market, 1.3% of deposits in the Ottawa County
market, and 4% of the deposits in the Allegan County market. Information as to
asset size of competitor financial institutions is derived from publicly
available reports filed by and with regulatory agencies.
The financial services industry continues to be increasingly competitive.
Principal methods of competition include loan and deposit pricing, advertising
and marketing programs and the types and quality of services provided. The
deregulation of the financial service industry has led to increased competition
among banks and other financial institutions for a significant portion of funds
which have traditionally been deposited with commercial banks. Competition
within the Bank's markets has been relatively stable within the past several
years. Management continues to evaluate the opportunities for the expansion of
products and services, such as trust services, and additional branching
opportunities.
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Growth of Bank
The following table sets forth certain financial information regarding the
growth of the Bank (and accordingly, excludes holding company data):
<TABLE>
Balances as of December 31,
(in thousands)
========================================================================================================================
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total Assets $299,882 $241,283 $216,755 $210,307 $187,079
Loans, Net of Unearned Income 222,133 168,953 145,069 142,813 127,286
Securities 54,734 59,988 57,302 56,702 45,598
Noninterest-Bearing Deposits 35,919 26,459 23,807 19,211 16,478
Interest-Bearing Deposits 181,789 158,244 146,442 150,807 134,603
Total Deposits 217,708 184,703 170,249 170,018 151,081
Stockholders' Equity 37,983 35,107 34,744 31,979 27,728
========================================================================================================================
</TABLE>
The Main Office in Byron Center began in a small 600 square foot building
in 1921. It was expanded to 1,100 square feet in 1954. In 1965 the Bank moved
next door to a new 10,000 square foot building. In 1987 construction of another
new building of 30,000 square feet was begun. The Main Office moved to this
facility in 1988 and currently occupies this space. The Bank's first branch was
opened in 1963 when the bank refitted an old bank building in Jamestown. The
building was once a bank which closed during the Great Depression. The Bank's
next branch was opened in Cutlerville in 1972. The original 2,500 square foot
building was expanded with a 1,000 square foot addition in 1987. The Bank's Dorr
office was opened in 1986 at the site of the Hillcrest Mall. It is a 2,500
square foot facility with a 2,500 square foot storage basement. In 1991, the
Bank opened its branch in Hudsonville. The Bank maximized this site for future
expansion with a 10,000 square foot building. The Bank occupies 2,500 square
feet while the remainder is rented to various office use tenants. During 1995,
the Bank purchased and remodeled a former bank branch in Grandville. Also, the
same year, the Bank purchased from National City Bank a building and the
deposits of its Moline branch. Currently, the Bank operates three off-site ATMs.
The Bank opened three new branches in 1998 at 10500 Chicago Drive in
Zeeland, Michigan, 6163 Lake Michigan Drive in Allendale, Michigan and 4601
134th Avenue, Suite C in Hamilton, Michigan. The Bank leases the facilities for
each of these three branches. In February 1999, the Kentwood, Michigan branch
was opened for business. The Kentwood branch was purchased from National City
Bank.
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<PAGE>
SUPERVISION AND REGULATION
The following is a summary of certain statutes and regulations affecting
the Company and the Bank. This summary is qualified in its entirety by such
statutes and regulations. A change in applicable laws or regulations may have a
material effect on the Company, the Bank and the business of the Company and the
Bank.
General
Financial institutions and their holding companies are extensively
regulated under federal and state law. Consequently, the growth and earnings
performance of the Company and the Bank can be affected not only by management
decisions and general economic conditions, but also by the statutes administered
by, and the regulations and policies of, various governmental regulatory
authorities. Those authorities include, but are not limited to, the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"), the FDIC,
the Commissioner of the Michigan Financial Institutions Bureau ("Commissioner"),
the Internal Revenue Service, and state taxing authorities. The effect of such
statutes, regulations and policies can be significant, and cannot be predicted
with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial
institutions and their holding companies regulate, among other things, the scope
of business, investments, reserves against deposits, capital levels relative to
operations, lending activities and practices, the nature and amount of
collateral for loans, the establishment of branches, mergers, consolidations and
dividends. The system of supervision and regulation applicable to the Company
and the Bank establishes a comprehensive framework for their respective
operations and is intended primarily for the protection of the FDIC's deposit
insurance funds, the depositors of the Bank, and the public, rather than
shareholders of the Bank or the Company.
Federal law and regulations establish supervisory standards applicable to
the lending activities of the Bank, including internal controls, credit
underwriting, loan documentation and loan-to-value ratios for loans secured by
real property.
The Company
General. The Company is a bank holding company and, as such, is registered
with, and subject to regulation by, the Federal Reserve Board under the Bank
Holding Company Act, as amended (the "BHCA"). Under the BHCA, the Company is
subject to periodic examination by the Federal Reserve Board, and is required to
file with the Federal Reserve Board periodic reports of its operations and such
additional information as the Federal Reserve Board may require.
In accordance with Federal Reserve Board policy, the Company is expected to
act as a source of financial strength to the Bank and to commit resources to
support the Bank in circumstances where the Company might not do so absent such
policy. In addition, if the Commissioner deems the Bank's capital to be
impaired, the Commissioner may require the Bank to restore its capital by a
special assessment upon the Company as the Bank's sole shareholder. If the
Company were to fail to pay any such assessment, the directors of the Bank would
be required, under Michigan law, to sell the shares of the Bank's stock owned by
the Company to the highest bidder at either a public or private auction and use
the proceeds of the sale to restore the Bank's capital.
Investments and Activities. In general, any direct or indirect acquisition
by the Company of any voting shares of any bank which would result in the
Company's direct or indirect ownership or control of more than 5% of any class
of voting shares of such bank, and any merger or consolidation of the Company
with another bank company, will require the prior written approval of the
Federal Reserve Board under the BHCA. In acting on such applications, the
Federal Reserve Board must consider various statutory factors, including among
others, the effect of the proposed transaction on competition in relevant
geographic and product markets, and each party's financial condition, managerial
resources, and record of performance under the Community Reinvestment Act.
Effective September 29, 1995, bank holding companies may acquire banks located
in any state in the United States without regard to geographic restrictions or
reciprocity requirements imposed by state law, but subject to certain
conditions, including limitations on the aggregate amount of deposits that may
be held by the acquiring company and all of its insured depository institution
affiliates.
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The merger or consolidation of an existing bank subsidiary of the Company
with another bank, or the acquisition by such a subsidiary of assets of another
bank, or the assumption of liability by such a subsidiary to pay any deposits in
another bank, will require the prior written approval of the responsible Federal
depository institution regulatory agency under the Bank Merger Act, based upon a
consideration of statutory factors similar to those outlined above with respect
to the BHCA. In addition, in certain such cases an application to, and the prior
approval of, the Federal Reserve Board under the BHCA and/or the Commissioner
under the Michigan Banking Code, may be required.
With certain limited exceptions, the BHCA prohibits any bank company from
engaging, either directly or indirectly through a subsidiary, in any activity
other than managing or controlling banks unless the proposed non-banking
activity is one that the Federal Reserve Board has determined to be so closely
related to banking or managing or controlling banks as to be a proper incident
thereto. Under current Federal Reserve Board regulations, such permissible
non-banking activities include such things as mortgage banking, equipment
leasing, securities brokerage, and consumer and commercial finance company
operations. As a result of recent amendments to the BHCA, well- capitalized and
well-managed bank holding companies may engage de novo in certain types of
non-banking activities without prior notice to, or approval of, the Federal
Reserve Board, provided that written notice of the new activity is given to the
Federal Reserve Board within 10 business days after the activity is commenced.
If a bank company wishes to engage in a non-banking activity by acquiring a
going concern, prior notice and/or prior approval will be required, depending
upon the activities in which the company to be acquired is engaged, the size of
the company to be acquired and the financial and managerial condition of the
acquiring bank company.
In evaluating a proposal to engage (either de novo or through the
acquisition of a going concern) in a non-banking activity, the Federal Reserve
Board will consider various factors, including among others the financial and
managerial resources of the bank company, and the relative public benefits and
adverse effects which may be expected to result from the performance of the
activity by an affiliate of the bank company. The Federal Reserve Board may
apply different standards to activities proposed to be commenced de novo and
activities commenced by acquisition, in whole or in part, of a going concern.
Capital Requirements. The Federal Reserve Board uses capital adequacy
guidelines in its examination and regulation of bank holding companies. If
capital falls below minimum guidelines, a bank company may, among other things,
be denied approval to acquire or establish additional banks or non-bank
businesses.
The Federal Reserve Board's capital guidelines establish the following
minimum regulatory capital requirements for bank holding companies: (i) a
leverage capital requirement expressed as a percentage of total assets, and (ii)
a risk-based requirement expressed as a percentage of total risk-weighted
assets. The leverage capital requirement consists of a minimum ratio of Tier 1
capital (which consists principally of shareholders' equity) to total assets of
3% for the most highly rated companies, with minimum requirements of 4% to 5%
for all others. The risk- based requirement consists of a minimum ratio of total
capital to total risk-weighted assets of 8%, of which at least one-half must be
Tier 1 capital.
The risk-based and leverage standards presently used by the Federal Reserve
Board are minimum requirements, and higher capital levels will be required if
warranted by the particular circumstances or risk profiles of individual banking
organizations. For example, Federal Reserve Board regulations provide that
additional capital may be required to take adequate account of, among other
things, interest rate risk and the risks posed by concentrations of credit,
nontraditional activities or securities trading activities. Further, any banking
organization experiencing or anticipating significant growth would be expected
to maintain capital ratios, including tangible capital positions (i.e., Tier 1
capital less all intangible assets), well above the minimum levels. The Federal
Reserve Board has not advised the Company of any specific minimum Tier 1 Capital
leverage ratio applicable to it.
Dividends. The Company is a corporation separate and distinct from the
Bank. Most of the Company's revenues are received by it in the form of dividends
paid by the Bank. Thus, the Company's ability to pay dividends to its
shareholders is indirectly limited by statutory restrictions on the Bank's
ability to pay dividends. See "SUPERVISION AND REGULATION - The Bank -
Dividends." Further, the Federal Reserve Board has issued a policy statement on
the payment of cash dividends by bank holding companies. In the policy
statement, the Federal Reserve Board expressed its view that a bank company
experiencing earnings weaknesses should not pay cash dividends exceeding its net
income or which can only be funded in ways that weakened the bank company's
financial health, such
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as by borrowing. Additionally, the Federal Reserve Board possesses enforcement
powers over bank holding companies and their non-bank subsidiaries to prevent or
remedy actions that represent unsafe or unsound practices or violations of
applicable statutes and regulations. Among these powers is the ability to
proscribe the payment of dividends by banks and bank holding companies. Similar
enforcement powers over the Bank are possessed by the FDIC. The "prompt
corrective action" provisions of federal law and regulation authorizes the
Federal Reserve Board to restrict the payment of dividends by the Company for an
insured bank which fails to meet specified capital levels.
In addition to the restrictions on dividends imposed by the Federal Reserve
Board, the Michigan Business Corporation Act provides that dividends may be
legally declared or paid only if after the distribution a corporation, such as
the Company, can pay its debts as they come due in the usual course of business
and its total assets equal or exceed the sum of its liabilities plus the amount
that would be needed to satisfy the preferential rights upon dissolution of any
holders of preferred stock whose preferential rights are superior to those
receiving the distribution. The Company's Articles of Incorporation do not
authorize the issuance of preferred stock and there are no current plans to seek
such authorization.
The Bank
General. The Bank is a Michigan banking corporation and its deposit
accounts are insured by the Bank Insurance Fund (the "BIF") of the FDIC. As a
BIF-insured Michigan chartered bank, the Bank is subject to the examination,
supervision, reporting and enforcement requirements of the Commissioner, as the
chartering authority for Michigan banks, and the FDIC, as administrator of the
BIF. These agencies and the federal and state laws applicable to the Bank and
its operations, extensively regulate various aspects of the banking business
including, among other things, permissible types and amounts of loans,
investments and other activities, capital adequacy, branching, interest rates on
loans and on deposits, the maintenance of non-interest bearing reserves on
deposit accounts, and the safety and soundness of banking practices.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to
pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a
risk-based assessment system under which all insured depository institutions are
placed into one of nine categories and assessed insurance premiums, based upon
their respective levels of capital and results of supervisory evaluation.
Institutions classified as well-capitalized (as defined by the FDIC) and
considered healthy pay the lowest premium while institutions that are less than
adequately capitalized (as defined by the FDIC) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The Federal Deposit Insurance Act ("FDIA") requires the FDIC to establish
assessment rates at levels which will maintain the Deposit Insurance Fund at a
mandated reserve ratio of not less than 1.25% of estimated insured deposits.
Accordingly, the FDIC established the schedule of BIF insurance assessments for
the first semi-annual assessment period of 1998, ranging from 0% of deposits for
institutions in the lowest risk category to .27% of deposits for institutions in
the highest risk category. For 1998, the Bank paid $27,750 in BIF insurance
assessments, representing a premium of .01%.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution or its
directors have engaged or are engaging in unsafe or unsound practices, or have
violated any applicable law, regulation, order, or any condition imposed in
writing by, or written agreement with, the FDIC, or if the institution is in an
unsafe or unsound condition to continue operations. The FDIC may also suspend
deposit insurance temporarily during the hearing process for a permanent
termination of insurance if the institution has no tangible capital.
Commissioner Assessments. Michigan banks are required to pay supervisory
fees to the Commissioner to fund the operations of the Commissioner. The amount
of supervisory fees paid by a bank is based upon the bank's total assets, as
reported to the Commissioner.
FICO Assessments. Pursuant to federal legislation enacted September 30,
1996, the Bank, as a member of the BIF, is subject to assessments to cover the
payments on outstanding obligations of the Financing Corporation ("FICO"). FICO
was created in 1987 to finance the recapitalization of the Federal Savings and
Loan Insurance Corporation, the
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predecessor to the FDIC's Savings Association Insurance Fund (the "SAIF") which
insures the deposits of thrift institutions. Until January 1, 2000, the FICO
assessments made against BIF members may not exceed 20% of the amount of FICO
assessments made against SAIF members. Currently, SAIF members pay FICO
assessments at a rate equal to approximately 0.063% of deposits while BIF
members pay FICO assessments at a rate equal to approximately 0.013% of
deposits. Between January 1, 2000 and the maturity of the outstanding FICO
obligations in 2019, BIF members and SAIF members will share the cost of the
interest on the FICO bonds on a pro rata basis. It is estimated that FICO
assessments during this period will be less than 0.025% of deposits.
