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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[ X ] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 (Fee Required)
For the fiscal year ended DECEMBER 31, 1996, or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required)
For the transition period from __________________ to __________________
COMMISSION FILE NUMBER 0-16311
CHARTER ONE FINANCIAL, INC.
---------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 34-1567092
-------- ----------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
1215 SUPERIOR AVENUE, CLEVELAND, OHIO 44114
------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (216) 566-5300
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 amendment to this
Form 10-K.
Yes X No
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The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 10, 1997 was $1,965,032,000. For this purpose, the
following holders are considered affiliates: directors and executive officers of
Charter One Financial, Inc. and individuals owning more than 5% of the voting
stock. The number of shares outstanding of the registrant's sole class of common
stock as of February 28, 1997 was 46,330,703.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for the April 24, 1997 Annual
Meeting of Shareholders are incorporated by reference in Part III.
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The purpose of this Annual Report on Form 10-K/A is to revise the signature
page contained in the Annual Report on Form 10-K/A filed with the Securities
and Exchange Commission on August 8, 1997.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM
NUMBER PAGE
- ------ ----
PART I
<S> <C>
1. Business
General ............................................................................. 1
Market Area and Competition ......................................................... 2
Discussion of Forward-looking Statements ............................................ 2
Lending Activities .................................................................. 3
Investment Activities ............................................................... 9
Sources of Funds .................................................................... 10
Subsidiaries ........................................................................ 11
Employees ........................................................................... 12
Regulation .......................................................................... 12
Federal and State Taxation .......................................................... 14
Executive Officers .................................................................. 15
2. Properties ............................................................................ 16
3. Legal Proceedings ..................................................................... 16
4. Submission of Matters to Vote of Security Holders ..................................... 17
PART II
5. Market for Registrant's Common Equity and Related Shareholder Matters ................. 17
6. Selected Financial Data ............................................................... 18
7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 20
8. Financial Statements and Supplementary Data ........................................... 37
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.. 71
PART III
10. Directors and Executive Officers of the Registrant .................................... 71
11. Executive Compensation ................................................................ 71
12. Security Ownership of Certain Beneficial Owners and Management ........................ 71
13. Certain Relationships and Related Transactions ........................................ 71
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ....................... 71
Signatures .................................................................................... 75
</TABLE>
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PART I
CHARTER ONE FINANCIAL, INC.
ITEM 1. BUSINESS
GENERAL
Charter One Financial, Inc. ("Charter One" or "the Company") is a Delaware
corporation organized in 1987 for the purpose of becoming a holding company and
owning all of the outstanding common stock of Charter One Bank, F.S.B. ("Charter
One Bank" or "the Bank") in connection with Charter One Bank's 1988 conversion
from a federally chartered mutual savings bank to a federally chartered stock
savings bank. In 1996, Charter One formed a new subsidiary, Charter Michigan
Bancorp, Inc. ("CMB"), headquartered in Michigan. Charter One's ownership of the
Bank was transferred to CMB to facilitate the Company's multistate operation.
Charter One remains a unitary savings institution holding company which, under
existing laws, has very few restrictions on permissible types of business
activities. Charter One's business has consisted primarily of the business of
Charter One Bank and its subsidiaries. The executive offices of Charter One are
located at 1215 Superior Avenue, Cleveland, Ohio 44114, and the telephone number
is (216) 566-5300.
Charter One Bank, chartered in 1934 as The First Federal Savings and Loan
Association of Cleveland, was the first federally chartered savings and loan
association in Ohio. In 1982, Charter One Bank converted to a federally
chartered savings bank, changing its name to The First Federal Savings Bank and,
in 1992, changed its name once again, to Charter One Bank, F.S.B.
On October 31, 1995, Charter One completed the most significant merger in its
history when it combined with FirstFed Michigan Corporation ("FirstFed") in a
merger of equals (the "Merger"). The Merger was accounted for as a pooling of
interests and, accordingly, the financial statements for the Company for all
periods prior to the Merger have been restated to include the results of
FirstFed. Also on the Merger Date, FirstFed's principal subsidiary, First
Federal of Michigan ("First Federal"), a savings and loan association, was
merged with and into Charter One Bank. See Management's Discussion and Analysis
of Financial Condition and Results of Operations ("MD&A") and Note 2 of the
"Notes to the Consolidated Financial Statements" for a discussion of the impact
of recent business combinations and asset acquisitions.
Headquartered in Cleveland, Ohio, Charter One Bank now operates through 172
banking offices: 94 in Ohio and 78 in Michigan. Offices in Ohio serve the
Cleveland, Toledo, Youngstown, Portsmouth, Akron and Canton metropolitan areas.
The Michigan franchise continues to operate under the First Federal of Michigan
name and its markets include all of southeast Michigan, Lansing, Owosso and
Kalamazoo. In addition to the banking offices, Charter One has nine loan
production offices in Columbus, Dayton, Brimfield, Medina and Findlay, Ohio;
Grand Rapids and Clarkston, Michigan; Indianapolis, Indiana; and Ashland,
Kentucky.
The business of Charter One Bank consists primarily of attracting deposits from
the general public and using such deposits, together with borrowings and other
funds, to make residential mortgage, multifamily, commercial real estate,
consumer and business loans. Charter One Bank has traditionally focused its
lending activities on origination, for its portfolio, of loans secured by
conventional first mortgages on owner-occupied one-to-four family residences
located in its primary market areas. Residential mortgage lending remains
Charter One Bank's most significant lending activity. Charter One Bank also
originates first mortgage loans on multifamily and commercial real estate
located primarily in its local market areas, as well as construction, consumer
and business loans. Through subsidiaries, Charter One Bank engages in real
estate appraisal, sales of tax-deferred annuities, mutual funds, and property
and casualty and life insurance and the development, operation and sale of real
estate. Additionally, in 1995, the Bank acquired companies, now owned as
subsidiaries, which engage in leasing of capital equipment and providing data
processing services. None of the subsidiary activities is considered to
constitute a business segment.
Charter One Bank is a member of the Federal Home Loan Bank System ("FHLBS") and
the Federal Home Loan Bank of Cincinnati, and its deposits are insured up to
prescribed limits by the Federal Deposit Insurance Corporation ("FDIC"). Charter
One Bank is subject to comprehensive examination, supervision and regulation by
its primary regulator, the Office of Thrift Supervision ("OTS"), and the FDIC.
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MARKET AREA AND COMPETITION
As of December 31, 1996, Charter One Bank is ranked among the 10 largest thrift
institutions in the country and operates 172 banking offices including 94
banking offices within 13 counties in Ohio and 78 within 9 counties in Michigan.
The Bank's Ohio franchise includes 46 offices in the Cleveland metropolitan
area, 19 offices serving Toledo, 14 offices serving Canton, and 10 offices
serving Akron. Additional Ohio markets include Portsmouth (two offices) and
Youngstown (three offices). The Michigan franchise is concentrated in
southeastern Michigan with 71 offices and includes four offices in Lansing and
Owosso located in the middle of the state. An additional four offices in
Kalamazoo in the southwest portion of Michigan round out the franchise. The
market areas now served by the Bank include approximately 37% of the population
of Ohio and 54% of Michigan.
Demographics vary according to the markets served and are considered diverse.
The offices in northeastern Ohio and southeastern Michigan serve what may be
characterized as heavily populated urban areas. In the southern portion of Ohio
and mid-Michigan, the market is more rural and less densely populated. Generally
speaking, the entire market is considered a relatively stable economic base for
the Bank's operations.
The Bank experiences substantial competition in attracting and retaining
deposits as well as in satisfying lending objectives. Historically, the primary
methodology employed by the Bank to attract deposits consists of attractive
interest rates paid on consumer investments, federal deposit insurance coverage,
many conveniently located offices and high quality service. The Company believes
that, as of June 30, 1996, the Bank's deposits represented an overall market
share of 7.7% in Ohio and 4.4% in Michigan in those counties in which it
operates.
The primary factors in competing for loans are interest rates, loan origination
fees, product offerings and service. Although fixed-rate loan products represent
a significant percentage of the Bank's originations, emphasis has been placed on
the generation of adjustable-rate and shorter term loans in keeping with prudent
management of interest rate risk factors. At December 31, 1996, the $12.8
billion portfolio of loans and mortgage-backed securities was composed of
approximately 41.9% with adjustable rates and 58.1% with fixed rates. This blend
helps moderate the effect of interest rate fluctuations on net interest income
and portfolio market value.
DISCUSSION OF FORWARD-LOOKING STATEMENTS
When used or incorporated by reference in disclosure documents, the words
"anticipate," "estimate," "expect," "project," "target," "goal" and similar
expressions are intended to identify forward-looking statements within the
meaning of Section 27A of the Securities Act. Such forward-looking statements
are subject to certain risks, uncertainties and assumptions, including those set
forth below. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated, estimated, expected or projected. These
forward-looking statements speak only as of the date of the document. The
Company expressly disclaims any obligation or undertaking to publicly release
any updates or revisions to any forward-looking statement contained herein to
reflect any change in the Company's expectation with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.
Economic Conditions and Real Estate Risk. Charter One's lending operations are
concentrated in Ohio and Michigan. As a result, the financial condition and
results of operations of the Company will be subject to general economic
conditions prevailing in those states. If economic conditions in those states
worsen, the Company may experience higher default rates in its existing
portfolio as well as a reduction in the value of collateral securing individual
loans. Separately, the Company's ability to originate the volume of loans or
achieve the level of deposits currently anticipated could be affected. As a
result, the occurrence of any of these events could affect the accuracy of
previously made forward-looking statements.
Interest Rate Risk. Charter One realizes income principally from the
differential or spread between the interest earned on loans, investments and
other interest-earning assets and the interest paid on deposits and borrowings.
Loan volumes and yields, as well as the volume of and rates on investments,
deposits and borrowings, are affected by market interest rates. Additionally,
because of the terms and conditions of many of the Company's loan documents and
deposit accounts, a change in interest rates could also affect the duration of
the loan portfolio and/or the deposit base, which could alter the Company's
sensitivity to future changes in interest rates. As a result, significant shifts
in interest rates could affect the accuracy of previously made forward-looking
statements.
2
<PAGE> 6
Lending ACTIVITIES
General. The composition of Charter One's loans and leases held for investment
is summarized below.
COMPOSITION OF LOANS AND LEASES
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- ---------------- ---------------- ------------------ ------------------
% of % of % of % OF % of
AMOUNT Total AMOUNT Total AMOUNT Total AMOUNT TOTAL AMOUNT Total
-------- ---- -------- ----- -------- ----- --------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage
loans:
Permanent:
One-to-four family ..... $6,072,927 75.0% $5,140,857 77.0% $5,266,481 80.0% $5,273,924 80.7% $4,880,129 79.0%
Multifamily ............ 290,195 3.6 359,056 5.4 394,676 6.0 430,870 6.6 440,981 7.1
Commercial
real estate .......... 348,787 4.4 368,372 5.5 351,892 5.3 392,280 6.0 428,684 7.0
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total permanent .... 6,711,909 83.0 5,868,285 87.9 6,013,049 91.3 6,097,074 93.3 5,749,794 93.1
Construction:
One-to-four family ..... 268,766 3.3 132,776 2.0 133,081 2.0 116,325 1.8 106,140 1.7
Multifamily ............ 14,517 .2 11,495 0.1 7,645 0.1 3,281 0.1 4,775 0.1
Commercial
real estate .......... 19,122 .2 38,592 0.6 32,863 0.5 31,706 0.4 27,061 0.4
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total
construction ..... 302,405 3.7 182,863 2.7 173,589 2.6 151,312 2.3 137,976 2.2
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total mortgage
loans .......... 7,014,314 86.7 6,051,148 90.6 6,186,638 93.9 6,248,386 95.6 5,887,770 95.3
Consumer loans ............... 929,204 11.4 594,609 8.9 483,531 7.3 392,001 6.0 414,035 6.7
Lease financings ............. 251,133 3.1 131,352 2.0 -- -- -- -- -- --
Business loans ............... 100,302 1.2 65,747 1.0 84,307 1.3 70,125 1.1 64,779 1.0
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total loans
and leases .... 8,294,953 102.4 6,842,856 102.5 6,754,476 102.5 6,710,512 102.7 6,366,584 103.0
Less net items ............... 194,611 2.4 168,596 2.5 166,923 2.5 171,259 2.7 187,031 3.0
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Loans and
leases, net .............. $8,100,342 100.0% $6,674,260 100.0% $6,587,553 100.0% $6,539,253 100.0% $6,179,553 100.0%
========== ===== ========== ===== ========== ===== ========== ===== ========== =====
</TABLE>
As of December 31, 1996, there was no concentration of loans or leases in any
type of industry which exceeded 10% of the Bank's total loans and leases that is
not included as a loan or lease category in the table above.
Charter One Bank has traditionally focused its lending activities on the
origination, for its portfolio, of loans secured by conventional first mortgages
on owner-occupied, one-to-four family residences located in its market areas in
Ohio and, since the Merger, in Michigan. Residential mortgage lending remains
the Bank's most significant lending activity. However, for many years, in an
effort to increase net yield and shorten asset duration, the Bank has emphasized
loans on multifamily and commercial real estate located primarily in its local
market areas, as well as construction, consumer and business loans. It is not
anticipated that Charter One Bank will alter its principal lending focus during
the next three years of operations, which will remain to continue to grow market
share through more efficient and deliberate delivery techniques together with
improved service and particular emphasis on non one-to-four family loan
products. Additionally, in January 1997 the Company formed a consumer finance
subsidiary which will market residential loans to sub-prime borrowers.
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The following table reflects the principal repayments contractually due
(assuming no prepayments) on the Bank's loans held for investment and
mortgage-backed securities held to maturity portfolio at December 31, 1996.
Management expects prepayments will cause actual maturities to be shorter.
CONTRACTUAL MATURITIES
<TABLE>
<CAPTION>
PRINCIPAL REPAYMENTS CONTRACTUALLY DUE IN THE YEAR(S) ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
2000- 2002- 2007- 2012 AND
1997 1998 1999 2001 2006 2011 THEREAFTER TOTAL
---- ---- ---- ------ ------ ------ ---------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage
loans:
Permanent............ $ 290,605 338,741 285,336 550,118 1,483,401 1,067,369 2,627,512 6,643,082
Construction loans... 16,523 15,728 8,005 5,097 16,664 20,315 101,110 183,442
Mortgage-backed
securities held to
maturity.............. 111,662 120,311 129,630 290,170 946,593 541,719 1,493,284 3,633,369
Consumer loans......... 80,074 80,123 79,606 148,302 482,503 43,787 14,355 928,750
Business loans......... 29,416 11,809 13,380 14,343 20,784 4,725 451 94,908
-------- -------- -------- ---------- ---------- ---------- ---------- -----------
Loans held for
investment and
mortgage-backed
securities held to
maturity, net(1).. $ 528,280 566,712 515,957 1,008,030 2,949,945 1,677,915 4,236,712 11,483,551
======== ======== ======== ========== ========== ========== ========== ===========
- ----------------------------
<FN>
(1) Of the $11.0 billion of loans and mortgage-backed securities due after
December 31, 1997, 64.5% are fixed rate and 35.5% are adjustable rate.
</TABLE>
The table below stratifies the Bank's mortgage-backed security and loan and
lease portfolios by adjustable-rate and fixed-rate balances. All amounts are
shown prior to any allowance for loan losses, unamortized premiums and
discounts, deferred points and fees and loans in process.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Adjustable-rate (1):
Mortgage loans and mortgage-
backed securities.............. $ 5,008,935 4,692,067 4,906,110 3,576,751 3,667,895
Consumer loans.................. 301,433 258,286 241,185 237,309 256,373
Business loans.................. 77,892 51,025 69,629 57,543 62,355
---------- ----------- ----------- ---------- ----------
Total adjustable-rate loans $ 5,388,260 5,001,378 5,216,924 3,871,603 3,986,623
========== =========== =========== ========== ==========
Fixed-rate:
Mortgage loans and mortgage-
backed securities............. $ 6,584,310 6,661,155 7,958,664 9,350,018 8,194,477
Consumer loans................. 627,771 336,323 242,346 154,692 157,662
Business loans................. 22,410 14,722 14,678 12,582 2,424
Lease financings............... 251,133 131,352 - - -
---------- ----------- ----------- ---------- ----------
Total fixed-rate loans...... $ 7,485,624 7,143,552 8,215,688 9,517,292 8,354,563
========== =========== =========== ========== ==========
Adjustable-rate loans, leases
and mortgage-backed
securities as a percentage of
total loans, leases and
mortgage-backed securities..... 41.85% 41.18% 38.84% 29.82% 32.30%
<FN>
(1) Substantially all loans, leases and mortgage-backed securities in the
adjustable-rate loan portfolio have contractual interest rates that
increase or decrease at periodic intervals no greater than three years, or
have original terms to maturity of three years or less.
</TABLE>
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<PAGE> 8
Residential Mortgage Lending. Under applicable federal regulations, Charter One
Bank may originate or purchase whole residential mortgage loans secured by
properties located anywhere in the United States. The Bank has, however,
traditionally focused its lending activities on the origination of first
mortgage loans on residential property in its market areas and, at December 31,
1996, over 90% of the Bank's one-to-four family residential loan portfolio was
secured by properties located in its primary market areas. The Bank offers
fixed-rate and adjustable-rate ("ARM") mortgage loans with terms ranging from 10
to 30 years, including traditional single-family home mortgage loans with terms
of either 15 or 30 years.
Over the past few years, the Bank has begun incorporating prepayment penalties
into many of its residential mortgage products, both fixed rate and adjustable
rate. The objective is to reduce the risk of mortgage prepayments during periods
of declining interest rates and reduce the likelihood that adjustable-rate loans
prepay before reaching the fully indexed interest rate. At December 31, 1996,
17% of the Bank's single-family loan portfolio included prepayment provisions,
up from 5% at the end of 1995.
The Bank's fixed-rate residential mortgage loans have terms of 10, 15 and 30
years and require level monthly payments sufficient to fully amortize principal
over the life of the loan. The Bank originates residential mortgage loans with
loan-to-value ratios up to 97%. On any mortgage loan exceeding an 85%
loan-to-value ratio, the Bank requires private mortgage insurance which protects
the Bank against losses of at least 25% of the mortgage loan amount. All
property securing real estate loans made by the Bank is appraised either by
appraisers regularly employed by the Bank or by independent appraisers selected
by the Bank and subject to review by Bank-employed appraisers.
Generally, Charter One Bank's ARMs have contractual maturities of 30 years and
amortize on a monthly basis. The Bank originates ARMs that adjust semi-annually,
annually or every three or five years. At December 31, 1996, the total balance
of three-year ARMs was $569.2 million, and the total balance of five-year ARMs
was $105.8 million. The Bank often originates ARMs at a competitive initial rate
below the rate that would prevail if the index used for repricing was to be
applied at origination. However, the Bank generally applies underwriting
criteria that limit the amount of the loan to an amount for which the borrower
could qualify at the indexed rate.
The Bank has originated ARMs tied to various indices, including six-month
Treasury bill and longer term Treasury security rates published by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). The
Bank's ARM products feature a stated margin, which may vary from time to time
depending on competitive conditions, over a specified published index, with
maximum decreases or increases in the interest rate during the year of 2.00%. In
addition, borrowers are entitled to refinance these loans at any time within the
first three years, upon the payment of specified fees, to any fixed-rate loan
plan available at the Bank at interest rates in effect at that time.
As part of its residential lending program, the Bank offers construction loans
with 80% loan-to-value ratios to qualified builders. Construction loans
generally have terms of up to 18 months and interest rates which generally
adjust in accordance with the Bank's specified index. Loan proceeds are
disbursed in increments as construction progresses and as inspections warrant.
In addition to builders' projects, the Bank finances the construction of
individual owner-occupied houses up to 90% loan-to-value where qualified
contractors are involved. Construction loans are structured either to be
converted to permanent loans at the end of the construction phase or to be paid
off upon receiving financing from another financial institution.
The Bank's residential mortgage loans customarily include "due-on-sale" clauses,
which are provisions giving the Bank the right to declare a loan immediately due
and payable in the event the borrower sells or otherwise disposes of the real
property subject to the mortgage. The Bank enforces due-on-sale clauses through
foreclosures and other legal proceedings to the extent permitted under
applicable laws. Loans insured by the Federal Housing Administration ("FHA") or
partially guaranteed by the Veterans Administration ("VA") do not contain
due-on-sale clauses. At December 31, 1996, FHA and VA loans represented 1.0% of
the Bank's total loan portfolio (excluding mortgage-backed securities).
Residential mortgage loan originations are derived from a number of sources,
including commission loan representatives, wholesale account representatives,
real estate broker referrals, present borrowers and savers, builders and walk-in
customers. The Bank also advertises its residential mortgages extensively in
local newspapers. Loan applications are accepted by designated loan
representatives and are underwritten by a separate staff of underwriters
employed at each of the Bank's divisional headquarters. Residential mortgage
loans
5
<PAGE> 9
exceeding $600,000 must be approved by two members of the Board of Directors who
are also members of the loan committee or one member of the Board of Directors
and the Executive Vice President of Mortgage Lending.
Commercial Real Estate and Multifamily Lending. The Bank originates loans
secured by multifamily and commercial real estate properties. At December 31,
1996, the Bank's permanent and construction multifamily and commercial real
estate loan portfolios totaled $672.6 million, representing 8.4% of the total
loan and lease portfolio (excluding mortgage-backed securities). Generally,
permanent loans are made to finance the acquisition of seasoned income-producing
properties located in the Bank's market areas or as the permanent financing
following completion of construction on such properties. Permanent loans have
a maximum amortization of 30 years, and typically have terms ranging from five
to 10 years. Rates on permanent loans adjust at specified intervals (typically
90-day, one-year, three-year or five-year intervals) to specified spreads over
related U.S. Treasury security indices. The Bank has also granted loans where
the borrower may elect to change the index and the adjustability of the loan.
Commercial real estate loans are generally written in amounts of 80% or less of
the appraised value of the property. Property securing commercial real estate
loans is required to be appraised by the Bank's appraisal subsidiary or by an
outside appraiser whose work is reviewed by the Bank's f appraisal subsidiary.