Capital Requirements. The FDIC has established the following minimum
capital standards for state-chartered, FDIC-insured non-member banks, such as
the Bank: a leverage requirement consisting of a minimum ratio of Tier 1 capital
to total assets of 3% for the most highly-rated banks with minimum requirements
of 4% to 5% for all others, and a risk-based capital requirement consisting of a
minimum ratio of total capital to total risk-weighted assets of 8%, at least
one-half of which must be Tier 1 capital. Tier 1 capital consists principally of
shareholders' equity. These capital requirements are minimum requirements.
Higher capital levels will be required if warranted by the particular
circumstances or risk profiles of individual institutions. For example, FDIC
regulations provide that higher capital may be required to take adequate account
of, among other things, interest rate risk and the risks posed by concentrations
of credit, nontraditional activities or securities trading activities.
Federal law provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," or "critically
undercapitalized." Federal regulations define these capital categories as
follows:
<TABLE>
Total Tier 1
Risk-Based Risk-Based
Capital Ratio Capital Ratio Leverage Ratio
<S> <C> <C> <C>
Well capitalized 10% or above 6% or above 5% or above
Adequately capitalized 8% or above 4% or above 4% or above
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly undercapitalized Less than 6% Less than 3% Less than 3%
Critically undercapitalized -- -- A ratio of tangible
equity to total assets
of 2% or less
</TABLE>
As of December 31, 1998, each of the Bank's ratios exceeded minimum
requirements for the well capitalized category.
Depending upon the capital category to which an institution is assigned,
the regulators' corrective powers include: requiring the submission of a capital
restoration plan; placing limits on asset growth and restrictions on activities;
requiring the institution to issue additional capital stock (including
additional voting stock) or to be acquired; restricting transactions with
affiliates; restricting the interest rate the institution may pay on deposits;
ordering a new election of directors of the institution; requiring that senior
executive officers or directors be dismissed; prohibiting the institution from
accepting deposits from correspondent banks; requiring the institution to divest
certain subsidiaries; prohibiting the payment of principal or interest on
subordinated debt; and ultimately, appointing a receiver for the institution.
In general, a depository institution may be reclassified to a lower
category than is indicated by its capital levels if the appropriate federal
depository institution regulatory agency determines the institution to be
otherwise in an unsafe or unsound condition or to be engaged in an unsafe or
unsound practice. This could include a failure by the institution, following
receipt of a less-than-satisfactory rating on its most recent examination
report, to correct the deficiency.
Dividends. Under Michigan law, the Bank is restricted as to the maximum
amount of dividends it may pay on its common stock. The Bank may not pay
dividends except out of net profits after deducting its losses and bad debts. A
Michigan state bank may not declare or pay a dividend unless the bank will have
a surplus amounting to at least 20%
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of its capital after the payment of the dividend. If the Bank has a surplus less
than the amount of its capital, it may not declare or pay any dividend until an
amount equal to at least 10% of net profits for the preceding one-half year (in
the case of quarterly or semi-annual dividends) or full-year (in the case of
annual dividends) has been transferred to surplus. A Michigan state bank may,
with the approval of the Commissioner, by vote of shareholders owning 2/3 of the
stock eligible to vote increase its capital stock by a declaration of a stock
dividend, provided that after the increase the bank's surplus equals at least
20% of its capital stock, as increased. The Bank may not declare or pay any
dividend until the cumulative dividends on preferred stock (should any such
stock be issued and outstanding) have been paid in full. The Bank's Articles of
Incorporation do not authorize the issuance of preferred stock and there are no
current plans to seek such authorization.
Federal law generally prohibits a depository institution from making any
capital distribution (including payment of a dividend) or paying any management
fee to its company if the depository institution would thereafter be
undercapitalized. The FDIC may prevent an insured bank from paying dividends if
the bank is in default of payment of any assessment due to the FDIC. In
addition, the FDIC may prohibit the payment of dividends by the Bank, if such
payment is determined, by reason of the financial condition of the Bank, to be
an unsafe and unsound banking practice.
Insider Transactions. The Bank is subject to certain restrictions imposed
by the Federal Reserve Act on any extensions of credit to the Company or its
subsidiaries, on investments in the stock or other securities of the Company or
its subsidiaries and the acceptance of the stock or other securities of the
Company or its subsidiaries as collateral for loans. Certain limitations and
reporting requirements are also placed on extensions of credit by the Bank to
its directors and officers, to directors and officers of the Company and its
subsidiaries, to principal shareholders of the Company, and to "related
interests" of such directors, officers and principal shareholders. In addition,
federal law and regulations may affect the terms upon which any person becoming
a director or officer of the Company or one of its subsidiaries or a principal
shareholder of the Company may obtain credit from banks with which the Bank
maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted
guidelines to promote the safety and soundness of federally insured depository
institutions. These guidelines establish standards for internal controls,
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, compensation, fees and
benefits, asset quality and earnings. In general, the guidelines prescribe the
goals to be achieved in each area, and each institution will be responsible for
establishing its own procedures to achieve those goals. If an institution fails
to comply with any of the standards set forth in the guidelines, the
institution's primary federal regulator may require the institution to submit a
plan for achieving and maintaining compliance. The preamble to the guidelines
states that the agencies expect to require a compliance plan from an institution
whose failure to meet one or more of the standards is of such severity that it
could threaten the safe and sound operation of the institution. Failure to
submit an acceptable compliance plan, or failure to adhere to a compliance plan
that has been accepted by the appropriate regulator, would constitute grounds
for further enforcement action.
State Bank Activities. Under federal law and FDIC regulations, FDIC-insured
state banks are prohibited, subject to certain exceptions, from making or
retaining equity investments of a type, or in an amount, that are not
permissible for a national bank. Federal law, as implemented by FDIC
regulations, also prohibits FDIC-insured state banks and their subsidiaries,
subject to certain exceptions, from engaging as principal in any activity that
is not permitted for a national bank or its subsidiary, respectively, unless the
bank meets, and continues to meet, its minimum regulatory capital requirements
and the FDIC determines the activity would not pose a significant risk to the
deposit insurance fund of which the bank is a member. Impermissible investments
and activities must be divested or discontinued within certain time frames set
by the FDIC in accordance with federal law. These restrictions are not currently
expected to have a material impact on the operations of the Bank.
Consumer Protection Laws. The Bank's business includes making a variety of
types of loans to individuals. In making these loans, the Bank is subject to
State usury and regulatory laws and to various federal statutes, such as the
Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in
Lending Act, the Real Estate Settlement Procedures Act, and the Home Mortgage
Disclosure Act, and the regulations promulgated thereunder, which prohibit
discrimination, specify disclosures to be made to borrowers regarding credit and
settlement costs, and regulate the mortgage loan servicing activities of the
Bank, including the maintenance and operation of escrow accounts and the
transfer of mortgage loan servicing. In receiving deposits, the Bank is subject
to extensive regulation under State and
-8-
<PAGE>
federal law and regulations, including the Truth in Savings Act, the Expedited
Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act,
and the Federal Deposit Insurance Act. Violation of these laws could result in
the imposition of significant damages and fines upon the Bank and its directors
and officers.
Branching Authority. Michigan banks, such as the Bank, have the authority
under Michigan law to establish branches anywhere in the State of Michigan,
subject to receipt of all required regulatory approvals (including the approval
of the Commissioner and the FDIC).
Effective June 1, 1997 (or earlier if expressly authorized by applicable
state law), the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "IBBEA") allows banks to establish interstate branch networks through
acquisitions of other banks, subject to certain conditions, including certain
limitations on the aggregate amount of deposits that may be held by the
surviving bank and all of its insured depository institution affiliates. The
establishment of de novo interstate branches or the acquisition of individual
branches of a bank in another state (rather than the acquisition of an
out-of-state bank in its entirety) is allowed by IBBEA only if specifically
authorized by state law. The legislation allowed individual states to "opt-out"
of interstate branching authority by enacting appropriate legislation prior to
June 1, 1997.
Michigan did not opt out of IBBEA, and now permits both U.S. and non-U.S.
banks to establish branch offices in Michigan. The Michigan Banking Code
permits, in appropriate circumstances and with the approval of the Commissioner,
(i) the acquisition of all or substantially all of the assets of a
Michigan-chartered bank by an FDIC- insured bank, savings bank, or savings and
loan association located in another state, (ii) the acquisition by a Michigan-
chartered bank of all or substantially all of the assets of an FDIC-insured
bank, savings bank or savings and loan association located in another state,
(iii) the consolidation of one or more Michigan-chartered banks and FDIC-insured
banks, savings banks or savings and loan associations located in other states
having laws permitting such consolidation, with the resulting organization
chartered by Michigan, (iv) the establishment by a foreign bank, which has not
previously designated any other state as its home state under the International
Banking Act of 1978, of branches located in Michigan, and (v) the establishment
or acquisition of branches in Michigan by FDIC-insured banks located in other
states, the District of Columbia or U.S. territories or protectorates having
laws permitting Michigan-chartered banks to establish branches in such
jurisdiction. Further, the Michigan Banking Code permits, upon written notice to
the Commissioner, (i) the acquisition by a Michigan-chartered bank of one or
more branches (not comprising all or substantially all of the assets) of an
FDIC-insured bank, savings bank or savings and loan association located in
another state, the District of Columbia, or a U.S. territory or protectorate,
(ii) the establishment by Michigan-chartered banks of branches located in other
states, the District of Columbia, or U.S. territories or protectorates, and
(iii) the consolidation of one or more Michigan-chartered banks and FDIC-insured
banks, savings banks or savings and loan associations located in other states,
with the resulting organization chartered by one of such other states.
-9-
<PAGE>
Item 2. Properties.
The Bank operates from ten facilities, located in seven communities, in
Kent, Ottawa and Allegan Counties, Michigan. The Bank's main office is located
at 2445 84th Street, S.W., Byron Center, Michigan. This facility is a two story
30,000 square foot building constructed in 1988 and is owned by the Bank. The
Bank's branch offices in Allendale, Dorr, Grand Rapids, Grandville, Hamilton,
Hudsonville, Jamestown, Moline and Zeeland are all single story facilities
ranging in size from 1,100 square feet to 10,000 square feet. The Bank owns its
branch offices in Dorr, Grand Rapids, Grandville, Hudsonville and Moline. The
Bank leases the facilities occupied by the Allendale, Hudsonville and Zeeland
branches. The Bank is in the process of remodeling its Kentwood, Michigan office
which was opened in February 1999.
Item 3. Legal Proceedings.
Neither the Company nor the Bank are involved in any legal proceedings
other than routine litigation incidental to the ordinary conduct of the business
of the Bank, none of which would result in a material impact on the Company or
the Bank, individually or in the aggregate, in the event of an adverse outcome.
Item 4. Submission of Matters to Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
-10-
<PAGE>
Additional Item - Executive Officers
Executive officers of the Company are appointed annually by the Board of
Directors. There are no family relationships among the officers and/or the
directors of the Company, or any arrangement or understanding between any
officer and any other person pursuant to which the officer was elected.
The following table sets forth certain information with respect to the
Company's officers as of December 31, 1998:
<TABLE>
Year Became
Name Age Position with Company an Officer
<S> <C> <C> <C>
John A. Van Singel 44 President, CEO and director of the Company 1976
and the Bank
Lois Smalligan 66 Director of the Company and the Bank, Vice 1975
President of the Bank
John Peterson 50 Executive Vice President of the Bank 1983
Forrest Bowling 50 Vice President of the Bank 1988
Martin Braun 43 Vice President of the Bank 1988
Stanley Roberts 45 Vice President of the Bank 1998
</TABLE>
[INTENTIONALLY LEFT BLANK]
-11-
<PAGE>
PART II
Item 5. Market Price of and Dividends on the Registrant's Common Equity and
Related Stockholder Matters.
There is no active market for the Company's Common Stock, and there is no
published information with respect to its market price. There are occasional
sales through brokers and direct sales by shareholders of which the Company's
management is aware. It is the understanding of the management of the Company
that over the last two years, the Company's Common Stock has sold at prices in
excess of book value. From January 1, 1997, through December 31, 1998, there
were, so far as the Company's management knows, 106 sales of shares of the
Company's Common Stock, involving a total of 79,600 shares. The price was
reported to management in only a few of these transactions, and management has
no way of confirming the prices which were reported. During this period, the
highest price known by management to be paid was $50.00 per share in the first
quarter of 1999, and the lowest price was $28.00 per share in the first quarter
of 1997. To the knowledge of management, the last sale of Common Stock occurred
on January 29, 1999, involving the sale of 90 shares at a price of $50.00 per
share. The per share information has been adjusted for the July 1, 1998, 2-for 1
stock split in the form of a dividend.
The following table sets forth the range of high and low sales prices of
the Company's Common Stock during 1997 and 1998 and through February 10, 1999,
based on information made available to the Company, as well as per share cash
dividends declared during those periods. Although management is not aware of any
transactions at higher or lower prices, there may have been transactions at
prices outside the ranges listed below:
<TABLE>
Cash
Sales Prices Dividends Declared
1997 High Low
<S> <C> <C> <C>
First Quarter......................... $ 31.50 $ 28.00 $1.00 (1)
Second Quarter........................ 32.50 31.50 $ .265
Third Quarter......................... 34.00 31.50
Fourth Quarter........................ 35.00 34.00 $ .285
1998 High Low
First Quarter......................... $ 35.00 $ 34.50 $ .50 (2)
Second Quarter........................ 35.00 35.00 $ .325
Third Quarter......................... 42.00 32.00
Fourth Quarter........................ 50.00 42.00 $ .35
1999
First Quarter......................... $50.00 $46.00
</TABLE>
(1) A special dividend of $1.00 per share.
(2) A special dividend of $.50 per share.
On May 7, 1998, the Board of Directors declared a 2-for-1 split of the
Corporation's common stock with an effective date of July 1, 1998 by means of a
one-for-one stock dividend to shareholders of record on June 1, 1998. All
references to per share amounts and prices of the shares have been restated to
give retroactive effect to the stock split.
-12-
<PAGE>
There are 4,000,000 shares of the Company's Common Stock authorized, of
which 2,041,779 shares were issued and outstanding as of February 28, 1999.
There were approximately 660 shareholders of record, including trusts and shares
jointly owned, as of that date. No warrants or options exist for the purchase of
additional common stock of the Company.
The holders of the Company's Common Stock are entitled to dividends when,
as and if declared by the Board of Directors of the Company out of funds legally
available for that purpose. Cash dividends have been paid on a semi-annual
basis. In determining dividends, the Board of Directors considers the earnings,
capital requirements and financial condition of the Company and the Bank, along
with other relevant factors. The Company's principal source of funds for cash
dividends is the dividends paid by the Bank. The ability of the Company and the
Bank to pay dividends is subject to regulatory restrictions and requirements.