In addition, the Bank's underwriting procedures require verification of the
borrower's credit history, income and financial statements, banking
relationships, references and income projections for the property. The Bank
generally requires that the property produce net income (i.e., income after all
operating expenses but before mortgage payments) in excess of 115% of the debt
service requirement. The Bank makes nonrecourse and partial recourse loans when,
in the opinion of management, the value of the property securing the loan
justifies it. Generally, the Bank e limits its multifamily and commercial real
estate loans to one borrower to amounts not exceeding $20 million, although its
legal limit at December 31, 1996 was $115 million.
The Bank also provides construction financing and land acquisition and
development loans. At December 31, 1996, the total amount of commercial real
estate construction loans and multifamily construction loans amounted to $33.6
million, of which $16.9 million was outstanding. Land acquisition and
development loans amounted to $20.1 million, of which $14.5 million was
outstanding at December 31, 1996. These loans may involve additional risks
attributable to the fact that funds are advanced upon the security of the
project under construction or development, which is of uncertain value prior to
the completion of construction or development and because it is relatively
difficult to evaluate accurately the total funds required to complete
construction or development or the time and interest carry required to lease
constructed property or sell developed property. At December 31, 1996,
commercial and multifamily construction loans represented .4% of the portfolio.
Acquisition and development loans represented .2% of the portfolio at December
31, 1996. The Bank's largest outstanding construction loan at December 31, 1996
totaled $7.4 million. The largest outstanding acquisition and development loan
at December 31, 1996 totaled $3.1 million.
The maximum term on construction and land acquisition and development loans is
36 months, but is more typically 24 months. Rates charged on construction and
land acquisition and development loans float over specified prime rates and
adjust monthly.
At December 31, 1996, the largest portion of the Bank's commercial real estate
loan portfolio consisted of loans on strip shopping centers. Those loans
comprise 36% of the commercial real estate loans. In addition to strip shopping
centers, the Bank's commercial real estate loan portfolio is on secured by
office buildings, warehouses, land, hotels, mobile home parks and other
properties. None of these groups represented more than 15% of the commercial
real estate loan portfolio. See Note 5 of the "Notes to Consolidated Financial
Statements" for further information concerning these loan balances.
Commercial mortgage lending generally involves greater risk than residential
mortgage lending. Such lending typically involves larger loan balances to single
borrowers or groups of related borrowers than residential mortgage loans.
Furthermore, the repayment of loans secured by income-producing properties is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced (for example, if leases
are not obtained or renewed), the borrower's ability to repay the Bank's loans
may be impaired. These risks can be affected significantly by supply and
demand in the market for the type of property securing the loan and by general
economic conditions, and commercial mortgage loans may thus be subject, to a
greater extent than residential property loans, to adverse conditions in the
economy. At December 31, 1996, $4.1 million, or .6%, of the Bank's multifamily
and commercial real estate loans were 61 days or more delinquent.
6
<PAGE> 10
Consumer Lending. Under applicable Federal law, the Bank is authorized to invest
up to 30% of its assets in consumer loans. Charter One Bank currently originates
a variety of consumer loans including lines of credit secured by owner-occupied
real estate, marine loans, unsecured loans and real estate equity loans. The
Bank's consumer loan portfolio, excluding unearned discounts, totaled
approximately $929.2 million at December 31, 1996 representing 11.4% of its
total loans and lease portfolio (excluding mortgage-backed securities). At
December 31, 1996, the Bank had authorized lines on home equity lines of credit
of $715.1 million, $280.5 million of which was outstanding under this program,
representing 30.2% of the consumer loan portfolio. The Bank's closed-end
consumer loans totaled $644.0 million, or 69.3% of consumer loans at December
31, 1996. These closed-end loans n included term loans secured by the first or
second mortgages on one-to-four family residential properties ($488.4 million),
marine loans ($112.7 million), and mobile home loans ($34.0 million).
In underwriting consumer loans, the Bank places primary emphasis on the
applicant's credit history, stable income and net worth. Loans secured by second
mortgages, together with loans secured by all prior liens, are usually limited
to 90% or less of the appraised value of the property securing the loan or 80%
in the case of non-amortizing home equity lines of credit. At December 31, 1996,
.4% of the Bank's consumer loan portfolio was 61 days or more delinquent.
Lease Financing. The Bank is engaged in equipment leasing through a subsidiary,
ICX Corporation ("ICX"). The equipment leased by ICX is for commercial and
industrial use only. The leasing business is targeted to upper middle-market and
larger companies ("lessee"), specifically those with revenues in excess of $100
million annually. Equipment leasing offers an alternative type of financing to
corporations for capital equipment acquisitions. Leases are for terms up to 15
years, are generally at fixed rates, and are noncancellable contractual
obligations of the lessee.
A lessee is evaluated from a credit perspective in the same fashion as a
borrower. It is expected to be able to make the rental payments based on its
business' cash flow and the strength of its balance sheet. Leases are usually
not evaluated as collateral based transactions and, therefore, the lessee's
overall financial strength is the most important credit evaluation factor. A
review of the leases is performed by the Bank's Business Loan Committee and
Board of Directors in accordance with its lending policies.
ICX transactions generally range in size from $25,000 to $10 million. On
December 31, 1996, ICX had an exposure exceeding $10.0 million to five lessees.
On December 31, 1996, ICX's lease portfolio amounted to $251.1 million or 3.1%
of the total loan and lease portfolio. On December 31, 1996, .13% of ICX's
leases were 30 days or more delinquent and there were no leases that were not
accruing interest. See Note 5 to the Consolidated Financial Statements for
further information concerning leases.
Business Lending. The Bank is permitted to invest up to 10% of its assets in
secured and unsecured loans for commercial, corporate, business and agricultural
purposes.
The Bank's business lending services are directed toward smaller "middle market"
companies, i.e., those with $5.0 million to $50.0 million in sales, located in
its market areas. Under its corporate banking program, the Bank offers
traditional lines of credit, revolving credits, term loans, single purpose
loans, commercial letters of credit and acceptances, and performance letters of
credit. The Bank also offers Small Business Administration guaranteed loans at
slightly higher rates.
The prevailing indices for rate adjustments are the Bank's prime rate, which is
adjusted to reflect changes in local or national money market conditions, and
the three-year U.S. Treasury rate. The majority of loans within the portfolio
carry a rate increment based upon factors such as the term of the loan, credit
risk, and the account relationship of the borrower. A few loans have fixed
interest rates determined at the time of takedown. Terms of such loans are
usually five years or less.
Business loans are made on the basis of the borrower's ability to repay from the
cash flow of the business and are generally secured by business assets, such as
accounts receivable, equipment and inventory. As a result, the availability of
funds for the repayment of business loans may be substantially dependent on the
success of the business itself. Collateral securing the loans may depreciate
over time, cannot be appraised with as much precision as residential real
estate, and may fluctuate in value based on the success of the business. At
December 31, 1996, 98.6% of total business loans were secured by some form of
collateral.
7
<PAGE> 11
The Bank's business loan commitments range in size from $100,000 to $17.4
million. At December 31, 1996, commitments of $1.0 million or more had been made
to 28 borrowers, including seven commitments in excess of $5 million. Business
loans over $1 million require approval of a majority of the Bank's Business Loan
Committee, which is comprised of members of the Board of Directors and
management.
The largest commitment totals $17.4 million, of which $6.4 million was
outstanding at December 31, 1996. The borrower, which engages in steel
warehousing, steel trucking and truck leasing, is performing in accordance with
contract terms. The second largest commitment totals $17.0 million, of which
$9.1 million was outstanding at December 31, 1996. The borrower, which
wholesales building materials and trucks, parts and accessories, manufactures
architectural and structural pre-cast concrete products, and processes mined
products, is performing in accordance with contract terms. The third largest
commitment totals $8.6 million, of which $8.6 million was outstanding at
December 31, 1996. The borrower is a full service commercial printer and is
performing in accordance with contract terms.
As of December 31, 1996, the Bank's business loan portfolio amounted to $100.3
million, or 1.2% of its total loan portfolio (excluding mortgage-backed
securities), while its unfunded commitments totaled $50.7 million. At such date,
the Bank had a total of 566 loans to 318 borrowers outstanding. Business loans
are generally considered to involve a higher degree of risk than residential
real estate loans. At December 31, 1996, 1.8% of the Bank's business loans were
30 days or more delinquent, including $300,000 that was not accruing interest.
Purchase, Sale and Servicing of Mortgage Loans and Mortgage-Backed Securities.
From time to time, the Bank has purchased whole loans and mortgage-backed
securities in accordance with ongoing asset and liability management objectives.
In addition, from 1991 to 1993, the Bank acquired $1.1 billion in loans when it
purchased Women's Federal, Civic Savings and First Federal of Toledo. The Bank
underwrites the loans it purchases on the basis of its own underwriting
standards. The Bank currently purchases loans only from federally insured
depository institutions or nationally recognized n mortgage bankers or on a
service-released basis. At December 31, 1996, loans serviced by others totaled
$306.6 million, representing 3.8% of the Bank's loan portfolio.
Charter One Bank originates loans primarily for retention in its portfolio. From
time to time, the Bank will use the secondary mortgage market to reduce the
Bank's interest rate risk. This also allows the Bank to continue to make loans
during periods when saving flows decline or funds are not n otherwise available
for lending purposes. In connection with such sales, the Bank generally retains
the servicing of the loans (i.e., collection of principal and interest
payments), for which it generally receives a fee payable monthly of .25% to
.50% per annum of the unpaid balance of each loan. The Bank has also engaged in
the sale of seasoned fixed-rate mortgage loans and mortgage-backed certificates
in order to attempt to reduce its exposure to interest-rate risk by investing
the proceeds in assets with higher rates and shorter terms. At December 31,
1996, the Bank serviced for others approximately $1.5 billion of mortgage
loans. The Bank has not typically sold loans with servicing fees materially in
excess of normal servicing fee rates, which would require an adjustment to the
selling price pursuant to SFAS No. 65.
The following table sets forth information as to the Bank's loan and lease
servicing portfolio, net of loans in process, at the dates shown.
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
------------------ ------------------ ------------------- ------------------ ------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
-------- ----- -------- ----- --------- ----- -------- ---- --------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans and
leases owned
and serviced
by the Bank $7,793,707 84.1% $6,431,056 84.5% $6,301,477 87.7% $6,009,254 86.2% $5,593,362 82.0%
Loans
serviced for
others....... 1,478,187 15.9 1,181,245 15.5 883,399 12.3 960,318 13.8 1,223,993 18.0
--------- ---- --------- ---- --------- ----- --------- ----- --------- -----
Total..... $9,271,894 100.0% $7,612,301 100.0% $7,184,876 100.0% $6,969,572 100.0% $6,817,355 100.0%
========= ===== ========= ===== ========= ===== ========= ===== ========= =====
</TABLE>
8
<PAGE> 12
Information concerning the Bank's servicing income from loans serviced for
others is summarized in the following table for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loan servicing income during the period ..... $5,829 $4,143 $4,735 $5,534 $6,589
Loan servicing income as a percentage
of net interest income .................... 1.54% 1.30% 1.52% 1.80% 2.67%
Gross servicing spread during the period .... 0.49% 0.45% 0.47% 0.45% 0.40%
</TABLE>
Delinquencies and Nonperforming Assets. Delinquent and problem loans and leases
are a normal part of any lending business. When a borrower fails to make a
required payment when the payment is due, the loan or lease is considered
delinquent and the Bank generally institutes internal collection procedures.
Delinquent loans and leases are identified by the 15th day of delinquency,
regardless of any grace period. The borrower is contacted by a representative of
the Bank to determine the reason for the delinquency. In most cases,
delinquencies are cured promptly. However, if a loan or lease has been
delinquent for 60 to 90 days, the Bank reviews the loan or lease status and,
where appropriate, appraises the condition of the property and the financial
circumstances of the borrower. Based upon the results of any such investigation,
the Bank may (i) accept a repayment program of the arrearage from the borrower;
(ii) seek evidence, in the form of a listing contract, of efforts by the
borrower to sell the property if the borrower has stated that it is attempting
to sell; (iii) request a deed in lieu of foreclosure; or (iv) initiate
foreclosure proceedings. A decision as to whether and when to initiate
foreclosure proceedings is based on such factors as the amount of the
outstanding loan in relation to the original indebtedness, the extent of
delinquency, the borrower's ability and willingness to cooperate in curing
delinquencies and, also, any environmental issue that may need to be addressed.
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu
of foreclosure is classified as real estate owned until it is sold. When
property is acquired, it is recorded at the lower of cost or estimated fair
value at the date of acquisition and any write-down resulting therefrom is
charged to the allowance for losses. Interest accrual, if any, ceases on the
date of acquisition and all costs incurred from that date in maintaining the
property are expensed. However, costs relating to the development and
improvement of the property are capitalized to the extent of fair value, less
estimated costs to sell.
Federal regulations require that each insured institution should independently
review and classify assets. For those assets that have been reviewed and
determined to have greater risk than normally acceptable, there are three
classifications - "substandard," "doubtful" and "loss." An asset classified
Substandard is inadequately protected by the net worth and paying capacity of
the obligor or by the collateral pledged, if any. Assets so classified suffer
from a well-defined weakness or weaknesses. They are characterized by the
distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected. An asset classified Doubtful has the weaknesses
of those classified Substandard with the added characteristic that the weakness
or weaknesses make collection or liquidation in full highly questionable and
improbable. An asset classified Loss is considered uncollectible and of such
little value that its continuance as an asset is unwarranted. On the basis of
management's review at December 31, 1996, the Bank had classified $44.1 million
in assets as substandard, $1.5 million as doubtful and $2.3 million as loss.
Management periodically reviews its loan and lease portfolio and has, in the
opinion of management, appropriately classified and established allowances
against all assets requiring classification under the regulation.
INVESTMENT ACTIVITIES
Federally chartered savings institutions have authority to purchase various
types of investments, including mortgage-backed securities, U.S. Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers' acceptances
and federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest a portion of their assets in commercial paper,
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly.
9
<PAGE> 13
As a member of the FHLB System, the Bank is required to maintain liquid assets
at minimum levels which vary from time to time. Funds not used by the Bank for
loan originations have been invested in instruments that enhance the Bank's
liquidity and yield within acceptable credit risk parameters. The general
objectives of the Bank's investment policy are to (i) furnish funds to meet the
anticipated and unanticipated operating needs of the Bank; (ii) maximize income
while protecting against credit risks; (iii) comply with legal liquidity
requirements; and (iv) manage the repricing characteristics of the Bank's assets
and liabilities. The Bank's investment activities are directly supervised by an
investment committee under investment policy guidelines adopted by the Board of
Directors. These guidelines generally limit investments to securities qualifying
as liquid assets under applicable regulations. With the prior approval of the
investment committee, the Bank may, however, purchase any security qualifying as
a legal investment subject to Board-approved limits by type. The relative size
and mix of investment securities and loans in the Bank's portfolio are based on
management's judgment as to the attractiveness of yields available on loans and
other investments of comparable maturities. The Bank emphasizes low credit risk
as a major factor in selecting investment securities.
SOURCES OF FUNDS
General. Deposits have historically been the most important source of the Bank's
funds for use in lending and for general business purposes. The Bank also
derives funds from FHLB advances, reverse repurchase agreements and other
borrowings, principal repayments on loans and mortgage-backed securities, funds
provided by operations and proceeds from the sale of loans and securities. At
December 31, 1996, 61% of interest-bearing liabilities were in the form of
deposits and 39% were in borrowings compared to 56% and 44%, respectively, at
December 31, 1995.
Deposit inflows and outflows are significantly influenced by general interest
rates, money market conditions and competitive factors. Borrowings are used to
compensate for reductions in normal sources of funds, such as deposit inflows.
They may also be used to support expending loan originations.
Deposits. The Bank reprices its deposits weekly, or more frequently if required,
based primarily on competitive conditions. In order to decrease the volatility
of its deposits, the Bank imposes stringent penalties on early withdrawal of its
certificates of deposit.
Consumer and commercial deposits are attracted principally from within the
Bank's market areas through the offering of a broad selection of deposit
instruments including passbook savings accounts, checking accounts, and money
market accounts. The Bank also offers certificates of deposit with terms ranging
from 30 days to 10 years. Interest rates on these certificates vary according to
the terms selected and are based upon several indices, including the rates paid
on government securities with similar maturities.
The following table indicates the amount of the Bank's certificates of deposit
and other deposits of $100,000 or more by the time remaining until maturity as
of December 31, 1996.
<TABLE>
<CAPTION>
CERTIFICATES CHECKING, SAVINGS AND
TIME TO MATURITY AS OF DECEMBER 31, 1996 OF DEPOSIT MONEY MARKET ACCOUNTS
---------------------------------------- ---------- ---------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less ............................................ $ 161,356 $ 294,578
Three through six months ........................................ 200,318 -
Six through twelve months ....................................... 159,643 -
Over twelve months .............................................. 132,985 -
--------- ---------
Total ........................................................ $ 654,302 $ 294,578
========= =========
</TABLE>
10
<PAGE> 14
The following table sets forth, by various interest rate categories, certain
information concerning maturities of the Bank's certificates of deposit at
December 31, 1996.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------------------------------------
MATURING IN TOTAL
--------------------------------------------------------- -------------
1997 1998 1999 THEREAFTER
---- ---- ---- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
4.00% or less ...................... $ 34,246 9,445 9,278 7,122 60,091
4.01 - 6.00% ....................... 2,744,012 477,934 144,333 101,341 3,467,620
6.01 - 8.00% ....................... 697,222 190,154 75,883 186,082 1,149,341
8.01 - 10.00% ...................... 6,696 8,171 11,386 51,618 77,871
10.01 - 12.00% ..................... 6,876 414 690 3,071 11,051
12.01 - 14.00% ..................... - 10 39 329 378
14.01% or more ..................... - 17 - - 17
---------- -------- -------- --------- ----------
Total certificates ............... $ 3,489,052 686,145 241,609 349,563 4,766,369
========== ======== ======== ======== ==========
Percent of total ................. 73.2% 14.4% 5.1% 7.3% 100.0%
===== ===== ==== ===== ======
</TABLE>
Borrowings. The Bank borrows funds from the FHLB ("FHLB advances") on the
security of its capital stock of the FHLB and a portion of its real estate loans
and mortgage-backed securities. The Bank must meet certain standards related to
creditworthiness and community support in connection with the borrowings. These
borrowings are made pursuant to several different credit programs with varying
interest rates and maturities. Over the past few years, the Bank has increased
its use of FHLB advances with variable-rate, interest-rate cap and call
features.
The Bank also uses reverse repurchase agreements as part of its funding sources.
These instruments have traditionally been short-term funding sources, but in
recent years agreements have included extended terms as well as variable-rate,
interest-rate cap and call features. Although replacement of its reverse
repurchase agreements as they mature is not guaranteed, management believes
established credit lines and collateral levels are sufficient to continue the
availability of this source of funds.
Further reference is made to Notes 8, 9 and 10 of the "Notes to Consolidated
Financial Statements" for an analysis of FHLB advances, reverse repurchase
agreements and other borrowings. See also Note 11 of the "Notes to Consolidated
Financial Statements" for information regarding the interest rate risk
management instruments used to extend the terms of liabilities and protect the
cost of funds from increasing interest rates.
The following table sets forth certain information regarding short-term
borrowings at the end of and during the periods indicated. The Company's
short-term borrowings consist entirely of reverse repurchase agreements.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Borrowings outstanding at end of period.... $ - 848,033 2,321,433
Weighted average rate at end of period(1).. -% 5.86% 5.61%
Maximum month-end balance of borrowings
during the period........................ $ 565,432 $ 2,662,000 $ 2,526,000
Approximate average borrowings outstanding
during the period(2)..................... 204,069 2,273,000 2,245,000
Approximate weighted average rate during
the period(1)............................ 5.58% 5.99% 4.44%
<FN>
- ----------
(1) Does not include the annualized effect of interest rate exchange, cap and
collar positions.
(2) Computed on a daily basis.
</TABLE>
SUBSIDIARIES
As a federally chartered savings bank, the Bank is permitted by federal
regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries which may engage exclusively in OTS-approved
11
<PAGE> 15
activities that are reasonably related to the Bank's business. The Bank may
invest an additional 1% of its assets in service corporations where such
additional funds are used for inner-city or community development purposes. The
net book value of the Bank's investment in and loans to its service corporations
at December 31, 1996 was $309.5 million, including a $10.0 million letter of
credit guaranteeing an equal amount of industrial revenue development bonds, the
proceeds of which were used for the construction of its headquarters building in
1986. Operations of the subsidiaries accounted for $25.1 million or 5.8% of 1996
consolidated total income.
Service corporations are involved principally in equipment leasing; real estate
appraisal; sales of tax-deferred annuities, mutual funds and property and
casualty insurance; data processing services; and the development, operation and
sale of real estate.
EMPLOYEES
At December 31, 1996, Charter One and its subsidiaries employed 2,552 full-time
equivalent employees, none of whom is represented by a collective bargaining
group. Management considers its relations with its employees to be excellent.
Charter One currently maintains a comprehensive employee benefit program
providing, among other benefits, an ESOP plan, a 401(k) savings plan,
hospitalization and major medical insurance, paid sick leave, long-term
disability insurance, life insurance and educational programs.
REGULATION
General. Charter One is a savings and loan holding company and, as such, is
subject to regulation by the OTS. Charter One Bank is a federally chartered
savings bank and is a member of the FHLBS, while its deposits are insured by the
FDIC through the Savings Association Insurance Fund ("SAIF"). The lending
activities of Charter One Bank must comply with various state and federal
regulatory requirements. The OTS periodically examines the Bank for compliance
with various regulatory requirements. The FDIC also conducts examinations of
SAIF members. The Bank must file reports with the OTS describing its activities
and financial condition. This supervision and regulation is intended primarily
for the protection of depositors. The following discussion provides an overview
of regulations that have the most significant effect on Charter One.
The laws and regulations governing savings institutions have been through at
least two major revisions in recent years. First, the Riegle-Neal Interstate
Banking and Efficiency Act of 1994, which when fully effective on June 1, 1997,
permits commercial banks interstate branching which could result in more intense
competition from out of state banks. Second, on September 30, 1996, the
Regulatory Paperwork Reduction Act was signed into Law. Among other things this
legislation eliminated the premium differential between SAIF insured
institutions and Bank Insurance Fund ("BIF") insured institutions. The new
legislation also provides for the merger of SAIF and BIF if certain conditions
are met by January 1, 1999.