See the discussion under "Business-Supervision and Regulation" above.
[INTENTIONALLY LEFT BLANK]
-13-
<PAGE>
Item 6. Selected Financial Data.
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
<TABLE>
Year Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Interest income $ 21,134 $ 18,624 $ 17,502 $ 16,268 $ 14,082
Interest expense 8,916 7,693 7,181 6,637 5,371
Net interest income 12,218 10,931 10,321 9,631 8,711
Provision for loan losses 400 50 0 275 170
Noninterest income 2,659 1,542 1,075 919 665
Noninterest expenses 7,334 5,782 5,169 4,511 4,097
Income before federal 7,144 6,641 6,227 5,764 5,109
income taxes
Net income 5,076 4,626 4,375 4,004 3,680
Per Share Data(1)(2):
Net income 2.54 2.30 2.17 1.99 1.83
Cash dividends declared 1.18 1.55 .47 .41 .34
Book Value 19.98 18.37 17.66 16.12 13.76
Weighted average shares
outstanding (1) 2,000 2,010 2,014 2,020 2,028
Balance Sheet Data:
Total assets $301,494 $243,088 $217,527 $210,880 $187,244
Loans, net of unearned income 222,133 168,953 145,069 142,813 127,286
Allowance for loan losses 2,879 2,565 2,376 2,305 2,056
Deposits 217,291 184,700 170,221 170,012 151,074
Stockholders' equity 39,953 36,915 35,544 32,559 27,900
Ratios:
Tax equivalent net interest
income to average earning
assets 5.02% 5.24% 5.23% 5.42% 5.24%
Return on average equity 13.28% 13.08 12.89 13.21 13.64
Return on average assets 1.90% 2.03 2.03 2.07 2.02
Nonperforming loans to
total loans 0.26% 0.14 0.82 0.66 0.24
Tier 1 leverage ratio 13.53% 15.03 15.97 15.42 15.36
Dividend payout ratio 46.30% 67.35 21.54 18.75 16.77
Equity to asset ratio 13.25% 15.19 16.34 15.44 14.90
</TABLE>
(1) At year end in thousands.
(2) As restated for a 2-for-1 common stock split in the form of a dividend
in 1998.
-14-
<PAGE>
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The following financial review presents management's discussion and
analysis of consolidated financial condition and results of operations during
the period of 1996 through 1998. The discussion should be read in conjunction
with the Company's consolidated financial statements and accompanying notes
thereto.
Summary
The Company and its subsidiary bank, Byron Center State Bank, consistently
have been ranked as a high performance community bank by various bank rating
companies. The Company's capital ratio of 13.25% as of December 31, 1998, makes
it one of the strongest capitalized community banks in the State of Michigan.
To achieve this status, the Company has relied on years of continuous
improvements in a business culture that emphasizes quality assets, managed in an
efficient manner so as to minimize the cost of overhead. Technology has also
been a key component to the Company's success and will remain an important tool
that will help management deliver more services and manage more assets at a
lower cost to support these functions.
The Company has a surplus of capital. The Board of Directors has made it a
priority to make more efficient use of capital. The primary emphasis is
re-leveraging capital through aggressive yet careful growth. This is expected to
be accomplished through competitive, cost effective products and services,
efficiently delivered without compromising the Bank's risk and underwriting
standards. The Company has increased its cash dividend pay-out ratio over the
years from 15% in 1993 to 46% in 1998, although there can be no assurance that
the Company will maintain comparable pay-out ratios in the future.
Results of Operations
Table 1 Earnings Performance (in thousands, except per share data)
<TABLE>
Year Ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income.................................... $5,076 $4,626 $4,375
Per share of common stock................... 2.54 2.30 2.17
Earnings ratios:
Return on average assets.................... 1.90% 2.03% 2.03%
Return on average equity.................... 13.28% 13.08% 12.89%
</TABLE>
Net Interest Income
The following schedule presents the average daily balances, interest income
(on a fully taxable equivalent basis) and interest expense and average rates
earned and paid for the Company's major categories of assets, liabilities, and
stockholders' equity for the periods indicated:
-15-
<PAGE>
Table 2 - Interest Yields and Costs (in thousands)
<TABLE>
Year ended December 31,
1998 1997 1996
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
Assets
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fed. funds sold $ 375 $ 21 5.60% $ 1,197 $ 67 5.60% $ 2,483 $ 133 5.36%
Securities:
Taxable 38,030 2,410 6.34 41,684 2,710 6.50 39,831 2,524 6.34
Tax-exempt 19,442 1,497 7.70 16,681 1,359 8.15 14,875 1,283 8.63
Loans(1)(2) 194,728 17,661 9.07 156,657 14,887 9.50 147,529 13,952 9.46
-------- ------- --------- -------- --------- --------
Total earning assets/total
interest income 252,575 21,589 8.55 216,219 19,023 8.80 204,718 17,892 8.74
------- -------- --------
Cash and due from banks 6,507 4,956 4,474
Unrealized gain 1,085 289 420
All other assets 9,428 8,427 7,999
Allowance for loan loss (2,663) (2,477) (2,462)
--------- ----------- ----------
Total assets $266,932 $227,414 $215,149
======== ======== ========
Liabilities and
Stockholders' Equity
Interest bearing deposits:
MMDA, Savings/NOW accounts $ 71,658 $ 2,027 2.83% $ 63,927 $ 1,927 3.01% $ 62,076 $ 1,854 2.99%
Time 98,870 5,547 5.61 90,180 5,131 5.69 87,885 4,916 5.59
Fed Funds Purchased 15,767 685 4.35 9,038 369 4.08 8,004 301 3.76
Other Borrowed Money 10,966 656 5.99 4,443 266 5.99 1,893 110 5.81
-------- --------- ---------- --------- ---------- ---------
Total interest bearing
liabilities/total
interest expense 197,261 8,915 4.52 167,588 7,693 4.59 159,858 7,181 4.49
------ --------- --------
Noninterest bearing deposits 29,324 22,764 19,762
All other liabilities 2,136 1,773 1,543
Stockholders' Equity:
Accumulated other comprehensive
income 716 191 277
Common Stock, Paid-in Capital,
Retained Earnings 37,495 35,098 33,709
--------- --------- ---------
Total liabilities and
stockholders' equity $266,932 $227,414 $215,149
======== ======== ========
Interest spread $12,218 4.03% $10,931 4.21% $10,321 4.25%
===== ===== =====
Net interest income-FTE $12,674 $11,330 $10,711
======= ======= =======
Net Interest Margin as
a Percentage of Average
Earning Assets - FTE 5.02% 5.24% 5.23%
===== ===== =====
</TABLE>
-16-
<PAGE>
(1) Nonaccruing loans are not significant during theyears indicated, and
for purposes of the computations above, are included in the average
daily loan balances.
(2) Interest on loans includes net origination fees totaling $183,443 in
1998,$249,067 in 1997 and $263,376 in 1996.
Net interest income is the principal source of income for the Company. In
the current year, tax equivalent net interest income increased $1,344,000 to
$12,674,000, a 11.9% increase from the same period in 1997.
Net interest income is the difference between interest earned on loans,
securities, and other earning assets and interest paid on deposits and borrowed
funds. In Table 2 and Table 3 the interest earned on investments and loans is
expressed on a fully taxable equivalent (FTE) basis. Tax exempt interest is
increased to an amount comparable to interest subject to federal income taxes in
order to properly evaluate the effective yields earned on earning assets. The
tax equivalent adjustment is based on a federal income tax rate of 34%. Table 3
analyzes the reasons for the increases and decreases in interest income and
expense. The change in interest due to changes in both balance and rate has been
allocated to change due to balance and change due to rate in proportion to the
relationship of the absolute dollar amounts of change in each.
Table 3 - Change in Tax Equivalent Net Interest Income (in thousands)
<TABLE>
1998 Compared to 1997 1997 Compared to 1996
----------------------- ---------------------
Amount of Amount of
Increase/(Decrease) Increase/(Decrease)
Due to Change In Due to Change In
Net Net
Amount of Amount of
Average Increase/ Increase/
Volume Rate (Decrease) Volume (Decrease)
Interest Income
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold.............. $ (46) $ 0 $ (46) $ (72) $ 6 $ (66)
Securities:
Taxable...................... (232) (54) (286) 120 52 172
Tax Exempt................... 213 (89) 124 149 (59) 90
Loans........................... 3,453 (679) 2,774 867 68 935
--------- ---------- --------- ------- ------- --------
Total interest income........... 3,388 (822) 2,566 1,064 67 1,131
--------- ---------- --------- ------- ------- -------
Interest Expense
Interest bearing deposits:
Savings/NOW Accounts......... 219 (119) 100 56 17 73
Time......................... 488 (72) 416 131 84 215
Fed Funds Purchased.......... 293 23 316 42 26 68
Other Borrowed Money......... 390 0 390 152 4 156
---------- ----------- ---------- ---------- ----------- -------
Total Interest Expense....... 1,390 168 1,222 381 131 512
--------- --------- --------- -------- --------- -------
Net interest income (FTE)....... $ 1,998 $ (654) $ 1,344 $ 683 $ ( 64) $ 619
========= ======== ======== ======= ======== =======
</TABLE>
The Company's commitment to reinvesting in the communities it serves is
evident in its ratios of loans to assets and loans to deposits, which are
generally greater than the comparable ratios of the Company's peers. This in
turn translates into above peer net interest margin. (Based on FFIEC uniform
bank performance report.)
Net interest income as a percent of total interest income FTE was 58.7% ,
59.6% and 59.9%, for 1998, 1997 and 1996, respectively. Net interest margin was
5.02%, 5.24% and 5.23% for the same years.
-17-
<PAGE>
Interest from loans represents 81.8%, 78.3% and 78.0% of total interest
income for 1998, 1997 and 1996, respectively. Net interest income is strongly
influenced by results of the Bank's lending activities.
Total interest expense increased 15.9% from 1997 to 1998 and also increased
7.1% from 1996 to 1997; such variances are detailed in Table 3. Cost of funds
are influenced by economic conditions and activities of the Federal Reserve. The
Bank's asset/liability committee seeks to manage sources and uses of funds, and
to monitor the gap in maturities of these funds to maintain a steady net
interest margin in varying market conditions.
Table 4 - Composition of Average Earning Assets and Interest Paying Liabilities
<TABLE>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
As a percent of average earning assets
Loans........................................ 77% 72% 72%
Other earning assets......................... 23% 28% 28%
----- ----- -----
Average earning assets.................... 100% 100% 100%
Savings and NOW accounts..................... 36% 38% 39%
Time deposits................................ 50% 54% 55%
Other borrowings............................. 14% 8% 6%
----- ----- -----
Average interest bearing liabilities...... 100% 100% 100%
Earning asset ratio............................ 95% 95% 95%
</TABLE>
Table 5 - Noninterest Income (in thousands)
<TABLE>
Year Ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Service charges on deposit accounts ......... $ 588 $ 527 $ 529
Net gains on asset sales:
Loans...................................... 1,367 414 133
Securities................................. 204 66 13
Other income................................. 500 535 400
-------- ------- -------
Total noninterest income................ $2,659 $1,542 $1,075
====== ====== ======
</TABLE>
Noninterest Income
Noninterest income consists of service charges on deposit accounts, service
fees, gains from sales of investment securities available-for-sale and gains
from sales of loans to the Federal Home Loan Mortgage Corporation (Freddie Mac).
The Company retains the servicing rights on these loans. Noninterest income
increased $1,117,000 or 72% for 1998 versus 1997. The increase was primarily due
to a $953,000 increase in gains on real estate mortgage loan sales and a
$138,000 increase on gains of securities available-for-sale.
-18-
<PAGE>
Table 6 Net Gains on the Sale of Real Estate Mortgage Loans (in thousands)
<TABLE>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Total Real estate mortgage loan
originations........................... $91,446 $39,112 $40,934
Real estate mortgage loan sales.............. 72,075 20,567 21,784
Real estate mortgage loans servicing
rights sold.............................. 0 0 0
Net gains on the sale of real
estate mortgage loans.................... 1,367 414 133
Net gains as a percent of real
estate mortgage loan sales............... 1.90% 2.01% 0.61%
</TABLE>
Net gains on the sale of real estate mortgage loans totaled $1,367,000,
$414,000 and $133,000 in 1998, 1997 and 1996, respectively. The increase from
1997 to 1998 of $953,000 was a result of a more favorable interest rate
environment. The increase from 1996 to 1997 of $281,000 was a result of adopting
SFAS No. 125 and a more favorable interest rate environment.
The Bank sells the majority of its fixed-rate obligations. Such loans are
sold without recourse. The Bank retains servicing rights on real estate mortgage
loans sold. The impact of new accounting standards in 1996 (see Discussion of
SFAS No.'s 122 and 125 in Notes to Consolidated Financial Statements) has been
and is expected to continue to be insignificant to the Company's consolidated
financial position and results of operations.
Noninterest Expense
Table 7 - Noninterest Expense (in thousands)
<TABLE>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Salaries and employee benefits............... $3,918 $3,028 $2,650
Occupancy and equipment...................... 1,143 897 845
FDIC assessment.............................. 28 27 17
Postage...................................... 115 129 104
Printing and supplies........................ 268 118 132
Marketing.................................... 213 163 161
Michigan Single Business Tax................. 192 220 197
Other........................................ 1,457 1,200 1,063
------- ------ -------
Total noninterest expense.................. $7,334 $5,782 $5,169
====== ====== ======
</TABLE>
Table 7 lists the Bank's most significant noninterest expenses.
Noninterest expense increased $1,552,000 or 26.8% for 1998 versus 1997.
Salaries and employee benefits increased $890,000 to $3,918,000, a 29.4%
increase which was the major factor for the increase in non-interest expense.
The increase was primarily due to staffing three new branches.
Noninterest expense increased $613,000 or 11.9% in 1997 versus 1996.
Salaries and employee benefits increased $378,000 to $3,028,000 a 14.3% increase
which was the major factor for the increase in non-interest expense.
-19-
<PAGE>
The 1997 increases in salary and employee benefit expense are related to
increased staffing, annual hourly and salary pay adjustments and increased
medical insurance expenses. The increased staffing is a long term initiative
that will be utilized to improve asset quality, regulatory compliance and build
and improve marketing and sales support.