Capital Requirements. Regulatory capital standards for savings institutions
consist of three components: a core capital requirement, a tangible capital
requirement and a risk-based capital requirement. All three components are
required to be no less stringent than the corresponding requirements applicable
to national banks.
All savings institutions must have core capital of at least 3.00% of adjusted
total assets. Charter One Bank's core capital equals shareholders' equity
adjusted for net unrealized gains and losses on securities available for sale
less the capitalization of the parent company, its investment in a real estate
subsidiary and goodwill. Charter One Bank's core capital ratio was 5.00% at
December 31, 1996.
Savings institutions have a statutory requirement to maintain tangible capital
of at least 1.5% of adjusted total assets. For purpose of this requirement,
Charter One Bank's tangible capital is equal to its core capital. At December
31, 1996, Charter One Bank's tangible capital ratio was 5.00%.
The risk-based capital standard adopted by the OTS currently requires savings
institutions to maintain a minimum ratio of total capital (core capital plus
supplementary capital) to risk-weighted assets of 8.00%. At the end of 1996,
Charter One Bank's supplementary capital consisted of general valuation
allowances. Supplementary capital may be used to satisfy the risk-based
requirement only up to an amount equal to core capital. In determining the
amount of risk-weighted assets, all assets, including certain off-balance sheet
items, are multiplied by a risk weight
<PAGE> 16
based on the risks which OTS deems inherent in the type of assets. Charter One
Bank's risk-based capital ratio was 10.62% at December 31, 1996.
The OTS has adopted final regulations adding an interest rate risk component to
the risk-based capital requirements for savings associations, although
implementation of the regulation has been delayed. In August 1995, the FDIC
revised its capital standards to state explicitly that it will consider the risk
of declines in the economic value of capital due to changes in interest rates.
The FDIC stated that in the future, after gaining more experience with the risk
measurement process, it will issue a proposed rule that would establish an
explicit minimum capital charge for interest rate risk. The ultimate effect of
such risk-based capital requirements cannot be determined until final
regulations are adopted.
See "MD&A - Capital and Dividends" and Note 14 of the "Notes to Consolidated
Financial Statements" for a discussion of Charter One Bank's capital calculation
and its compliance with regulatory capital requirements and the Prompt
Corrective Action Act at December 31, 1996.
Capital Distributions Regulation. The OTS regulation on capital distributions
imposes limits on all capital distributions by savings institutions. Since this
regulation applies to Charter One Bank, it affects the Bank's ability to pay
dividends to its parent, CMB, which pays dividends to Charter One, which in turn
pays dividends to its shareholders. The regulation establishes a three-tiered
system of regulation, with the greatest flexibility being afforded to
well-capitalized institutions. An institution that has regulatory capital which
is at least equal to its capital requirement and has not been notified that it
"is in need of more than normal supervision," is a Tier 1 institution. Charter
One Bank was a Tier 1 institution at the end of 1996. A Tier 1 institution is
permitted to make capital distributions during a calendar year up to the greater
of (i) 100% of its net income to date during the calendar year plus the amount
that would reduce by one-half its surplus capital ratio at the beginning of the
calendar year, or (ii) 75% of its net income over the most recent four-quarter
period. In December 1994, the OTS proposed revisions to its capital distribution
regulations to conform with the capital adequacy classification adopted under
FDICIA. Under the proposal, savings associations generally would be authorized
to make capital distributions so long as they are not deemed in troubled
condition and would remain classified as at least adequately capitalized
following a proposed distribution. Savings associations held by savings and loan
holding companies would still be required to submit prior written notification
to the OTS, as was the case at the end of 1996.
Charter One's principal source of capital is dividends paid to it by CMB which
principal source of capital is dividends paid to it by Charter One Bank. In
1996, Charter One Bank paid dividends of $100 million to the Company (prior to
the formation of CMB) and $108 million to CMB. The above-described regulation on
capital distributions does not currently affect the ability of Charter One to
pay dividends to its shareholders. See "Item 5. Market for Registrant's Common
Equity and Related Shareholder Matters" for dividends paid to shareholders.
Deposit Insurance. Charter One Bank's deposits are insured up to $100,000 by the
FDIC through the SAIF and backed by the full faith and credit of the United
States Government. The Bank is charged an annual premium for this insurance. The
rate assessed is based on the capital adequacy and supervisory rating of the
institution and is assigned by the FDIC.
The FDIC is authorized to establish separate annual assessment rates for deposit
insurance for members of the Bank Insurance Fund ("BIF") and the SAIF. The FDIC
may increase assessment rates for either fund if necessary to restore the fund's
ratio of reserves to insured deposits to its target level within a reasonable
time. See "MD&A - General" for a discussion of the recapitalization of the SAIF
in 1996.
The FDIC has established a risk-based assessment system for both SAIF and BIF
members. During 1996, under this system, SAIF assessments ranged from .23% to
.31% of insured deposits of the institution and BIF assessments ranged from .00%
to .27%, based on the risk the institution poses to its deposit insurance fund.
This risk level is determined based on the institution's capital level and the
FDIC's level of supervisory concern about the institution. See "MD&A - General"
for a discussion of assessments expected in 1997.
Classification of Assets. Federal regulations require savings institutions to
review their assets on a regular basis and to classify them as "substandard,"
"doubtful" or "loss," if warranted. General valuation allowances for loan losses
are required to be established, as needed, for assets classified as substandard
or doubtful. If an asset is classified as a loss, the institution must either
establish a specific valuation allowance equal to the amount classified as a
loss or charge off such amount. The institution's OTS Regional Director has the
authority to
13
<PAGE> 17
approve, disapprove or modify any asset classification, or the amounts
established as allowances for loan losses. Management believes that following
these procedures results in a level of valuation allowances that is consistent
with generally accepted accounting principles. For additional information, see
"Business - Delinquencies and Nonperforming Assets."
Community Reinvestment Act. Federally chartered savings associations are subject
to regulatory oversight by the OTS under various consumer protection and fair
lending laws. These laws govern, among other things, truth-in-lending
disclosure, equal credit opportunity, fair credit reporting and community
reinvestment. Failure to abide by federal laws and regulations governing
community reinvestment could limit the ability of an association to open a new
branch or engage in a merger transaction. The OTS has recently revised
regulations governing community reinvestment to evaluate actual lending and
investment within an association's designated service area, with particular
emphasis on low-to-moderate income areas and borrowers. These new regulations
also evaluate an association's service to low-and moderate-income areas in terms
of branch locations. The Bank does not anticipate a significant impact on its
operations as a result of these revised regulations.
Federal Home Loan Bank System. Charter One Bank is a member of the FHLBS, which
consists of 12 regional Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board. The FHLBs provide a central
credit facility primarily for member institutions by offering funding sources in
the form of FHLB advances. As a member of the FHLB of Cincinnati, Charter One
Bank is required to acquire and hold shares of capital stock in the FHLB of
Cincinnati based on the size of its residential mortgage portfolio and the
outstanding FHLB advances and letters of credit. The Bank is also required to
hold shares of capital stock in the FHLB of Indianapolis (of which First Federal
was a member) until FHLB advances issued to First Federal prior to the Merger
mature. Charter One Bank is in compliance with these requirements at December
31, 1996, with a consolidated investment in FHLB stock of $215.8 million.
FEDERAL AND STATE TAXATION
Federal Taxation. Charter One is subject to the provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), which subject corporations to an
income tax generally calculated at 35% of taxable income. The Company and its
subsidiaries file a consolidated federal income tax return.
At December 31, 1996, the Company had no net operating loss carryforwards for
federal income tax purposes. Federal income tax rules allow net operating losses
to be carried back three years and carried forward 15 years.
Audits of tax returns have been completed by the Internal Revenue Service with
respect to tax returns through 1993 for the Bank and through 1988 for FirstFed.
However, the Bank is currently under audit by the Internal Revenue Service with
respect to tax returns for 1994 and 1995. FirstFed is currently under audit by
the Internal Revenue Service with respect to tax returns from 1993 through
October 31, 1995. No material tax liabilities are outstanding related to tax
issues for 1996 and prior years.
See Note 1 and Note 12 of the "Notes to Consolidated Financial Statements" for
further information concerning the financial statement reporting of federal
income taxes of the Company and a discussion of 1996 legislation affecting the
tax treatment of the bad debt deduction.
State Taxation. Charter One is subject to the Ohio franchise tax on holding
companies of financial institutions. The tax imposed is the greater of the tax
on net worth after adjustments to exclude the portion attributable to the
financial institution or the tax on net income. The tax on net income is
computed on federal taxable income adjusted to exclude distributions from the
financial institutions, and subject to certain other adjustments. The rate of
tax differs for the net worth and net income computations and can include a
surtax if based on net income and an add-on litter tax under either method.
Charter One is also subject to the Delaware franchise tax, which is based on the
total number of authorized shares of stock.
Charter One Bank is also taxed under Ohio law. Charter One Bank is subject to an
Ohio franchise tax based on its net worth plus certain reserve amounts. Total
net worth for this purpose is reduced by certain exempt assets. As a result of
the Merger, the resulting net taxable value is apportioned between Ohio and
Michigan, with the Ohio portion taxed at a rate of 1.5%.
14
<PAGE> 18
Additionally, as a result of the Merger, the Company is now subject to taxes
imposed by the State of Michigan. The Single Business Tax ("SBT") is the primary
tax, and is a value-added type of tax for the privilege of doing business in the
State of Michigan and carries a tax rate of 2.30%. The major components of the
tax base are: compensation, federal taxable income and depreciation, less the
cost of acquisition of tangible assets during the year. Charter One and its
Michigan subsidiaries file separate returns. The Bank is also subject to an
Intangibles Tax of $.20 on each $1,000 of Michigan savings deposits, which
amounted to $386,000 for 1996. The State of Michigan had audited First Federal
through 1990. No material tax liabilities are outstanding related to tax issues
for 1996 and prior years. SBT rules have no net operating loss carryback
provisions; however, business losses may be carried forward for 10 years.
Because of FirstFed's business loss in 1994 of $63.2 million and for the 10
months ended October 31, 1995 of $11.3 million, the Company had a business loss
carryforward for SBT purposes of approximately $74.5 million at December 31,
1995. This loss carryforward was utilized in 1996.
EXECUTIVE OFFICERS
Executive Officers of the Registrant. The executive officers of the Company,
each of whom is currently an executive officer of the Bank, are identified
below. The executive officers of the Company are elected annually by its Board
of Directors to serve until the next annual election of officers following the
annual meeting of shareholders.
<TABLE>
<CAPTION>
AGE AT
DECEMBER 31, OFFICER
NAME 1996 POSITION WITH THE COMPANY SINCE
------ ------------- ------------------------- --------
<S> <C> <C> <C>
Charles John Koch........... 50 Chairman of the Board, President and Chief Executive Officer 1987
Mark D. Grossi.............. 43 Senior Vice President 1992
John David Koch............. 44 Senior Vice President 1987
Richard W. Neu.............. 40 Senior Vice President and Chief Financial Officer 1995
Robert J. Vana.............. 47 Chief Corporate Counsel and Corporate Secretary 1987
</TABLE>
Executive Officers of the Bank. The following table sets forth certain
information regarding the executive officers of the Bank. The executive officers
of the Bank are elected annually by the Board of Directors to serve until the
next annual election of officers.
<TABLE>
<CAPTION>
AGE AT
DECEMBER 31, OFFICER
NAME 1996 PRINCIPAL POSITION WITH THE BANK SINCE
---- ------------- -------------------------------- ---------
<S> <C> <C> <C>
Charles John Koch........... 50 Chairman of the Board, President and Chief Executive Officer 1976
Mark D. Grossi.............. 43 Executive Vice President, Retail Banking 1992
John David Koch............. 44 Executive Vice President, Lending and Credit Administration 1982
Richard W. Neu.............. 40 Executive Vice President and Chief Financial Officer 1995
Robert J. Vana.............. 47 Senior Vice President and Corporate Secretary 1982
</TABLE>
Charles John Koch has been President of Charter One Bank since 1980 and was
Chief Operating Officer of Charter One from 1980 to 1988, when he was appointed
Chief Executive Officer of Charter One. In February 1995, he was appointed
Chairman of the Board of the Company and of the Bank. Mr. Koch is the brother of
John David Koch.
Mark D. Grossi has been Senior Vice President of the Company and an Executive
Vice President of the Bank, responsible for retail banking and branch
administration, since the Company's merger with First American Savings Bank in
September 1992. Prior to the merger, he was President and Chief Executive
Officer of First American from December 1989 and the President and Chief
Operating Officer from 1987 to 1989.
John David Koch joined the Bank in 1982 and is a Senior Vice President of the
Company and an Executive Vice President of the Bank. Mr. Koch is responsible for
the credit and lending functions of the Bank and has management responsibility
for numerous service corporations. Mr. Koch is the brother of Charles John Koch.
Richard W. Neu is Senior Vice President and Treasurer of Charter One Financial,
Inc., and is Executive Vice President and Chief Financial Officer of the Bank.
He joined Charter One from First Federal upon the Merger.
15
<PAGE> 19
He had served as Executive Vice President and Chief Financial Officer of First
Federal since 1989, and joined First Federal in 1985.
Robert J. Vana has been Chief Corporate Counsel and Corporate Secretary of the
Company since 1988 and joined the Bank as Senior Vice President and Corporate
Secretary in 1982.
ITEM 2. PROPERTIES
Charter One Bank's executive offices are located at 1215 Superior Avenue,
Cleveland, Ohio in a seven-story office building owned by a subsidiary of the
Bank. The bank operates a branch facility in the building and leases a portion
of the office space. Charter One Bank also maintains an operations center in a
single-story building owned by the Bank and located in Cleveland, Ohio. The Bank
owns various other office buildings including a 23-story office building in
Detroit, nine-story office building in Toledo, and a four-story office building
in downtown Canton. The buildings in Detroit, Toledo and Canton each include
space for a branch office and various divisional administrative functions, with
any remaining space leased to tenants.
As of December 31, 1996, Charter One Bank conducted business from 181 locations:
94 banking offices located throughout Ohio, 78 banking offices in Michigan and 9
loan production offices in Ohio, Michigan, Indiana and Kentucky. The Bank
operates 133 ATMs at various banking offices and is a member of the Money Access
Center System ("MAC"), which provides its customers access to ATMs nationwide. A
summary of the Bank's banking and loan production offices by market area is
presented in the table below. The lease terms for branch offices are not
individually material. Terms range from monthly to seven years.
<TABLE>
<CAPTION>
METROPOLITAN AREA OWNED LEASED TOTAL
----------------- ----- ------ -----
<S> <C> <C> <C>
OHIO
Cleveland .......................................... 27 19 46
Akron .............................................. 5 7 12
Columbus ........................................... - 2 2
Youngstown ......................................... 2 1 3
Toledo ............................................. 19 1 20
Portsmouth ......................................... 2 -- 2
Canton ............................................. 10 4 14
--- -- ---
Ohio total ....................................... 65 34 99
--- -- ---
INDIANA AND KENTUCKY - 2 2
MICHIGAN
Detroit ............................................ 68 3 71
Grand Rapids ....................................... 1 - 1
Kalamazoo .......................................... 3 1 4
Lansing/Owosso ..................................... 3 1 4
--- -- ---
Michigan total ................................... 75 5 80
--- -- ---
Total banking and loan production offices ...... 140 41 181
=== == ===
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
The Bank and its subsidiaries are involved as plaintiff or defendant in various
actions incident to their business, none of which is believed to be material to
the financial condition of the Bank, except as discussed below.
Prior to the Merger, Charter One and First Federal each filed a lawsuit against
the United States based upon the breach of certain agreements between Charter
One and First Federal, respectively, and the government involving supervisory
goodwill and capital credits in the aggregate amount of approximately $126
million. FIRST FEDERAL OF MICHIGAN V. UNITED STATES, No. 95-464C was filed in
the United States Court of Federal Claims on July 20, 1995. CHARTER ONE BANK,
F.S.B. V. UNITED STATES, No. 95-528C was filed in the same court on August 8,
1995. These actions, claiming damages for the government's breach of four
separate contractual agreements, have been
16
<PAGE> 20
consolidated and the case is proceeding pursuant to the terms of a Case
Management Order ("CMO") entered by the Court to govern all similar
goodwill/contract cases.
Pursuant to that CMO, Charter One filed a motion for summary judgment on
liability as to two of the four contractual agreements at issue on Charter One's
complaint. That motion is currently pending. The status of the litigation is
dependent to some degree upon factors which are out of the control of Charter
One, including, but not limited to, the outcome of the damages litigation in
GLENDALE FEDERAL BANK V. U.S., No. 90-772C in the United States Court of Federal
Claims and STATESMAN SAVINGS BANK V. U.S., No. 90-773C. The United States
Supreme Court found, on July 1, 1996, that the government, by enacting FIRREA,
had breached contractual agreements with Glendale and with Statesman, whereby
the government had agreed to recognize supervisory goodwill and capital credits
as assets includible in regulatory capital. The cases were then remanded to the
Court of Federal Claims for a trial on damages before Chief Judge Smith. The
Court has indicated that decisions in those cases should be expected
approximately 90 days after the conclusion of the damages trials.
Under the CMO, trials in other pending cases are expected to commence in
mid-to-late 1997, following the conclusion of the trials in the Glendale and
Statesman cases. Due to the pendency of these other related cases, and the
uncertainty inherent in litigation, Charter One is not able to estimate either
the time frame for resolution of its claims, or the final outcome of its
litigation against the government, including the damages, if any, which could be
awarded if Charter One ultimately prevails on liability issues.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter ended December 31, 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
See "MD&A - Capital and Dividends" for information required by this item.
ITEM 6. SELECTED FINANCIAL DATA
17
<PAGE> 21
FIVE-YEAR SUMMARY
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Operating data:
Interest income ................................ $ 1,004,478 1,087,410 1,006,180 1,082,156 1,131,758
Interest expense ............................... 621,086 769,594 694,207 774,762 884,752
----------- ----------- ----------- ---------- -----------
Net interest income ............................ 383,392 317,816 311,973 307,394 247,006
Provision for loan and lease losses ............ 4,001 1,032 2,948 7,549 12,544
----------- ----------- ----------- ---------- -----------
Net interest income after provision
for loan and lease losses .................... 379,391 316,784 309,025 299,845 234,462
Other income:
Net gain (loss)(1) ........................... 1,893 (92,303) (145,786) 6,832 25,078
Other ........................................ 55,245 44,467 35,397 33,027 28,414
Administrative expenses(2) ..................... 244,024 215,743 175,961 178,889 167,516
----------- ----------- ----------- ---------- -----------
Income before federal income taxes,
extraordinary item and cumulative
effect of accounting change .................. 192,505 53,205 22,675 160,815 120,438
Federal income taxes ........................... 64,783 19,173 7,056 56,415 42,270
----------- ----------- ----------- ---------- -----------
Income before extraordinary item
and cumulative effect of
accounting change ............................ 127,722 34,032 15,619 104,400 78,168
Extraordinary item - early
extinguishment of debt, net of tax
benefit of $6,361 .......................... - - (12,348) - -
Cumulative effect of accounting
change(3) .................................... - - - - 14,825
----------- ----------- ----------- ---------- -----------
Net income ..................................... $ 127,722 34,032 3,271 104,400 92,993
=========== =========== =========== ========== ===========
EARNINGS PER COMMON AND COMMON
EQUIVALENT SHARE(4):
Income before extraordinary item
and accounting change ......................... $ 2.67 .71 .32 2.18 1.87
Extraordinary item - early
extinguishment of debt ........................ - - (.26) - -
Cumulative effect of accounting
change ........................................ - - - - .35
----------- ----------- ----------- ---------- -----------
Net income ..................................... $ 2.67 .71 .06 2.18 2.22
=========== =========== =========== ========== ===========
Dividends declared and paid per
common share(5) ............................... $ .86 .71 .56 .40 .30
Common stock price range:
High ......................................... 44.75 31.79 22.86 23.81 19.05
Low .......................................... 27.14 17.98 16.90 16.19 10.79
Close ........................................ 42.00 29.17 18.09 18.81 19.05
Dividend payout ratio .......................... 32.21% 100.00% * 18.34% 13.51%
<FN>
- ----------
* Not meaningful.
(1) 1995 includes $101.8 million of merger-related costs, $66.1 million after
tax. 1994 includes $152.8 million in restructuring charges, $100.9 million
after tax.
(2) 1996 includes $56.3 million from special SAIF assessment. 1995 includes
$37.5 million of merger expenses.
(3) During 1992, the Company changed its method of accounting for income taxes
by adopting Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes."
(4) All historical earnings per share have been restated to reflect the 5% stock
dividend issued on September 30, 1996. During 1995 and 1992, the Company
completed mergers which were accounted for as poolings of interests.
(5) The amounts presented herein are historical per share amounts declared and
paid by the Company, as adjusted for stock splits and stock dividend. No
adjustment has been made for mergers accounted for as pooling of interests.