Financial Condition--Summary
During 1998, total assets increased 24% to $301,493,990, deposits increased
17.6% to $217,290,807 and loans grew 31.5% to $222,133,200. The Bank is
emphasizing relationship banking and has competed aggressively to obtain
deposits and loans. A discussion of changes in balance sheet amounts by major
categories follows:
The Loan Portfolio
The loan personnel of the Bank are committed to making quality loans that
produce a competitive rate of return for the Bank and also serve the community
by providing funds for home purchases, business purposes, and consumer needs. It
is management's intent to maintain a loan to deposit ratio of at least 80%,
enabling the Company to earn the highest interest rates available on loans. Loan
demand in the Bank's service area is expected to remain strong to achieve that
goal.
The majority of loans are made to businesses in the form of commercial
loans and real estate mortgages. The Bank's consumer mortgage activity is
substantial; however, only a small portion of these loans are retained for the
Bank's own portfolio. The Bank does retain servicing rights on substantially all
such sold loans. Over the past seven years the Bank has built an one hundred
twenty-two million dollar servicing portfolio with the Federal Home Loan
Mortgage Corporation ("FHLMC"). At December 31, 1998 and 1997, the Bank was
servicing loans of $126,651,000 and $93,000,000, respectively, which relate
primarily to residential mortgages originated by the Bank. The Bank originated
$91,446,000 (1,073 loans) and $39,112,000 (441 loans) in mortgage loans in 1998
and 1997, respectively, and sold to FHLMC $72,676,000 (872 loans) in 1998 and
$20,567,000 (233 loans) in 1997. Repayments and early payoffs were $17,768,000
in 1998 and $13,102,000 in 1997.
The loan portfolio mix at December 31, 1998 consists of 51% commercial real
estate, 17% residential real estate, 18% commercial and 14% consumer
installment. The growth rate of the lending portfolio was 16.5% from 1996 to
1997 and 31.5% from 1997 to 1998.
Nearly 80% of loans are placed within the area the Bank designates as its
market for purposes of regulatory Community Reinvestment Act ("CRA") compliance.
Nearly all loans are placed within the metropolitan area of Grand Rapids and
surrounding communities.
Table 8 - Loan Portfolio Composition (in thousands)
<TABLE>
Year ended December 31
1998 1997 1996
Amount % Amount % Amount %
<S> <C> <C> <C> <C> <C> <C>
Commercial Real Estate....................... $114,248 51 $ 90,005 53 $ 72,280 50
Residential Real Estate...................... 36,554 17 38,886 23 33,443 23
Other Commercial............................. 40,825 18 26,380 16 27,452 19
Installment.................................. 30,506 14 13,682 8 11,894 8
---------- --------- -- --------- --
Total loans............................... 222,133 100% 168,953 100% 145,069 100%
==== ==== ====
Less:
Allowance for Loan Losses................... (2,879) (2,565) (2,376)
------------ ---------- ----------
Total Loans Receivable, Net.................. $219,254 $166,388 $142,693
======== ========= ========
</TABLE>
-20-
<PAGE>
The lending policy of the Bank was written to reduce credit risk, enhance
earnings and guide the lending officers in making credit decisions. There are 8
levels in the loan authorization procedure depending on the dollar amount of the
loan request.
$1,800,001 to $4,500,000 Board of Directors
$ 750,001 to $1,800,000 Executive Loan Committee
0 to $ 750,000 Loan Committee
0 to $ 250,000 Class 1 Lender
0 to $ 150,000 Class 2 Lender
0 to $ 75,000 Class 3 Lender
0 to $ 30,000 Class 4 Lender
Student Loans Only Class 5 Lender
The class of lender is approved by the Bank's Board of Directors. The Board
of Directors has appointed a Chief Lending Officer who is responsible for the
supervision of the lending activities of the Bank. The Board has also appointed
a loan review officer who monitors the credit quality of the loan portfolio
independent of the loan approval process. Periodic reviews are submitted by the
loan review officers to the Chief Lending Officer and these reviews are
submitted to the Audit/Compliance Committee on a quarterly basis. The Bank has
no foreign loans and there were no concentrations greater than 10% of total
loans that are not disclosed as a separate category in Table 8.
The extent of loan quality is demonstrated by the low ratios of
nonperforming loans and charge offs as a percentage of the loan portfolio. As
referenced in more detail in Table 10 below, the Bank's ratio of nonperforming
loans to total loans at December 31, 1998 was only .26%. The Bank had net
charge-offs of $86,000 in 1998 and net recoveries of $139,000 in 1997.
Nonperforming assets are comprised of loans for which the accrual of
interest has been discontinued, accruing loans 90 days or more past due in
payments, collateral for loans which have been in-substance foreclosed, and
other real estate which has been acquired primarily through foreclosure and is
awaiting disposition. Loans, including loans considered impaired under SFAS No.
118, are generally placed on a nonaccrual basis when principal or interest is
past due 90 days or more and when, in the opinion of management, full collection
of principal and interest is unlikely.
Table 9 Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table shows the amount of total loans outstanding as of
December 31, 1998 which, based on remaining scheduled repayments of principal,
are due in the periods indicated.
<TABLE>
Maturing
(in thousands of dollars)
After one but
Within one Year within five years After five years Total
<S> <C> <C> <C> <C>
Residential Real Estate.............. $ 11,856 $ 21,269 $3,429 $ 36,554
Installment.......................... 1,679 27,054 1,773 30,506
Commercial Real Estate............... 27,667 76,722 9,859 114,248
Other Commercial..................... 23,021 17,428 376 40,825
---------- ---------- -------- --------
Totals......................... $64,223 $142,473 $15,437 222,133
======= ======== =======
Allowance for Loan Losses............ (2,879)
----------
Total Loans Receivable, Net.......... $219,254
========
</TABLE>
-21-
<PAGE>
Below is a schedule of the amounts maturing or repricing which are
classified according to their sensitivity to changes in interest rates.
<TABLE>
Interest Sensitivity
(in thousands of dollars)
Fixed Rate Variable Rate Total
<S> <C> <C> <C>
Due within 3 months.................................... $ 7,443 $44,563 $ 52,006
Due after 3 months within 1 year....................... 19,341 1,595 20,936
Due after one but within five years.................... 135,349 0 135,349
Due after five years................................... 13,842 0 13,842
---------- --------- ----------
Total.................................................. $175,975 $46,158 222,133
======== =======
Allowance for loan losses.............................. (2,879)
-----------
Total loans receivable, net............................ $219,254
========
</TABLE>
Table 10 - Nonperforming Assets (in thousands)
<TABLE>
December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Nonaccrual loans................................................ $ 353 $ 105 $1,080
90 days or more past due & still accruing....................... 217 132 114
------- ------- ---
Total nonperforming loans................................... 570 237 1,194
Other real estate............................................... 116 45 0
------- -------- ------
Total nonperforming assets.................................. $ 686 $ 282 $1,194
====== ====== ======
Nonperforming loans as a percent of total loans................. 0.26% 0.14% 0.82%
Nonperforming assets as a percent of total loans................ 0.31% 0.17% 0.82%
Nonperforming loans as a percent of the allowance
for loan losses............................................. 20% 9% 50%
</TABLE>
Nonperforming loans equal 20% of the Bank's allowance for loan losses as of
December 31, 1998; management believes that the allowance for loan losses is
adequate for these loans and the remainder of the lending portfolio. As of
December 31, 1998 there were no other interest bearing assets which required
classification. Management is not aware of any recommendations by regulatory
agencies, which, if implemented, would have a material impact on the Company's
liquidity, capital or results of operations.
It is expected that the $116,000 in other real estate will be liquidated
without loss in 1999.
The table below presents the interest income that would have been earned on
non-performing loans outstanding at December 31, 1998, 1997, and 1996 had those
loans been accruing interest in accordance with the original terms of the loan
agreement (pro forma interest) and the amount of interest income actually
included in net interest income for those years.
-22-
<PAGE>
Table 11 - Foregone Interest on Non-Performing Loans
<TABLE>
For the Year Ended December 31
(in thousands)
1998 1997 1996
Non-accrual Restructured Non-accrual Restructured Non-accrual Restructured
<S> <C> <C> <C> <C> <C> <C>
Pro forma interest $33 $ - $11 $25 $212 $ -
Interest earned 32 - 8 25 11 -
---- ------- ----- ---- ----- -----
Foregone interest income $ 1 $ - $ 3 $ 0 $201 -
==== ====== ==== ==== ==== =====
</TABLE>
Table 12 - Loan Loss Experience (in thousands)
The following is a summary of loan balances (excluding loans held for sale)
at the end of each period and their daily average balances, changes in the
allowance for loan losses arising from loans charged off and recoveries on loans
previously charged off, and additions to the allowance which have been expensed.
<TABLE>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Loans:
Average daily balance of loans for the year.................... $190,472 $155,286 $146,052
Amount of loans outstanding at end of period................... $222,133 $168,953 $145,069
Allowance for loan losses
Balance at beginning of year................................... $2,565 $ 2,376 $ 2,305
Loans charged off:
Real estate.................................................. 0 0 0
Commercial................................................... 90 0 108
Consumer..................................................... 117 124 71
------------ --------- ---------
Total charge-offs........................................ 207 124 179
Recoveries of loans previously charged off
Real estate.................................................. 0 0 56
Commercial................................................... 33 224 157
Consumer..................................................... 88 39 37
------------ --------- ---------
Total recoveries......................................... 121 263 250
----------- -------- ---------
Net (charge off) recoveries.................................... (86) 139 71
Additions to allowance charged to operations................... 400 50 0
----------- ---------- -----------
Balance at end of year................................... $ 2,879 $ 2,565 $ 2,376
========= ======== =========
Ratios:
Net (charge offs) recoveries to average daily balance
of loans for the year....................................... (.05%) .09% .05%
Allowance for loan losses to loans outstanding at year end..... 1.30% 1.52% 1.64%
</TABLE>
-23-
<PAGE>
Table 13 - Allocation of the Allowance for Loan Losses
The allowance for loan losses is analyzed quarterly by management. In so
doing, management assigns a portion of the allowance to specific credits that
have been identified as problem loans and reviews past loss experience. The
local economy and particular concentrations are considered, as well as a number
of other factors.
<TABLE>
Year ended December 31
1998 1997 1996
---- ---- ----
% of each % of each % of each
category category category
Allowance to total Allowance to total Allowance to total
Amount loans Amount loans Amount loans
<S> <C> <C> <C> <C> <C> <C>
Commercial.................... $2,175 68.8% $1,895 68.9% $1,734 68.7%
Real estate mortgages......... 310 16.5 205 23.0 188 23.1
Consumer...................... 378 13.7 179 8.1 158 8.2
Unallocated................... 16 .0 286 .0 296 .0
--------- --------- ------- -------- ------- -------
Total....................... $2,879 100.0% $2,565 100.0% $2,376 100.0%
====== ====== ====== ====== ====== ======
</TABLE>
The above allocations are not intended to imply limitations on usage of the
allowance. The entire allowance is available for any future loans without regard
to loan type.
Investment Securities
Securities are purchased and classified as "available-for-sale." These
securities may be sold to meet the Bank's liquidity needs or to improve the
quality of the investment portfolio. The primary objective of the Company's
investing activities is to provide for safety of the principal invested.
Secondary considerations include earnings, liquidity, and the overall exposure
to changes in interest rates. The Company's net holdings of investment
securities decreased $5.4 million in 1998 and increased $3.7 million in 1997.
The mortgage backed securities are issues of the Federal Home Loan Mortgage
Corporation, GNMA, and FNMA which pay monthly amortized principal and interest
payments.
Table 14 - Available-for-Sale Securities Portfolio
<TABLE>
Year Ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
U. S. Treasury and U.S. Government Agencies..................... $32,453 $ 39,176 $ 40,048
State and political subdivisions................................ 21,007 19,604 15,880
Other........................................................... 2,887 3,013 2,143
--------- ---------- ---------
$56,347 $ 61,793 $ 58,071
======= ========= ========
</TABLE>
Excluding those holdings of the investment portfolio in U.S. Treasury and
U.S. Government Agency Securities, there were no investments in securities of
any one issuer which exceeded 10% of shareholders' equity.
-24-
<PAGE>
Table 15 - Schedule of Maturities of Investment Securities and Weighted Average
Yields
The following is a schedule of maturities and their weighted average yield
of each category of investment securities as of December 31, 1998. The weighted
average interest rates have been computed on a fully taxable equivalent basis,
based on amortized cost. The rates shown on securities issued by states and
political subdivisions are stated on a taxable equivalent basis using a 34% tax
rate.
<TABLE>
Maturing
(Dollars in Thousands)
Investments With
Due Within One to Five to After No Contractual
One Year Five Years Ten Years Ten Years Maturity
Fair Avg. Fair Avg. Fair Avg. Fair Avg. Fair Avg.
Value Yield Value Yield Value Yield Value Yield Value Yield
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available for Sale:
U.S. Treasury
and U.S.
Government
Agencies $1,383 6.52% $21,835 6.75% $ 7,471 6.66% $1,764 6.04% $ - -
States and
Political
Subdivisions 1,760 10.30% 6,404 8.82% 9,372 7.48% 3,471 7.48% - -
Other Securities - - - - - - - - 2,887 7.13%
------ ------ ------- ------- ------ -------
$3,143 8.62% $28,239 7.22% $16,843 7.12% $5,235 4.97% $2,887 7.13%
</TABLE>
Deposits
Deposits are gathered from the communities the Bank serves. Recently the
Bank has emphasized relationship marketing to reinforce the core nature of its
deposit base.
Table 16 indicates a relatively stable base of deposits spread over the
Bank's product lines. Average total deposits grew 13.0% from 1997 to 1998 and
grew 4.2% from 1996 to 1997. The increase in 1997 resulted primarily from
gaining market share and opening three branches.
The Bank is continually enhancing its deposit product. In addition to
relationship pricing the Bank has instituted telephone and personal computer
banking as new alternatives to customer access. The Bank operates nine automated
teller machines, three of which are off-site.
Table 16 - Average Daily Deposits (in thousands)
<TABLE>
Average for the Year
1998 1997 1996
Amount % of Assets Amount % of Assets Amount % of Assets
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing demand........... $ 29,324 11% $ 22,764 10% $ 19,762 9%
NOW accounts......................... 15,352 6 12,687 6 11,840 6
MMDA/Savings ........................ 56,306 21 51,240 22 50,236 23
Time................................. 98,870 37 90,180 40 87,885 41
---------- ---- --------- ---- --------- ---
Total Deposits.................... $199,852 75% $176,871 78% $169,723 79%
======== ==== ======== ==== ======== ===
</TABLE>
-25-
<PAGE>
Table 17 - Average Deposit Balances
The following table sets forth the average deposit balances and the
weighted average rates paid thereon:
<TABLE>
Average for the Year
1998 1997 1996
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing demand........... $29,324 $ 22,764 $ 19,762
NOW Accounts......................... 15,352 2.45% 12,687 2.44% 11,840 2.44%
MMDA/Savings......................... 56,306 2.93 51,240 3.16 50,236 3.11
Time................................. 98,870 5.61 90,180 5.69 87,885 5.99
-------- ----- --------- ------ --------- ----
Total Deposits.................... $199,852 3.79% $176,871 3.99% $169,723 3.99%
========= ======== ========
</TABLE>
Table 18 - Maturity Distribution of Time Deposits of $100,000 Or More
The following table summarizes time deposits in amounts of $100,000 or
more by time remaining until maturity as of December 31, 1998:
<TABLE>
Amount
<S> <C>
Three months or less............................. $4,663
Over 3 months through 6 months................... 2,552
Over 6 months through 1 year.................... 4,454
Over 1 year...................................... 3,007
-------
$14,676
=======
</TABLE>
The Bank operates in a very competitive environment. Management monitors
rates at other financial institutions in the area to ascertain that its rates
are competitive with the market. Management also attempts to offer a wide
variety of products to meets the needs of its customers. The Bank offers
business and consumer checking accounts, regular and money market savings
accounts, and certificates having many options in their terms.
Market Risk
The Bank complements its stable core deposit base with alternate sources of
funds, which includes advances from the Federal Home Loan Bank and on a very
limited basis, jumbo certificates of deposit from outside its market area.
Management evaluates the funding needs and makes a decision based on current
interest rates and terms whether to fund internally or from alternate sources.
To date, the Bank has not employed the use of derivative financial instruments
in managing the risk of changes in interest rates.
Capital
A financial institution's capital ratio is looked upon by the regulators
and the public as an indication of its soundness. Table 19 summarizes the
Company's regulatory capital and its capital ratios. Also shown are the capital
requirements established by the regulatory agencies for adequately and
well-capitalized institutions. The Bank's strong capital ratio puts it in the
best classification on which the FDIC bases its assessment charge. As capital
ratios continue to increase, management is challenged to find ways to
effectively invest and administer the Bank's resources.
In 1998, the Company paid cash dividends totaling $2,350,000, approximately
46% of earnings. In 1997, the Company paid cash dividends totaling $3,115,620,
approximately 67% of earnings. In 1996, the Company paid cash dividends of
$942,389, approximately 22% of earnings.
-26-
<PAGE>
On February 2, 1998, the Company paid a special $1.00 per share cash
dividend. This distribution was in addition to the regular dividends for 1998.
The Company remains in all the top regulatory categories for adequately and
well-capitalized institutions after paying such dividends.
Table 19 - Capital Resources (in thousands)
<TABLE>
Regulatory Requirements December 31
Adequately Well
Capitalized Capitalized 1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C> <C>
Tier 1 capital..................... $39,232 $35,689 $34,566
Tier 2 capital..................... 2,879 2,293 1,976
--------- --------- ---------
Total qualifying capital......... $42,111 $37,982 $36,542
======= ======= =======
Tier 1 leverage ratio.............. 4% 5% 13.53% 15.03% 15.97%
Tier 1 risk-based capital.......... 4% 6% 16.02% 19.48% 21.92%
Total risk-based capital........... 8% 10% 17.20% 20.74% 23.18%
</TABLE>
Asset/Liability Management
The Bank's Asset/Liability Management committee ("ALCO") meets regularly to
evaluate the Bank's interest rate sensitivity position, address issues of
liquidity, and review the interest margin, analyzing causes for changes in net
interest income. During 1998, the Bank's one year gap position averaged a 43%
negative gap.
Management was able to influence the gap by selling fixed rate mortgages,
investments/sales of available-for- sale securities that met the criteria that
filled the gap position decided by the Asset/Liability Committee.
The Company's sources of liquidity include principal payments received on
loans, maturing investment securities, sale of securities held in the "available
for sale" designation, customer deposits, borrowings from the Federal Home Loan
Bank of Indianapolis, other bank borrowings, Federal Funds and the issuance of
common stock. The Company has ready access to significant sources of liquidity
on an almost immediate basis. Management anticipates no difficulty in
maintaining liquidity at levels necessary to conduct the Bank's day-to-day
business activity.
-27-
<PAGE>
Table 20 - Asset/Liability Gap Position (in thousands)
<TABLE>
December 31, 1998
0-3 4-12 1-5 5+
Months Months Years Years Total
Interest earning assets:
<S> <C> <C> <C> <C> <C>
Loans................................... $52,006 $20,936 $135,349 $13,842 $222,133
Securities.............................. 10,167 3,970 6,514 35,696 56,347
Loans held for sale..................... 4,680 - - - 4,680
--------- --------- ----------- --------- ---------
Total interest earning assets........... $66,853 $24,906 $141,863 $49,538 $283,160
======= ======= ========= ======= ========
Interest bearing liabilities:
Savings & NOW........................... $28,241 $ - $ - $52,430 $ 80,671
Time.................................... 23,547 51,307 26,264 - 101,118
-------- --------- ----------- ------------- ---------
Total deposits.......................... 51,788 51,307 26,264 52,430 181,789
Other borrowings........................ 30,126 4,000 8,000 - 42,126
-------- ---------- ----------- ------------- ----------
Total interest bearing liabilities..... $81,914 $55,307 $ 34,264 $52,430 $223,915
------- ------- --------- -------
Rate sensitivity gap and ratios:
Gap for period.......................... (15,061) (30,401) 107,599 (2,892)
Cumulative gap.......................... (15,061) (45,462) 62,137 59,245
Ratio for period as a % of assets......... (5.0)% (10.1)% 35.7% (1.0)%
Cumulative rate sensitive ratio as
a % of assets.......................... (5.0)% (15.1)% 20.6% 19.7%
</TABLE>
The savings and NOW accounts are categorized in the above table based upon
the Bank's historical experience.
Impact of Inflation
The majority of assets and liabilities of financial institutions are
monetary in nature. Generally, changes in interest rates have a more significant
impact on earnings of the Bank than inflation. Although influenced by inflation,
changes in rates do not necessarily move in either the same magnitude or
direction as changes in the price of goods and services. Inflation does impact
the growth of total assets, creating a need to increase equity capital at a
higher rate to maintain an adequate equity to assets ratio, which in turn
reduces the amount of earnings available for cash dividends.
Year 2000
Because many computerized systems use only two digits to record the year in
date fields (for example, the year 1998 is recorded as 98), such systems may not
be able to accurately process dates ending in the year 2000 and after. The
effects of the issue will vary from system to system and may adversely affect
the ability of a financial institution's operations as well as its ability to
prepare financial statements.
Company management has developed and the Board of Directors has approved a
comprehensive Year 2000 Compliance Plan. The Company has an internal task force
to assess Year 2000 compliance by the Company, its vendors, and major commercial
loan customers. In addition, the Bank asks commercial borrowers about Year 2000
compliance as part of the loan application and review process.
To date, the Company has spent approximately $5,000 on Year 2000 compliance
and expects to spend an additional $5,000 to complete this work.
-28-
<PAGE>
The Company presently anticipates that it will complete its Year 2000
assessment and remediation by December 31, 1999. However, there can be no
assurance that the Company will be successful in implementing its Year 2000
remediation plan according to the anticipated schedule. In addition, the Company
may be adversely affected by the inability of other businesses whose systems
interact with the Company to become Year 2000 compliant.
Although the Company expects its internal systems to be Year 2000 compliant
as described above, the Company is in the process of preparing a contingency
plan that will specify what it plans to do if important internal or external
systems are not Year 2000 compliant in a timely manner.
Management does not anticipate that the Company will incur material
operating expenses or be required to invest heavily in computer system
improvements to be Year 2000 compliant. Nevertheless, the inability of the
Company to successfully address Year 2000 issues could result in interruptions
in the Company's business and have a material adverse effect on the Company's
results of operations.
Forward Looking Statements
This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse affect on the
operations and future prospects of the Company and the subsidiaries include, but
are not limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Further
information concerning the Company and its business, including additional
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
-29-
<PAGE>
ITEM 7A: Quantitative and Qualitative Disclosures About Market Risk
A derivative financial instrument includes futures, forwards, interest rate
swaps, option contracts, and other financial instruments with similar
characteristics. The Company currently does not enter into futures, forwards,
swaps, or options. However, the Company is party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates and may require collateral from the borrower if deemed
necessary by the Company. Standby letters of credit are conditional commitments
issued by the Company to guarantee the performance of a customer to a third
party up to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Company until the instrument is exercised.
The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximize income. Management realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and a simulation model. The Company has no market risk
sensitive instruments held for trading purposes. It appears the Company's market
risk is reasonable at this time.
-30-
<PAGE>
Item 8. Financial Statements and Supplementary Data.
O.A.K. FINANCIAL CORPORATION TABLE OF CONTENTS
AND SUBSIDIARY
- --------------------------------------------------------------------------------
PAGE
Independent Auditors' Report 32
Consolidated Financial Statements
Consolidated Balance Sheets 33
Consolidated Statements of Income 34
Consolidated Statements of Comprehensive Income 35
Consolidated Statements of Changes in Stockholders' Equity 36
Consolidated Statements of Cash Flows 37
Notes to Consolidated Financial Statements 38-52
-31-
<PAGE>
REHMANN
ROBSON
- --------------------------------------------------------------------------------
CPA'S & CONSULTANTS - PC Member of Summit International
Associates, Inc.
Worldwide Association of
Accounting Firms
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
O.A.K. Financial Corporation and Subsidiary
Byron Center, Michigan
We have audited the accompanying consolidated balance sheets of O.A.K. Financial
Corporation and Subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of income, comprehensive income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1998. These consolidated financial statements are the responsibility of O.A.K.
Financial Corporation's management. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 O.A.K. Financial
Corporation and Subsidiary as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ Rehmann Robson, P.C.
Grand Rapids, Michigan
January 29, 1999
3230 Eagle Park Drive, N.W., Suite 201, - Grand Rapids, MI 49525 -
Phone (616) 975-4100 - FAX (616) 975-4400
-32-
<PAGE>
O.A.K. FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS
AND SUBSIDIARY
- --------------------------------------------------------------------------------
<TABLE>
December 31,
-----------------------------------
ASSETS 1998 1997
------------ -------------
<S> <C> <C>
Cash and due from banks $8,913,513 $5,367,937
Available-for-sale securities - amortized cost of
$55,079,539 - 1998 ($60,999,414 - 1997) 56,346,568 61,792,674
Loans receivable, net 219,253,824 166,387,650
Loans held for sale 4,679,962 1,345,615
Accrued interest receivable 2,026,185 1,513,146
Premises and equipment, net 7,092,765 4,534,281
Other assets 3,181,173 2,146,617
------------ -------------
Total assets $301,493,990 $243,087,920
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Interest bearing $181,789,253 $158,243,971
Noninterest bearing 35,501,554 26,456,357
------------ -------------
Total deposits 217,290,807 184,700,328
Borrowed funds 27,752,803 11,300,000
Securities sold under agreements to repurchase 14,373,304 8,657,583
Other liabilities 2,124,091 1,515,231
------------ -------------
Total liabilities 261,541,005 206,173,142
------------ -------------
Stockholders' equity
Common stock, $1 par value; 4,000,000 shares authorized;
2,000,000 shares issued and outstanding,
(1,000,000 shares in 1997) 2,000,000 1,000,000
Additional paid-in capital 5,622,680 5,622,680
Retained earnings 31,494,055 29,768,536
Accumulated other comprehensive income 836,250 523,562
------------ ------------
Total stockholders' equity 39,952,985 36,914,778
------------ ------------
Total liabilities and stockholders' equity $301,493,990 $243,087,920
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-33-
<PAGE>
O.A.K. FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
AND SUBSIDIARY
- --------------------------------------------------------------------------------
<TABLE>
Year Ended December 31,
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Interest income
Loans $17,629,417 $14,858,954 $13,922,548
Available-for-sale securities 3,485,214 3,697,712 3,445,883
Federal funds sold 19,827 67,073 133,136
----------------- ----------------- -----------------
Total interest income 21,134,458 18,623,739 17,501,567
----------------- ----------------- -----------------
Interest expense
Deposits 7,574,458 7,058,031 6,770,126
Borrowed funds 849,088 314,015 137,212
Securities sold under agreements to repurchase 492,626 320,519 273,350
----------------- ----------------- -----------------
Total interest expense 8,916,172 7,692,565 7,180,688
----------------- ----------------- -----------------
Net interest income 12,218,286 10,931,174 10,320,879
Provision for loan losses 400,000 50,000 0
----------------- ----------------- -----------------
Net interest income after provision for
loan losses 11,818,286 10,881,174 10,320,879
----------------- ----------------- -----------------
Noninterest income
Service charges 587,786 527,099 529,471
Net gain on sale of available-for-sale loans 1,367,075 414,364 133,000
Loan servicing fees 183,735 203,295 180,837
Net gain on sale of availiable-for-sale securities 204,076 66,190 13,071
Other 316,633 331,126 218,562
----------------- ----------------- -----------------
Total noninterest income 2,659,305 1,542,074 1,074,941
----------------- ----------------- -----------------
Noninterest expenses
Salaries and employee benefits 3,917,992 3,028,338 2,649,626
Occupancy 465,271 384,237 361,280
Furniture and fixtures 678,055 512,896 483,930
Michigan single business tax 192,042 220,000 197,000
Printing and supplies 267,682 117,941 132,251
Other 1,813,030 1,518,062 1,344,441
----------------- ----------------- -----------------
Total noninterest expenses 7,334,072 5,781,474 5,168,528
----------------- ----------------- -----------------
Income before federal income taxes 7,143,519 6,640,974 6,227,292
Federal income taxes 2,068,000 2,015,000 1,852,000
----------------- ----------------- -----------------
Net income $5,075,519 $4,625,974 $4,375,292
================= ================= =================
Net income per basic share of common stock $2.54 $2.30 $2.17
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-34-
<PAGE>
O.A.K. FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF
AND SUBSIDIARY COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
<TABLE>
Year Ended December 31,
----------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Unrealized gains (losses) on available-
for-sale securities arising during the year $676,764 $491,830 ($591,457)
Less reclassification adjustment for realized
gains included in net income 204,076 66,190 13,071
----------------- ----------------- -----------------
Comprehensive income (loss)
before income taxes 472,688 425,640 (604,528)
Related income taxes (benefit) 160,000 145,000 (205,000)
----------------- ----------------- -----------------
Other comprehensive income (loss) 312,688 280,640 (399,528)
Net income 5,075,519 4,625,974 4,375,292
----------------- ----------------- -----------------
Comprehensive income $5,388,207 $4,906,614 $3,975,764
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-35-
<PAGE>
O.A.K. FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF
AND SUBSIDIARY CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
Year Ended December 31,
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Shares of common stock issued and outstanding
Balance, beginning of year 1,000,000 1,006,174 915,562
Common stock dividends 1,000,000 0 91,522
Repurchases and retirements 0 (6,174) (910)
----------------- ----------------- -----------------