</TABLE>
18
<PAGE> 22
FIVE-YEAR SUMMARY (CONTINUED)
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Financial condition and
OTHER DATA:
Cash, federal funds sold and other .... $ 270,304 658,371 341,935 271,643 266,060
Investment securities ................. 243,632 407,427 467,247 428,579 687,285
Mortgage-backed securities ............ 4,704,074 5,314,749 6,628,591 6,718,615 5,946,949
Loans and leases, net ................. 8,100,342 6,678,600 6,592,975 6,562,088 6,234,954
Other assets .......................... 575,489 499,214 491,432 466,583 499,612
------------ ------------ ------------ ------------ ------------
Total assets ........................ $ 13,893,841 13,558,361 14,522,180 14,447,508 13,634,860
============ ============ ============ ============ ============
Deposits .............................. $ 7,841,197 7,012,491 7,089,153 7,280,125 7,088,649
FHLB advances ......................... 3,194,333 3,163,144 2,968,290 2,316,523 2,203,627
Other borrowings ...................... 1,760,958 2,298,540 3,415,305 3,692,732 3,275,105
Other liabilities ..................... 175,629 199,313 225,761 255,889 333,628
Shareholders' equity .................. 921,724 884,873 823,671 902,239 733,851
------------ ------------ ------------ ------------ ------------
Total liabilities and shareholders'
equity ............................. $ 13,893,841 13,558,361 14,522,180 14,447,508 13,634,860
============ ============ ============ ============ ============
Total assets as initially reported(1) . $ 13,893,841 13,558,361 6,130,172 5,215,426 4,261,850
Loan servicing portfolio .............. $ 1,478,187 1,181,245 883,399 960,318 1,223,993
Number of offices:
Full service branches ............... 172 155 157 170 173
Loan production offices ............. 9 9 6 3 4
Number of employees (FTEs) ............ 2,552 2,416 2,401 2,564 2,533
Book value per share(2) ............... $ 19.85 19.66 17.44 19.14 17.89
SELECTED RATIOS:
Net yield on average interest-
earning assets ....................... 2.92% 2.23% 2.24% 2.18% 1.86%
Interest rate spread during
the period ........................... 2.66 1.96 1.99 1.89 1.53
Return on average equity(3):
Before SAIF assessment, restructuring,
merger-related charges and accounting
change, net ........................ 17.93 14.61 14.02 12.28 11.34
After SAIF assessment, restructuring,
merger-related charges and accounting
change, net ........................ 13.89 3.93 .39 12.28 13.49
Return on average assets(3):
Before SAIF assessment, restructuring,
merger-related charges and accounting
change, net ........................ 1.22 .86 .82 .72 .57
After SAIF assessment, restructuring,
merger-related charges and accounting
change, net ........................ .94 .23 .02 .72 .68
Average shareholders' equity to
average assets ....................... 6.80 5.91 5.84 5.84 5.01
Total shareholders' equity to total
assets (at end of year) .............. 6.63 6.53 5.67 6.24 5.38
Efficiency ratio excluding SAIF
assessment and merger expenses(4) .... 42.22 48.98 50.48 52.12 60.14
Administrative expenses to
average assets ....................... 1.80 1.47 1.23 1.23 1.22
Net interest income to
administrative expenses .............. 1.57x 1.47x 1.77x 1.72x 1.47x
<FN>
- ----------
(1) The amounts presented represent amounts as initially reported by the company
in the respective year's annual report to shareholders.
(2) Per share data has been restated to reflect the 5% stock dividend issued
September 30, 1996.
(3) Returns are presented before and after significant nonrecurring items: in
1996 the SAIF assessment reduced net income by $37,130,000, after tax; in
1995 net charges related to FirstFed Merger reduced net income by
$92,594,000, after tax; and in 1994 net charges related to FirstFed's
financial restructuring reduced net income by $114,005,000.
(4) Including the federal deposit insurance special assessment of $56.3 million,
the 1996 efficiency ratio was 55.04%. Including merger expenses of $37.5
million, the 1995 efficiency ratio was 59.34%.
</TABLE>
19
<PAGE> 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following financial review presents an analysis of the asset and liability
structure of the Company and a discussion of the results of operations for each
of the periods presented in the annual report and sources of liquidity and
capital resources. Certain statements under this caption, "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
constitute `forward-looking statements' under the Private Securities Litigation
Reform Act of 1995 (the `Reform Act'). See "Part I. Item 1. Business -
Discussion of Forward-looking Statements."
HOLDING COMPANY BUSINESS
Charter One Financial, Inc. ("Charter One" or the "Company") is a Delaware
corporation organized as a unitary savings and loan holding company and owns all
of the outstanding capital stock of Charter Michigan Bancorp., Inc. which is a
Michigan corporation organized as a unitary savings and loan holding company,
which in turn owns all of the outstanding capital stock of Charter One Bank,
F.S.B. (the "Bank".) The business of the Bank and, therefore, the primary
business of the Company is providing consumer and business banking services to
certain major markets in Ohio and, after October 1995, in Michigan. At the end
of 1996 the Bank was doing business through 172 full service banking branches
and 9 loan production offices.
GENERAL
Much of the Company's growth in recent years has been through mergers and
acquisitions. On October 31, 1995, Charter One completed the most significant
merger in its history when it combined with FirstFed Michigan Corporation
("FirstFed") in a merger of equals (the "FirstFed Merger") which was accounted
for as a pooling of interests and, accordingly, the financial statements for the
Company for all periods prior to the merger have been restated to include the
results of FirstFed. FirstFed was the holding company for First Federal of
Michigan ("First Federal"), a $7.7 billion savings and loan headquartered in
Detroit, Michigan. See Note 2 to the Consolidated Financial Statements for
further information concerning this merger.
In 1996, the only merger and acquisition activity was the acquisition of First
Nationwide's 21 Michigan branches on June 28 (the "First Nationwide
transaction".) The branch deposits totaled $796.7 million and were assumed at a
cost of $57.0 million which was reflected as goodwill.
Also in 1996, two major legislative events occurred which not only affected
current year results but will impact the savings and loan industry going
forward. The first event was in August when legislation was passed by Congress
to substantially limit recapture of the tax liability on certain accumulated bad
debt reserves which previously would have penalized any thrift choosing to adopt
a bank charter, either independently or in conjunction with a merger
transaction. Charter One's unrecorded potential liability approximated $60
million at the time of the legislation.
The second event occurred in September when Congress moved to recapitalize the
Savings and Loan Insurance Fund ("SAIF".) The recapitalization was accomplished
through a one-time special assessment of member institutions. The Bank's share
of the assessment resulted in an after-tax charge of $37.1 million (the "SAIF
assessment".) Due to the recapitalization, the Bank's deposit insurance rate
will be reduced to 6.5 basis points of insured deposits starting in 1997, down
from 23 basis points in 1996. As a result, it is expected that the Bank's
federal deposit insurance premium expense will be approximately $11.0 million
lower in 1997 than in 1996.
RESULTS OF OPERATIONS
The Bank's net income generally depends upon its net interest income, which is
the difference between the interest and dividend income earned on its loans and
investments and the interest expense on its deposits and borrowings. The Bank's
net interest income is significantly affected by general economic conditions and
policies of regulatory authorities.
20
<PAGE> 24
For the year ended December 31, 1996, Charter One reported net income of $127.7
million, $34.0 million and $3.3 million in the years ended December
31, 1995 and 1994, respectively. On a per share basis, net income was $2.67,
$0.71 and $0.06 in 1996, 1995 and 1994 respectively. As discussed below, the
FirstFed Merger had a significant impact on 1995 and 1994 results. In addition,
the 1996 results were adversely affected by the SAIF assessment detailed above.
IMPACT OF FIRSTFED MERGER
The FirstFed Merger had a major impact on 1995 results. Additionally, because
the transaction was accounted for as a pooling of interests, it had a similar
impact on combined results reported for 1994. Because of the size, timing and
nature of the FirstFed Merger, much of the discussion here as it relates to
historical results cannot be meaningfully applied to future results and
operations.
1995 Impact
An integral component of the FirstFed Merger was a plan to reposition the
combined balance sheet in order to reduce the wholesale component of the
Company's operation and conform the interest rate risk profile to that of
Charter One before the merger. This plan, which was fully executed by year-end
1995, included the sale of $940 million of fixed, low-rate mortgage-backed
securities, the sale of $330 million of fixed, low-rate mortgage loans, and a
$740 million reduction in maturing agency investments. Proceeds from these sales
and maturities were used to repay approximately $1.5 billion of short-term
borrowings. Additionally, management took advantage of a relatively flat yield
curve to lengthen the maturity of $900 million in medium-term borrowings.
Finally, $750 million in interest rate exchange agreements ("swaps") and $800
million in interest rate cap agreements ("caps") were eliminated. The charges
related to the repositioning and those related to the merger itself totaled
$92.6 million, after tax, and are summarized below.
<TABLE>
<CAPTION>
EFFECT ON YEAR ENDED
DECEMBER 31, 1995
-----------------------
PRETAX AFTER
------ -----
TAX
---
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Merger expenses:
Transaction costs ......................................... $(5,900) (5,900)
Severance costs ........................................... (18,715) (12,163)
Other costs to combine operations ......................... (12,913) (8,392)
--------- -------
Total merger expenses ................................... (37,528) (26,455)
Loss on loans and securities ................................ (25,545) (16,605)
Termination of swaps and caps ............................... (76,207) (49,534)
--------- -------
Impact of repositioning and merger expenses on 1995 results $(139,280) (92,594)
========= ========
</TABLE>
1994 Impact
FirstFed reported a net loss for 1994 which, because of pooling of interests
accounting, is now reflected in Charter One's consolidated results for 1994.
FirstFed's loss was the result of a financial restructuring undertaken in the
first quarter of 1994, based upon an evaluation of its existing capital position
and then current market conditions with a goal of increasing future core
earnings and improving the corporation's overall financial profile. The major
components of the restructuring were: (i) reducing mortgage-backed securities by
$1.1 billion; (ii) terminating $900 million of interest rate swaps and
eliminating the liabilities to which they were specifically assigned; (iii)
extinguishing $194 million of FHLB advances; (iv) recording a $52.7 million
federal income tax benefit; and (v) adopting SFAS No. 72 to change the
accounting for goodwill. When originally reported, the aggregate effect from
these transactions was a net charge to FirstFed's after-tax net earnings of $146
million. However, in accounting for the FirstFed Merger, timing of the adoption
of SFAS No. 72 was conformed to Charter One's adoption date of January 1, 1990,
which reduced the net charge to the combined after-tax net earnings for 1994 to
$114 million.
PERFORMANCE OVERVIEW
As mentioned previously, the Company's reported results in each of the last
three years were significantly affected by the SAIF assessment and the FirstFed
Merger. By excluding the 1996 SAIF assessment of $56.3 million, the
21
<PAGE> 25
1995 merger expenses of $37.5 million and the restructuring and repositioning
expenses in 1995 and 1994, a more comparable pretax core earnings can be
examined.
The following table summarizes the components of pretax core earnings.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Net interest income ........................................ $ 383,392 317,816 311,973
Provision for loan and lease losses ........................ (4,001) (1,032) (2,948)
Other income, excluding gains and losses ................... 55,245 44,467 35,397
Administrative expenses .................................... (187,766) (178,215) (175,961)
---------- ---------- ----------
Pretax core earnings ..................................... $ 246,870 183,036 168,461
========== ======= =======
</TABLE>
In general, the above comparison reflects consistent growth in net interest
income, the Company's low credit risk (as characterized by modest provision
levels) and an increasing percentage of core earnings being derived by
non-interest income. Additionally, the Company's efforts to control overhead
costs are illustrated by an efficiency ratio (excluding the SAIF assessment and
merger-related charges) of 42%, 49% and 50% for 1996, 1995 and 1994,
respectively. The efficiency ratio is the ratio of administrative expenses
(excluding goodwill amortization) to net interest income and other income
exclusive of net gains and losses.
NET INTEREST INCOME
Net interest income is the principal source of earnings for the Company. It is
affected by a number of factors including the level, pricing and maturity of
interest-earning assets and interest-bearing liabilities, interest rate
fluctuations and asset quality.