Balance, end of year 2,000,000 1,000,000 1,006,174
================= ================= =================
Common stock
Balance, beginning of year $1,000,000 $1,006,174 $915,562
Common stock dividends 1,000,000 0 91,522
Repurchase and retirement of common shares 0 (6,174) (910)
----------------- ----------------- -----------------
Balance, end of year 2,000,000 1,000,000 1,006,174
----------------- ----------------- -----------------
Additional paid-in-capital
Balance, beginning of year 5,622,680 6,036,338 6,084,056
Repurchase and retirement of common shares 0 (413,658) (47,718)
----------------- ----------------- -----------------
Balance, end of year 5,622,680 5,622,680 6,036,338
----------------- ----------------- -----------------
Retained earnings
Balance, beginning of year 29,768,536 28,258,182 24,916,801
Net income 5,075,519 4,625,974 4,375,292
Common stock dividends (1,000,000) 0 (91,522)
Cash dividends (2,350,000) (3,115,620) (942,389)
----------------- ----------------- -----------------
Balance, end of year 31,494,055 29,768,536 28,258,182
----------------- ----------------- -----------------
Accumulated other comprehensive income
Balance, beginning of year 523,562 242,922 642,450
Other comprehensive income (loss) 312,688 280,640 (399,528)
----------------- ----------------- -----------------
Balance, end of year 836,250 523,562 242,922
----------------- ----------------- -----------------
Total stockholders' equity $39,952,985 $36,914,778 $35,543,616
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-36-
<PAGE>
O.A.K. FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF
AND SUBSIDIARY CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
Year Ended December 31,
--------------------------------------------------------
1998 1997 1996
------------------ ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $5,075,519 $4,625,974 $4,375,292
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 553,789 459,915 441,655
Provision for possible loan losses 400,000 50,000 0
Proceeds from sales of loans held
for sale 73,442,003 20,981,500 21,917,000
Originations of loans held for sale (75,409,274) (19,979,751) (21,784,000)
Net gain on sale of available-for-sale
securities (204,076) (66,190) (13,071)
Net gain on sale of loans held for sale (1,367,075) (414,364) (133,000)
Net amortization of investment premiums 203,231 196,390 211,107
Changes in operating assets and liabilities
which (used) provided cash
Accrued interest receivable (513,039) (59,748) 116,746
Other assets (1,034,556) (223,816) (104,533)
Other liabilities 608,860 290,516 (147,407)
------------------ ----------------- -----------------
Net cash provided by operating activities 1,755,382 5,860,426 4,879,789
------------------ ----------------- -----------------
Cash flows from investing activities
Available-for-sale securities
Proceeds from maturities 11,773,936 10,278,679 9,466,608
Proceeds from sales 2,213,374 7,445,638 3,159,555
Purchases (8,228,435) (21,299,916) (14,019,935)
Net increase in loans held for investment (53,266,174) (23,744,280) (3,938,702)
Purchases of premises and equipment (3,111,510) (335,955) (477,122)
------------------ ----------------- -----------------
Net cash used in investing activities (50,618,809) (27,655,834) (5,809,596)
------------------ ----------------- -----------------
Cash flows from financing activities
Net increase in non-interest bearing demand
deposits, NOW accounts and savings deposits 25,040,906 3,256,194 8,792,535
Net increase (decrease) in time deposits 7,549,573 11,223,227 (8,583,471)
Net borrowed funds 16,452,803 8,099,006 1,200,000
Net increase in securities sold under agreements
to repurchase 5,715,721 1,321,285 2,399,741
Dividends paid (2,350,000) (3,115,620) (942,389)
Repurchase and retirement of common shares 0 (419,832) (48,628)
------------------ ----------------- -----------------
Net cash provided by financing activities 52,409,003 20,364,260 2,817,788
------------------ ----------------- -----------------
Net increase (decrease) in cash and
cash equivalents 3,545,576 (1,431,148) 1,887,981
Cash and cash equivalents, beginning of year 5,367,937 6,799,085 4,911,104
------------------ ----------------- -----------------
Cash and cash equivalents, end of year $8,913,513 $5,367,937 $6,799,085
================== ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-37-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - O.A.K. Financial Corporation (the ACorporation") through its wholly
owned subsidiary, Byron Center State Bank (the "Bank") provides a variety of
financial services to individuals and businesses in the southern portion of the
greater Grand Rapids, Michigan area through its seven branches located in Byron
Center, Jamestown, Cutlerville, Hudsonville, Grandville, Moline and Dorr. Active
competition, principally from other commercial banks and credit unions, exists
in all of the Bank's principal markets. The Bank's results of operations can be
significantly affected by changes in interest rates or changes in the local
economic environment.
The Bank's primary deposit products are interest and noninterest bearing
checking accounts, savings accounts and time deposits and its primary lending
products are commercial loans, real estate mortgages, and consumer loans.
The Bank is a state chartered bank and a member of the Federal Deposit Insurance
Corporation's ("FDIC") Bank Insurance Fund. The Bank is subject to the
regulations and supervision of the FDIC, Federal Reserve Bank and the Financial
Institutions Bureau and undergoes periodic examinations by these regulatory
authorities (see Note 10).
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. The
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan losses and the fair
value of certain financial instruments.
Accounting Policies - The accounting policies used in the preparation of the
accompanying consolidated financial statements conform to predominant banking
industry practices and are based on generally accepted accounting principles.
The principles which materially affect the determination of the Corporation's
consolidated financial position or results of operations are summarized as
follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Corporation
and the Bank. All significant intercompany accounts and transactions have been
eliminated in consolidation.
Comprehensive Income
In 1998, the Corporation adopted Statement of Financial Accounting Standards
(SFAS) No. 130, Reporting Comprehensive Income. This statement establishes
presentation standards for the reporting and display of comprehensive income and
its components. Comprehensive income for the Corporation consists of net income
and net unrealized gains and losses on available- for-sale securities and is
presented in a separate Statement of Comprehensive Income. The adoption of SFAS
No. 130 had no impact on net income or stockholders' equity. Prior year
financial statements have been reclassified to conform to the SFAS No. 130
requirements.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks and
federal funds sold. Generally, federal funds are sold for a one-day period.
Available-For-Sale Securities
All securities are classified as available-for-sale and are recorded at fair
value. Unrealized appreciation and depreciation, net of the effect of applicable
income taxes, on available-for-sale securities are reported as a net amount in
other comprehensive income. Realized gains or losses on securities sold are
determined using the specific identification method. Premiums and discounts are
recognized in interest income using the interest method over the period to
maturity.
Loans held for Investment and Related Income
Loans held for investment are stated at their principal amount outstanding.
Interest on loans is accrued over the term of the loan based on the principal
amount outstanding. Management reviews loans delinquent 90 days or more to
determine if interest accrual should be discontinued based on the estimated fair
market value of the or the present value of estimated future cash flows. The
carrying values of impaired loans are periodically adjusted to reflect cash
payments, revised estimates of future cash flows, and increases in the present
value of
-38-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
expected cash flows due to the passage of time. Cash payments representing
interest income are reported as such. Other cash payments are reported as
reductions in carrying value, while increases or decreased due to changes in
estimates of future payments and due to the passage of time are reported as
reductions or increases in the provision for loan losses.
Loan fees net of direct loan origination costs are deferred and recognized as
interest income over the term of the loan using the constant yield method.
Mortgage Banking Activities
Loans held for sale are carried at the lower of aggregate amortized cost or
market value. Lower of cost or market value adjustments, as well as realized
gains and losses, are recorded in current earnings. SFAS No. 122 as amended by
SFAS No. 125 requires the Bank to recognize as separate assets the rights to
service mortgage loans for others that have been acquired by purchase or the
origination and subsequent sale of a loan with servicing retained. The fair
value of capitalized originated mortgage servicing rights has been determined
based upon market value quotes for similar servicing. The impact of adopting
SFAS Nos. 122 and 125 on the Corporation's consolidated financial position and
results of operations was not material.
Mortgage servicing rights are allocated between the loan (without the servicing
rights) and the servicing rights, based on their relative fair values. The costs
allocated to mortgage servicing rights are recorded as a separate asset and
amortized in proportion to, and over the life of, the net servicing income.
Gains and losses on the sale of loans, which are sold without recourse, are
recognized when proceeds from the loan sales are received by the Bank and are
measured by the difference between the net selling price and the carrying value
of such loans. The carrying value of the mortgage servicing rights is
periodically evaluated for impairment. Impairment is recognized using the fair
value of individual stratum of servicing rights based on the underlying risk
characteristics of the serviced loan portfolio, compared to an aggregate
portfolio approach under existing accounting guidance.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure establishing a new
cost basis.
Allowance for Loan Losses
An allowance for loan losses is recorded because some loans may not be repaid in
full. The allowance is increased by a provision in the income statement and by
recoveries on loans previously charged off. The allowance is decreased as loans
are charged off. A charge-off, in whole or in part, occurs once a significant
probability of loss has been determined, with consideration given to such
factors as the customer's financial condition, underlying collateral and
guarantees. Collection efforts continue and future recoveries may occur with
respect to loans previously charged off.
Estimating the risk of loss and the amount of loss on any loan is necessarily
subjective. Management's evaluation of the allowance is based upon periodic
reviews of the loan portfolios. These reviews are performed by the responsible
lending officers and internal loan review personnel who consider, among other
factors, the Bank's past loan loss experience, the effects of current
developments with respect to the borrowers, the estimated value of underlying
collateral, changes in economic conditions, specific impaired loans, and results
of examinations by bank regulatory authorities.
Impaired loans, as defined, are measured based on the present value of expected
cash flows discounted at the loans effective interest rate or, as a practical
expedient, at the loans observable market price or at the fair value of
collateral if the loan is collateral dependent. Loans considered to be impaired
are reduced to the present value of expected future cash flows or to the fair
value of collateral, by allocating a portion of the allowance for loan losses to
such loans. If these allocations cause the allowance for loan losses to
increase, such increase is reported as additional provision for loan losses.
-39-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Smaller-balance homogeneous loans are residential first mortgage loans secured
by one-to-four family residences, residential construction loans, automobile,
home equity and second mortgage loans and are collectively evaluated for
impairment. Commercial loans and first mortgage loans secured by other
properties are evaluated individually for impairment. Management uses the Bank's
normal credit analysis information, including delinquency reports, non-accrual
listings and an internally prepared watch list, to identify loans which should
be evaluated for impairment. A loan is considered impaired when management
concludes it is probable that the borrower will not remit payments in accordance
with the terms of the agreement. Loans, or portions thereof, are charged off
when deemed uncollectible. The nature of disclosures for impaired loans is
considered generally comparable to prior nonaccrual, past due, trouble debt
restructuring and nonperforming asset disclosures.
In management's judgment, the allowance for loan losses is maintained at a level
adequate to provide for estimated potential losses inherent in the loan
portfolio. However, because of uncertainties inherent in the estimation process,
it is possible that the allowance for loan losses may change in the near term.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using both the straight-line and accelerated methods
over the related assets estimated useful lives which generally range from 5 to
approximately 40 years. Maintenance, repairs and minor alterations are charged
to current operations as expenditures occur and major improvements are
capitalized. Management annually reviews these assets to determine whether
carrying values have been impaired.
Net Income Per Share
Net income per basic share of common stock is calculated on the basis of the
weighted average number of shares outstanding, which was approximately 2,000,000
in 1998, 2,010,000 in 1997 and 2,014,000 in 1996, as adjusted for the common
stock split in 1998 effected in the form of a dividend (Note 17). Given the
simple capital structure of the Corporation, only basic earnings per share is
presented.
Federal Income Taxes
Income taxes are provided for the tax effects of transactions reported in the
financial statements and consist of the taxes currently due plus deferred taxes.
Deferred income taxes are recognized for temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Deferred income tax assets and
liabilities represent the future tax return consequences of those differences,
which will either be taxable or deductible when the assets or liabilities are
recorded or settled. As changes in income tax laws or rates are enacted,
deferred income tax assets and liabilities are adjusted through the provision
for income taxes.
The Corporation and its subsidiary file a consolidated federal income tax return
on a calendar year basis.
Reclassifications
Certain amounts as originally reported in the 1997 and 1996 financial statements
have been reclassified to conform to the 1998 presentation.
-40-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. AVAILABLE-FOR-SALE SECURITIES
The amortized cost, gross unrealized appreciation, gross unrealized depreciation
and fair value of investment securities, all of which are classified as
available-for-sale as of December 31, are as follows:
<TABLE>
Gross Gross
Amortized Unrealized Unrealized Fair
1998 Cost Appreciation Depreciation Value
- ---- ----------- ------------ -------------- -------
<S> <C> <C> <C> <C>
U.S. Treasury, government
agencies and corporations $32,109,957 $ 391,951 $48,809 $32,453,099
States and political subdivisions 20,083,303 927,464 3,577 21,007,190
Other 2,886,279 - - 2,886,279
------------ ----------- -------- -----------
Total $55,079,539 $1,319,415 $52,386 $56,346,568
============ =========== ======== ===========
1997
- -----
U.S. Treasury, government
agencies and corporations $38,998,513 $349,221 $172,346 $39,175,388
States and political subdivisions 18,987,600 618,246 1,861 19,603,985
Other 3,013,301 - - 3,013,301
------------ --------- --------- -----------
Total $60,999,414 $967,467 $174,207 $61,792,674
============ ========= ========= ===========
</TABLE>
The amortized cost and fair value of available-for-sale securities by
contractual maturity at December 31, 1998 is shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
Amortized Fair
Cost Value
------------ -------------
<S> <C> <C>
Due in one year or less $ 2,731,092 $ 2,775,450
Due after one year through five years 8,546,336 8,817,447
Due after five years through ten years 15,799,717 16,299,507
Due after ten years 3,311,763 3,470,779
------------ -------------
Subtotal 30,388,908 31,363,183
Mortgage-backed securities 24,690,631 24,983,385
------------ -------------
Total $55,079,539 $56,346,568
============ =============
</TABLE>
Investment income from taxable and nontaxable securities for the years ended
December 31, is as follows:
<TABLE>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Taxable $2,410,611 $2,709,564 $2,523,572
Nontaxable 1,074,603 988,148 922,311
---------- ---------- ----------
Total $3,485,214 $3,697,712 $3,445,883
========== ========== ==========
</TABLE>
-41-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Proceeds from sales of available-for-sale securities during 1998, 1997 and 1996
were $2,213,374, $7,445,638 and $3,159,555 respectively. The gross gains and
gross losses realized on sales for the years ended December 31, are as follows:
<TABLE>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Gross realized gains $ 231,259 $ 87,375 $ 19,711
Gross realized losses (27,183) (21,185) (6,640)
--------- -------- --------
Net realized gain on sale of
available-for-sale securities $ 204,076 $ 66,190 $ 13,071
========= ======== ========
</TABLE>
Investment securities with a carrying value of approximately $34,943,000 and
$23,396,000 at December 31, 1998 and 1997, respectively, were pledged to secure
public deposits and for various other purposes as required or permitted by law.
The fair value of these investments approximates carrying value.
3. LOANS
The Bank grants commercial, consumer and residential loans to customers
primarily in a fifteen mile radius of its branches which are located south of
Grand Rapids, Michigan. Substantially all of the consumer and residential loans
are secured by various items of property, while commercial loans are secured
primarily by business assets, and personal guarantees; a portion of loans are
unsecured. The source of repayment of approximately 20% of the loan portfolio is
generated from cash flows from developers and owners of commercial real estate.
Major classifications of loans held for investment at December 31 are as
follows:
<TABLE>
1998 1997
---- ----
<S> <C> <C>
Commercial real estate $114,248,448 $ 90,004,939
Residential real estate 36,554,021 38,885,996
Commercial 40,825,169 26,379,822
Consumer 30,505,562 13,682,323
------------- ------------
Total loans receivable, net of deferred loan
fees of $142,131 - 1998 and $213,259 - 1997 222,133,200 168,953,080
Less allowance for loan losses 2,879,376 2,565,430
------------- ------------
Loans receivable, net $219,253,824 $166,387,650
============= ============
</TABLE>
At December 31, 1998, scheduled maturities of loans with fixed rates of interest
are as follows:
<TABLE>
<S> <C>
One year or less $26,783,988
One to five years 135,349,071
Over five years 13,842,358
------------
Total $175,975,417
============
</TABLE>
-42-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Variable rate loans of $46,157,783 at December 31, 1998 reprice quarterly or
more frequently.
The Bank extends loan commitments in the normal course of business to meet
financing needs of its customers. These commitments to make loans and lines of
credit are recorded when proceeds are disbursed. The Bank follows the same
credit policy to make such commitments, including collateral, as is followed for
those loans recorded in the financial statements; no significant losses are
anticipated as a result of these commitments. At December 31, 1998, the Bank had
commitments for standby letters of credit of approximately $2,532,000, loan
commitments outstanding of approximately $46,556,000 and unused credit lines and
revolving credit agreements of approximately $48,603,000.
Loans on which the accrual of interest has been discontinued and those loans
past due 90 days or more amounted to $570,280 and $237,189 at December 31, 1998
and 1997, respectively. Interest income that would have been recorded under the
original terms of such loans would have been approximately $1,000, $3,000 and
$201,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998 and 1997, the Bank was servicing loans for others amounting
to approximately $127,000,000 and $93,000,000, respectively; such loans are not
included in the accompanying consolidated balance sheets. Servicing loans for
others generally consists of collecting mortgage payments, maintaining escrow
accounts, disbursing payments to investors and taxing authorities, and
foreclosure processing. Loan servicing income is recorded on an accrual basis
and includes servicing fees from investors and certain charges collected from
borrowers, such as late payment fees.
Certain directors, executive officers and their related interests were loan
customers of the Bank. All such loans were made on substantially the same terms,
including interest rates and collateral, as those prevailing at the same time
for comparable transactions and do not represent more than a normal risk of
collectibility or present other unfavorable features. The total loans
outstanding to these customers aggregated approximately $6,420,000 and
$5,615,000 at December 31, 1998 and 1997, respectively; new loans and repayments
during 1998 were approximately $3,767,000 and $2,962,000, respectively.
4. ALLOWANCE FOR LOAN LOSSES
The following is an analysis of changes in the allowance for loan losses for the
years ended December 31:
<TABLE>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year $2,565,430 $2,375,970 $2,304,848
Provision for loan losses 400,000 50,000
Recoveries 121,382 263,109 249,854
Loans charged off (207,436) (123,649) (178,732)
---------- ---------- ----------
Balance, end of year $2,879,376 $2,565,430 $2,375,970
========== ========== ==========
</TABLE>
-43-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Information regarding impaired loans is as follows for the year ended December
31:
<TABLE>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance of impaired loans at year-end $570,280 $478,250 $1,079,602
Allowance for loan losses allocated
to the impaired loan balance 202,021 47,716 75,000
Average investment in impaired loans 445,645 620,890 847,835
Interest income recognized on
impaired loans (no interest
income was recognized on the
cash basis) 44,818 42,940 14,456
</TABLE>
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 follows:
<TABLE>
1998 1997
-------------- ------------
<S> <C> <C>
Land $ 2,099,757 $ 880,376
Buildings and improvements 5,252,099 4,369,850
Furniture and equipment 3,714,796 2,760,477
-------------- ------------
Total premises and equipment 11,066,652 8,010,703
Less accumulated depreciation 3,973,887 3,476,422
-------------- ------------
Premises and equipment, net $ 7,092,765 $ 4,534,281
============== ===========
</TABLE>
6. DEPOSITS
The following is a summary of the distribution of deposits at December 31:
<TABLE>
1998 1997
---- ----
<S> <C> <C>
Interest bearing
NOW accounts $ 17,182,308 $ 13,114,691
Savings 36,980,476 31,576,744
Money market demand 26,508,552 19,984,192
Time, $100,000 and over 14,676,281 11,367,451
Other time 86,441,636 82,200,893
------------- --------------
Total interest bearing 181,789,253 158,243,971
Noninterest bearing demand 35,501,554 26,456,357
------------- --------------
Total deposits $217,290,807 $184,700,328
============= ==============
</TABLE>
-44-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
At December 31, 1998, scheduled maturities of time deposits are as follows:
<TABLE>
<S> <C>
1999 $ 74,853,460
2000 19,750,295
2001 1,834,524
2002 2,246,032
2003 2,433,606
-------------
Total time deposits $101,117,917
=============
</TABLE>
Deposits of Bank directors, executive officers and their related interests were
approximately $1,004,000 and $1,127,000 at December 31, 1998 and 1997,
respectively.
Interest expense on time deposits issued in denominations of $100,000 or more
was approximately $721,000 in 1998, $520,000 in 1997 and $270,000 in 1996.
7. BORROWED FUNDS
Borrowed funds at December 31, consist of the following obligations:
<TABLE>
1998 1997
---- ----
<S> <C> <C>
Federal funds purchased $14,200,000 $ 3,300,000
Federal Home Loan Bank advances 12,000,000 6,000,000
Treasury tax and loan note option 1,552,803 2,000,000
------------- ------------
Total borrowed funds $27,752,803 $11,300,000
============= ============
</TABLE>
Federal funds are generally purchased for a one-day period. The Federal Home
Loan Bank borrowings are collateralized by U.S. government agency securities
with a fair value of approximately $12,749,000 and $6,892,000 at December 31,
1998 and 1997, respectively. The Federal Home Loan Bank advances at December 31,
1998 are comprised of six $2,000,000 advances with an average interest rate of
6.03%. These advances mature at dates ranging from December 14, 1999 through
August 21, 2003. The Treasury Tax and Loan Note option is collateralized by U.S.
Government agency securities with a fair value of approximately $2,714,000 and
$2,822,000 at December 31, 1998 and 1997, respectively. The Treasury Tax and
Loan Note option is a daily borrowing with the Federal Reserve Bank, due on
demand, at 25 basis points below the national federal fund interest rate (4.75%
at December 31, 1998).
8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase at December 31, 1998 and 1997
mature within one day from the transaction date and have an average interest
rate of 3.0% and 3.93%, respectively. The U.S. government agency securities
underlying the agreements have a fair value of approximately $19,480,000 and
$13,573,000 at December 31, 1998 and 1997, respectively. Such securities remain
under the control of the Bank. The maximum amount outstanding at any month end
during the years ended December 31, 1998 and 1997 was $17,272,000 and
$9,661,000, respectively with the daily average balance being $12,195,000 and
$8,158,000, respectively.
-45-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. FEDERAL INCOME TAXES
The provision for federal income taxes for the years ended December 31
consists of:
<TABLE>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current $1,947,000 $1,953,700 $1,859,000
Deferred (benefit) 121,000 61,300 (7,000)
----------- ----------- -----------
Federal income taxes $2,015,000 $2,068,000 $1,852,000
=========== =========== ===========
</TABLE>
A reconciliation between federal income tax expense and the amount computed by
applying the statutory federal income tax rate of 34% to income before taxes for
the years ended December 31, is as follows:
<TABLE>
1998 1997 1996
---------- ----------- ------------
<S> <C> <C> <C>
Statutory rate applied to income
before income taxes $2,428,756 $2,257,829 $2,117,279
Effect of tax-exempt interest
income (387,285) (355,031) (294,221)
Change in valuation allowance - 64,000 25,000
Other - net 26,529 48,202 3,942
---------- ----------- ------------
Federal income taxes $2,068,000 $2,015,000 $1,852,000
========== =========== ============
</TABLE>
The net deferred income tax asset (liability) as of December 31, is comprised of
the tax effect of the following temporary differences:
<TABLE>
1998 1997
------------ -----------
<S> <C> <C>
Deferred tax assets
Allowance for loan losses $ 878,000 $ 770,000
Deferred compensation plan 245,000 224,000
Deferred loan fees 3,000 7,000
------------ ----------
Total deferred tax assets 1,126,000 1,001,000
Valuation allowance (719,000) (719,000)
------------ ----------
Net deferred tax assets 407,000 282,000
------------ ----------
Deferred tax liability
Discount accretion (25,000) (19,000)
Loan servicing rights (312,000) (72,000)
------------ ----------
Total deferred tax liabilities (337,000) (91,000)
------------ ----------
Net deferred tax assets entering into the determination of
the provision for federal income taxes 70,000 191,000
Additional deferred tax liability related to
other comprehensive income (430,000) (270,000)
------------ ----------
Net deferred tax liability included in other
liabilities on the accompanying balance sheets $ (360,000) $ (79,000)
============ ==========
</TABLE>
-46-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
10. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
its primary regulator, the Federal Reserve Bank ("FRB"). Failure to meet minimum
capital requirements can initiate certain mandatory and/or discretionary actions
by the FRB. These actions could have a material effect on the Bank's financial
statements. Under FRB capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Bank must meet specific capital guidelines
that involve quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting standards. The
Bank's capital amounts and classification under the prompt corrective action
guidelines are also subject to regulatory qualitative judgments about
components, risk weighting and other factors. Measurements established by
regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios of total capital to risk weighted assets (as defined in the
regulations), Tier 1 capital to risk weighted assets and Tier 1 capital to
adjusted total assets (as defined). Management believes, as of December 31,
1998, that the Bank meets all capital adequacy requirements to which it is
subject.
As of December 31, 1998 the most recent notification from the FRB categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To remain categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the following table. The Bank's actual capital amounts and
ratios are presented in the table (dollars in thousands). There are no
conditions or events since the most recent notification that management believes
has changed the Bank's category.
<TABLE>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total capital (to risk
weighted assets) $39,305 16.22% $19,386 >=8.0% $24,232 >=10.0%
Tier 1 capital (to risk
weighted assets) $36,426 14.97% $ 9,733 >=4.0% $14,600 >= 6.0%
Tier 1 capital (to
average assets) $36,426 13.60% $10,714 >=4.0% $13,392 >= 5.0%
As of December 31, 1997
Total capital (to risk
weighted assets) $36,147 19.93% $14,629 >=8.0% $18,287 >=10.0%
Tier 1 capital (to risk
weighted assets) $33,880 18.68% $ 7,256 >=4.0% $10,884 >= 6.0%
Tier 1 capital (to
average assets) $33,880 14.13% $ 9,591 >=4.0% $11,989 >= 5.0%
</TABLE>
The Bank is required to deposit certain amounts with the Federal Reserve Bank.
These reserve balances vary depending upon the level of certain customer
deposits in the Bank. At December 31, 1998 and 1997, those required reserve
balances were $1,737,000 and $986,000, respectively.
The Bank is also subject to limitations under the Federal Reserve Act on the
amount of loans or advances that can be extended to the Corporation and
dividends that can be paid to the Corporation. Approval is needed if total
dividends declared in any calendar year exceed the retained "net profit" (as
defined in the Federal Reserve Act) of that year plus the retained "net profit"
of the preceding two years. The amount that was not subject to this restriction
is approximately $7,400,000 at January 1, 1999.
-47-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
11. RETIREMENT PLANS
Profit Sharing - The Bank maintains a profit sharing and a 401(k) plan for
substantially all employees. Under the 401(k) plan, employees may make voluntary
contributions based on a percentage of covered compensation. The Bank matches
each employee contribution at a rate of up to 50% of the first 3% contributed by
the employee. The profit sharing plan also allows the Bank, at the discretion of
the Board of Directors, to provide an annual contribution. The Bank's
contributions to these plans were $240,200, $203,055, and $191,459 for 1998,
1997 and 1996, respectively.
Deferred Compensation - The Bank sponsors a deferred compensation plan for all
directors who wish to participate. The cost of the plan was $152,000, $109,000
and $105,000 in 1998, 1997 and 1996, respectively. The accrued benefit
obligation for this plan was $717,578 and $659,448 as of December 31, 1998 and
1997, respectively, and is included in other liabilities. The Bank has purchased
life insurance policies on participating directors.
12. CONTINGENCIES
The Bank is party to litigation arising in the normal course of business. In the
opinion of management, based on consultation with legal counsel, liabilities
from such litigation, if any, would not have a material effect on the
Corporation's consolidated financial statements. As a result of acquiring real
estate from foreclosure proceedings, the Bank is subject to potential claims and
possible legal proceedings involving environmental matters. No such claims have
been asserted at December 31, 1998.
13. FAIR VALUES OF FINANCIAL INSTRUMENTS
The Corporation utilized quoted market prices, where available, to compute the
fair value of its financial instruments. In cases where quoted market prices
were not available, the Bank used present value methods to estimate the fair
values of its financial instruments. These estimates of fair value are
significantly affected by the assumptions made and, accordingly, do not
necessarily indicate amounts which could be realized in a current market
exchange. The fair values of certain financial instruments and all nonfinancial
instruments including, among other elements, the estimated earning power of core
deposit accounts, the trained workforce, customer goodwill and similar items are
not required to be determined. Accordingly, the aggregate net fair values are
not necessarily indicative of the underlying value of the Bank.
The following methods and assumptions were used by the Corporation in estimating
the fair value disclosures for financial instruments:
Cash and Cash Equivalents - The carrying amounts reported in the balance sheets
for cash approximate those assets' fair values.
Investment Securities - Fair values for investment securities are based on
quoted market prices.
Loans Receivable - For variable rate loans that reprice frequently and with no
significant change in credit risk, fair values approximate carrying values. The
fair values for other loans are estimated using discounted cash flow analysis,
using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The resulting amounts are adjusted to
estimate the effect of declines, if any, in the credit quality of borrowers
since the loans were originated.
Loans Held for Sale - The fair value of loans held for sale, including the fair
value of associated mortgage servicing rights, is estimated based on the present
value of estimated future cash flows of the loan and related servicing rights
using a discount rate commensurate with the risks associated with the respective
financial instruments.
Deposit Liabilities - The fair values disclosed for demand deposits (e.g.,
interest and noninterest checking, passbook savings, and money market accounts)
are, by definition, equal to the amount payable on demand. The fair values of
approximately 53% and 50% of the Bank's deposits at December 31, 1998 and 1997,
respectively were equal to their carrying values. Fair values for fixed rate
time deposits and other time deposits with stated maturities are based on the
discounted value of contractual cash flows, using interest rates currently being
offered for deposits of similar remaining maturities.
Securities Sold Under Agreements to Repurchase Fair value approximates the
carrying value since the majority of these instruments were entered into at our
near December 31, 1998 and 1997.
-48-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Borrowed Funds - The carrying amount is a reasonable estimate of fair value of
other borrowings as these financial instruments are tied to floating rate
indices such as prime and LIBOR, and reprice frequently.
Off-Balance-Sheet Instruments - Commitments to extend credit were evaluated and
fair value was estimated using the fees currently charged to enter into similar
agreements, taking into consideration the remaining terms of the agreements and
the present credit worthiness of the counterparties. For fixed-rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates. As the Bank does not charge fees for
lending commitments, it is not practicable to estimate the fair value of these
instruments.
The estimated fair values of the Bank's financial instruments at December 31,
are as follows:
<TABLE>
1998 Carrying Fair
---- Amount Value
-------------- --------------
<S> <C> <C>
Financial assets
Cash and cash equivalents $ 8,913,513 $ 8,913,513
Available-for-sale securities 56,346,568 56,346,568
Loans receivable, net 219,253,824 223,293,988
Loans held for sale 4,679,962 4,679,962
Accrued interest receivable 2,026,185 2,026,185
Financial liabilities
Deposits 217,290,807 218,071,445
Borrowed funds 27,752,803 27,913,887
Securities sold under agreements
to repurchase 14,373,304 14,373,304
Other liabilities 2,124,091 2,124,091
1997
----
Financial assets
Cash and cash equivalents $ 5,367,937 $ 5,367,937
Available-for-sale securities 61,792,674 61,792,674
Loans receivable, net 166,387,650 168,077,719
Loans held for sale 1,345,615 1,345,615
Accrued interest receivable 1,513,146 1,513,146
Financial liabilities
Deposits 184,700,328 185,197,789
Borrowed funds 11,300,000 11,314,409
Securities sold under agreements
to repurchase 8,657,583 8,657,583
Other liabilities 1,515,231 1,515,231
</TABLE>
-49-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
14. SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
Cash paid for interest and income taxes during the years ended December 31, is
as follows:
<TABLE>
1998 1997 1996
----------- ------------ -------------
<S> <C> <C> <C>
Interest $8,838,116 $7,583,946 $7,216,223
=========== ============ =============
Income taxes $1,795,773 $1,941,029 $1,916,713
=========== ============ =============
</TABLE>
15. O.A.K. FINANCIAL CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
The following summarizes parent company financial information as of December 31,
1998 and 1997 and the related condensed statements of income and cash flows for
each of the three years in the period ended December 31, 1998:
<TABLE>
Condensed Balance Sheets
1998 1997
-------------- -------------
<S> <C> <C>
Assets
Cash $ 416,959 $ 2,734
Investment in subsidiary 37,983,469 35,107,243
Available-for-sale securities 1,612,479 1,804,801
-------------- -------------
Total assets $40,012,907 $36,914,778
============== =============
Other liabilities $ 59,922 $ -
Stockholders' equity 39,952,985 36,914,778
-------------- -------------
Total liabilities and stockholders' equity $ 40,012,907 $36,914,778
============== =============
</TABLE>
<TABLE>
Condensed Statements of Income
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Income
Dividends from subsidiary $2,362,500 $4,543,040 $1,211,471
Interest from available-for-sale securities 59,065 38,876 22,232
Net realized gain on sale of
available-for-sale securities 209,722 - -
----------- ----------- -----------
Total income 2,631,287 4,581,916 1,233,703
Other expenses 119,305 38,876 22,232
Income before equity in undistributed net ----------- ---------- -----------
income of subsidiary 2,511,980 4,543,040 1,211,471
Equity in undistributed net income of
subsidiary 2,563,539 82,934 3,163,821
----------- ----------- -----------
Net income $5,075,519 $4,625,974 $4,375,292
=========== =========== ===========
</TABLE>
-50-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
Condensed Statements of Cash Flows
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 5,075,519 $ 4,625,974 $ 4,375,292
Adjustments to reconcile net income
to net cash provided by operating
activities:
Undistributed earnings of subsidiary (2,563,539) (82,934) (3,163,821)
Changes in other liabilities 59,922 - -
------------ ------------ ------------
Net cash provided by operating
activities 2,571,902 4,543,040 1,211,471
------------ ------------ ------------
Cash flows from investing activities
Available-for-sale securities sold 204,823 - -
Available-for-sale securities purchased (12,500) (1,011,272) (220,453)
------------ ------------ ------------
Net cash provided by (used in)
investing activities 192,323 (1,011,272) (220,453)
------------ ------------ ------------
Cash flows from financing activities
Repurchase and retirement of common
shares - (419,832) (48,628)
Dividends paid (2,350,000) (3,115,620) (942,389)
------------ ------------ ------------
Net cash used in financing activities (2,350,000) (3,535,452) (991,017)
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents 414,225 (3,684) 1
Cash and cash equivalents,
beginning of year 2,734 6,418 6,417
------------ ------------ ------------
Cash and cash equivalents,
end of year $ 416,959 $ 2,734 $ 6,418
============= ============ ============
</TABLE>
-51-
<PAGE>
O.A.K. FINANCIAL CORPORATION NOTES TO CONSOLIDATED
AND SUBSIDIARY FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
16. COMMITMENTS
The Bank has remaining construction contracts amounting to $2,700,000 on
building construction.
17. STOCKHOLDERS EQUITY
On May 7, 1998, the Board of Directors declared a 2-for-1 split of the
Corporation's common stock effected on July 1, 1998 in the form of a one-for-one
stock dividend to shareholders of record on June 1, 1998. The par value of the
common stock remained at $1 per share. As a result, $1,000,000, representing the
total par value of the new shares issued, was transferred from retained earnings
to common stock. All references in the consolidated financial statements to
amounts per share and to the number of shares have been restated to give
retroactive effect to the stock split.
18. SUBSEQUENT EVENTS
Acquisition
On February 1, 1999, the Bank established a subsidiary, Byron Acquisition
Company, which purchased an Insurance Agency. Total consideration exchanged
consisted of 28,775 shares of the Corporation's stock valued at $1,439,000 in
exchange for 40,000 shares of the Insurance Agency's stock.
Stock Option Plans
On January 28, 1999 the Corporation's Board of Directors adopted, subject to
shareholder approval, a stock compensation plan for key employees and a stock
option plan for directors. Together, a total of 200,000 shares of common stock
are reserved for issuance under the plans.
-52-
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None
PART III
Item 10. Directors and Executive Officers of the Registrant.
Directors
The information with respect to Directors and Nominees of the Registrant,
set forth under the caption "Information About Directors and Nominees" on pages
4 through 5 of the Company's definitive proxy statement, as filed with the
Commission and dated March 26, 1999, relating to the April 22, 1999 Annual
Meeting of Shareholders, is incorporated herein by reference.
Executive Officers
The information called for by this item is contained in Part I of this Form
10-K Report.
Item 11. Executive Compensation.
The information set forth under the caption "Executive Compensation
Summary" on page 6 of the Company's definitive proxy statement, as filed with
the Commission and dated March 26, 1999, relating to the April 22, 1999 Annual
Meeting of Shareholders, is incorporated herein by reference. Information under
the caption "Committee Report on Executive Compensation" on page 6 of the
definitive proxy statement is not incorporated by reference herein and is not
deemed to be filed with the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information set forth under the caption "Voting Securities and
Beneficial Ownership of Management" on page 3 of the Company's definitive proxy
statement, as filed with the Commission and dated March 26, 1999, relating to
the April 22, 1999 Annual Meeting of Shareholders, is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions.
The information set forth under the caption "Certain Transactions" on page
7 of the Company's definitive proxy statement, as filed with the Commission and
dated March 26, 1999, relating to the April 22, 1999 Annual Meeting of
Shareholders, is incorporated herein by reference.
-53-
<PAGE>
Item 14. Exhibits, Financial Statement Schedules and Report on Form 8-K.
(a) 1. Financial Statements
Independent Auditors' Report
Consolidated Financial Statements
Consolidated Balance Sheet as of
December 31, 1998 and 1997
Consolidated Statements of Income for each of the Three
Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Comprehensive Income for each
of the Three Years Ended December 31, 998, 1997 and
1996
Consolidated Statements of Changes in Stockholders'
Equity for each of the Three Years Ended December 31,
1998, 1997 and 1996
Consolidated Statements of Cash Flows for each of the
Three Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Not applicable
3. Exhibits (Numbered in accordance with Item 601 of Regulation
S-K) The Exhibit Index is located on the final page of this
report on Form 10-K.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of the year
ended December 31, 1998.
-54-
<PAGE>
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, dated March 11 , 1999.
O.A.K. FINANCIAL CORPORATION
/s/John A. Van Singel
John A. Van Singel
President, Chief Executive Officer
(Principal Executive Officer)
/s/Martin R. Braun
Martin R. Braun
Vice President
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated. Each director of the Registrant,
whose signature appears below, hereby appoints David G. Van Solkema and John A.
Van Singel, and each of them severally, as his or her attorney-in-fact, to sign
in his or her name and on his or her behalf, as a director of the Registrant,
and to file with the Commission any and all Amendments to this Report on Form
10-K.
Signature Date
/s/ Robert Deppe March 11, 1999
Robert Deppe
/s/ Norman Fifelski March 11, 1999
Norman Fifelski
Dellvan Hoezee
Lois Smalligan
/s/John A. Van Singel March 11, 1999
John A. Van Singel
/s/David Van Solkema March 11, 1999
David Van Solkema
/s/Gerald Williams March 11, 1999
Gerald Williams
-55-
<PAGE>
EXHIBIT INDEX
The following exhibits are filed herewith, indexed according to the
applicable assigned number:
Exhibit
Number
3. Amendment to the Articles of Incorporation of Registrant filed April
28, 1998, increasing authorized shares of common stock from 2,000,000
to 4,000,000 shares.
21 Subsidiaries of Registrant
27 Financial Data Schedule
The following exhibits, indexed according to the applicable assigned
number, were previously filed by the Registrant and are incorporated by
reference in this Form 10-K Annual Report.
Exhibit
Number
3.1 Articles of Incorporation of the Registrant are incorporated by
reference to Exhibit 3.1 of the Registrant's Registration Statement on
Form 10, as amended
3.2 Bylaws of the Registrant are incorporated by reference to Exhibit 3.1
of the Registrant's Registration Statement on Form 10, as amended
4 Form of Registrant's Stock Certificate are incorporated by reference
to Exhibit 3.1 of the Registrant's Registration Statement on Form 10,
as amended
10.1 1999 Stock Compensation Plan, incorporated by reference to Appendix A
to the Registrant's Definitive Proxy Statement filed with respect to
its April 22, 1999 annual meeting of shareholders.
10.2 1999 Directors' Stock Option Plan, incorporated by reference to
Appendix B to the Registrant's Definitive Proxy Statement filed with
respect to its April 22, 1999 annual meeting of shareholders.
10.3 1988 Director Deferred Compensation Plan is incorporated by reference
to Exhibit 10 of the Registrant's Registration Statement on Form 10,
as amended
-56-
<PAGE>
Exhibit 3 - Amendment to Articles of Incorporation
CERTIFICATE OF AMENDMENT
TO THE ARTICLES OF INCORPORATION
Pursuant to the provisions of Act 284, Public Acts of 1972, as amended, the
undersigned corporation executes the following Certificate:
1. The present name of the corporation is:
O.A.K. Financial Corporation
2. The identification number assigned by the Bureau is: 467-551
3. The location of the registered office is:
2445 - 84th Street, S.W.
Byron Center, MI 49315
4. The following amendment to the Articles of Incorporation was duly
adopted on the 16th day of April, 1998. The amendment was duly adopted in
accordance with Section 611(2) of the Act by the vote of the shareholders.
The necessary votes were cast in favor of the amendment.
Article III of the Corporation's Articles of Incorporation is hereby
amended in its entirety to read as follows:
ARTICLE III
The total authorized capital stock is 4,000,000 shares of a single class of
common stock, par value $1.00 per share. Each such share shall be equal to every
other such share.
Signed this 16th day of April, 1998.
By: /s/ John A. Van Singel
John A. Van Singel, President
<PAGE>
Exhibit 21 - Subsidiaries of Registrant - 100% Owned
Byron Center State Bank
2445 84th Street, S.W.
Byron Center, MI 49315
O.A.K. Financial Services, Inc. (100% owned subsidiary of Byron Center
State Bank)
2445 84th Street, S.W.
Byron Center, MI 49315
Dornbush Insurance Agency, Inc. (100% owned subsidiary of O.A.K.
Financial Services, Inc.)
5445 32nd Avenue
Hudsonville, MI 49426
-57-
::ODMA\PCDOCS\GRR\250327\4
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,913,513
<INT-BEARING-DEPOSITS> 181,789,253
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0
0
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</TABLE>