Net interest income for 1996 was $383.4 million, an increase of $65.6 million,
or 20.6%, over the $317.8 million of net interest income in 1995. The increase
in net interest income was primarily due to a lower cost of interest-bearing
liabilities in 1996. The cost of interest-bearing liabilities decreased by 68
basis points to 4.99% for 1996. This lower cost of funds reduced interest
expense by $70.4 million to $621.1 million in 1996, from $769.6 million for
1995. This improvement in the cost of funds was primarily the result of the
financial restructuring undertaken in the fourth quarter of 1995 in conjunction
with the FirstFed Merger. The financial restructuring also reduced the average
balance of interest-earning assets and interest-bearing liabilities. The net
effect of reducing balances with negative spreads caused net interest income to
increase by $4.0 million for 1996 as the average balance of assets and
liabilities each declined by $1.1 billion.
The lower cost of interest-bearing liabilities for 1996 was the primary reason
the interest rate spread improved to 2.66% from 1.96% for 1995. Similarly, the
net yield on interest-earning assets increased to 2.92% for 1996 from 2.23% for
1995.
Net interest income for 1995 was $317.8 million, an increase of $5.8 million, or
1.9%, over net interest income in 1994. The increase in the yield on net
interest-earning assets in 1995 was the primary reason for the increase in net
interest income. The yield increased during 1995 primarily due to higher market
interest rates in 1995 as compared to 1994 and a shifting of assets from lower
yielding mortgage-backed securities available for sale to higher yielding
mortgage-backed securities, investment securities and loans. During the same
period, the cost of interest-bearing liabilities increased by 42 basis points.
This was due to higher market interest rates and customers shifting deposits
from core accounts to certificates of deposit. The average balance of
certificates of deposit was $536.8 million higher in 1995 than 1994. Conversely,
core deposit average balances (checking, savings and money market accounts) were
$329.3 million lower in 1995 than in 1994. This change in the mix of deposit
balances accounted for $23.6 million of the $41.1 million increase in deposit
interest expense. This resulted in the interest rate spread decreasing by 3
basis points to 1.96% for 1995.
22
<PAGE> 26
The following table shows average balances, interest earned or paid and average
interest rates for the years indicated. Average balances are calculated on a
daily basis.
AVERAGE BALANCES, INTEREST AND YIELDS/COSTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
1996 1995 1994
------------------------------- ------------------------------ ------------------------------
AVG. AVG. AVG.
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
---------- --------- -------- ---------- --------- ------- ---------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets:
Loans and lease
financings(1) ...... $7,442,375 $ 602,432 8.09% $6,766,695 $ 557,936 8.25% $6,642,343 $ 532,719 8.02%
Mortgage-backed
securities:
Available for sale 1,134,928 78,143 6.89 368,526 23,820 6.46 1,137,084 64,482 5.67
Held to maturity 3,881,557 279,832 7.21 5,808,992 418,344 7.20 5,326,992 364,306 6.84
Investment
securities available
for sale .......... 316,843 21,205 6.69 893,433 59,746 6.69 418,125 26,122 6.25
Other interest-
earning assets 350,385 22,866 6.53 412,543 27,564 6.68 375,819 18,551 4.94
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
Total interest-
earning assets.. 13,126,088 1,004,478 7.65 14,250,189 1,087,410 7.63 13,900,363 1,006,180 7.24
--------- --------- ---------
Allowance for loan
and lease losses ..... (65,620) (64,540) (64,355)
Noninterest-earning
assets(2) ............ 466,478 478,640 486,209
---------- ---------- ----------
Total assets .. $13,526,946 $14,664,289 $14,322,217
========== ========== ==========
Interest-bearing
liabilities:
Deposits:
Checking
accounts ........ $ 777,274 9,720 1.25 667,209 9,809 1.47 672,544 10,670 1.59
Money market
accounts ........ 1,082,869 36,159 3.34 853,140 27,229 3.19 989,654 29,151 2.95
Savings accounts 913,489 22,000 2.41 1,057,514 25,544 2.42 1,244,971 30,287 2.43
Certificates of
deposit ......... 4,597,054 259,069 5.64 4,614,460 284,023 6.16 4,077,693 235,386 5.77
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
Total deposits 7,370,686 326,948 4.44 7,192,323 346,605 4.82 6,984,862 305,494 4.37
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
FHLB advances ....... 3,237,680 185,439 5.73 2,902,779 177,704 6.12 2,770,428 150,744 5.44
Other borrowings 1,826,084 108,699 5.95 3,467,715 245,285 7.07 3,474,927 237,969 6.85
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
Total borrowings 5,063,764 294,138 5.81 6,370,494 422,989 6.64 6,245,355 388,713 6.22
---------- --------- ------ ---------- --------- ------ ---------- --------- ------
Total interest-
bearing
liabilities ..... 12,434,450 621,086 4.99 13,562,817 769,594 5.67 13,230,217 694,207 5.25
--------- --------- ---------
Noninterest-bearing
liabilities 173,140 235,003 255,259
---------- ---------- ----------
Total liabilities 12,607,590 13,797,820 13,485,476
Shareholders' equity 919,356 866,469 836,741
---------- ---------- ----------
Total liabilities
and share-
holders' equity
$13,526,946 $14,664,289 $14,322,217
========== ========== ==========
Net interest income $ 383,392 $ 317,816 $ 311,973
========= ========= =========
Interest rate spread 2.66 1.96 1.99
====== ====== ======
Net yield on average
interest-earning
assets ............... 2.92 2.23 2.24
====== ====== ======
Average interest-
earning assets to
average interest-
bearing liabilities .. 105.6% 105.1% 105.1%
====== ====== ======
<FN>
- ----------
(1) Nonaccrual loans are included in the average balance.
(2) Includes mark-to-market adjustments on securities available for sale.
</TABLE>
23
<PAGE> 27
The following rate-volume analysis shows the approximate relative contribution
of changes in average interest rates and volume to changes in net interest
income for the years indicated.
RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 V. 1995 YEAR ENDED DECEMBER 31, 1995 V. 1994
------------------------------------ ------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
-------------------------- --------------------------
RATE(1) VOLUME(1) TOTAL RATE(1) VOLUME(1) TOTAL
------- --------- ----- ------- --------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans and leases ................... $ (10,356) 54,852 44,496 15,048 10,169 25,217
Mortgage-backed securities
Available for sale ............... 1,652 52,671 54,323 7,973 (48,635) (40,662)
Held to maturity ................. 442 (138,954) (138,512) 19,971 34,067 54,038
Investment securities available
for sale ......................... 48 (38,589) (38,541) 1,961 31,663 33,624
Other interest-earning assets ...... (629) (4,069) (4,698) 7,056 1,957 9,013
--------- ----------- ---------- -------- -------- ---------
Total ........................... (8,843) (74,089) (82,932) 52,009 29,221 81,230
--------- ----------- ---------- -------- -------- ---------
Interest expense:
Checking, savings and
money market accounts ............. (348) 5,645 5,297 1,316 (8,842) (7,526)
Certificates of deposit ............ (23,887) (1,067) (24,954) 16,197 32,440 48,637
FHLB advances ...................... (11,920) 19,655 7,735 19,510 7,450 26,960
Other borrowings ................... (34,253) (102,333) (136,586) 7,811 (495) 7,316
--------- ----------- ---------- -------- -------- ---------
Total ........................... (70,408) (78,100) (148,508) 44,834 30,553 75,387
--------- ----------- ---------- -------- -------- ---------
Change in net interest income ........ $ 61,565 4,011 65,576 7,175 (1,332) 5,843
========= =========== ========== ======== ======== =========
<FN>
- ----------
(1) Changes not solely attributable to volume or rate have been allocated in
proportion to the changes due to volume and rate.
</TABLE>
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses represents a charge against current
earnings in order for management to maintain the allowance for loan and lease
losses at a level that will absorb estimated future loan and lease charge-offs.
The provision for loan and lease losses was $4.0 million in 1996, $1.0 million
in 1995 and $2.9 million in 1994. The increase in the provision was primarily
due to growth in the loan and lease portfolio. The loan and lease portfolio at
December 31, 1996 was $8.1 billion, a 21.3% increase over the $6.7 billion
balance at December 31, 1995. The majority of this growth was in loans secured
by one-to-four family residential real estate, as that portfolio grew by $1.0
billion in 1996. Nonperforming loans and leases as a percentage of total loans
and leases were .44% at December 31, 1996. This was an improvement over the
December 31, 1995 and 1994 ratios of .65% and .75%, respectively. Net loan and
lease charge-offs have remained low. They were .03%, .02% and .04% of average
loan and lease balances for 1996, 1995 and 1994, respectively. See "Financial
Condition - Loans and Leases" for a further discussion about nonperforming
assets and the allowance for loan and lease losses.
OTHER INCOME
Other income for 1996 was $57.1 million as compared to a negative $47.8 million
for 1995. Other income for 1995 was negative as a result of the balance sheet
repositioning implemented in conjunction with the previously discussed FirstFed
Merger. The swap terminations in that repositioning resulted in a loss of $76.2
million in 1995. There was no similar event in 1996. Other net gains and losses
on the sale of investments and mortgage-backed securities during the 1996 period
improved by $19.0 million as compared to 1995 also due to the financial
repositioning that occurred in 1995. The sales of investments available for sale
in the 1996 period were executed to purchase higher yielding investments. The
mortgage-backed security sales in 1996 were in response to significant
deterioration in an issuer's creditworthiness as well as steps taken to
eliminate securities with outstanding balances less than 15% of original
amounts. Separately, recurring fee income increased $11.5 million or 32% during
the 1996 period, the increase consisting of $9.0 million in service fees and
other charges and $2.5 million in loan servicing fees. The improvement was
attributable to increases in fees from checking accounts, fees on servicing
loans for others, brokerage commissions earned by a subsidiary of the Bank, and
prepayment penalties on payoffs of commercial real estate loans. Checking
account fees increased as the number of checking
24
<PAGE> 28
accounts opened increased when comparing 1996 to 1995. The primary reason for
the increase in the number of checking accounts relates to the acquisition of
over 55,000 demand deposit accounts in the First Nationwide Bank transaction.
Also, the Charter One checking account programs were introduced in Michigan
during 1996 along with a continuing sales effort in Ohio. Loan servicing fees
increased because the balance of loans serviced for others was higher in the
1996 period. In addition to the loans sold as part of the fourth quarter 1995
financial restructuring, in June 1996 another $510 million of mortgage loans
were sold, servicing retained, as part of an interest rate risk management
strategy. Also, mortgage loan prepayment penalties increased as a result of
payoffs on several large commercial real estate loans in 1996. Brokerage
commissions were higher in 1996 as a result of expanded operations.
Other income for 1995 was a negative $47.8 million as compared to a negative
$110.4 million for the 1994 period. As mentioned above, the negative other
income in 1995 was a result of the financial repositioning executed in the
fourth quarter of 1995 in connection with the FirstFed Merger. Other income for
1994 was a negative $110.4 million due to the loss on termination of swaps
associated with FirstFed's 1994 restructuring, as previously discussed. Income
from leasing operations was $7.9 million in 1995, the year ICX Corporation
("ICX") was acquired. See Note 2 to the Consolidated Financial Statements for a
further discussion of the ICX acquisition. Service fees and other charges
increased $2.2 million, or 9.1%, in 1995 over 1994 primarily due to increases in
checking account and ATM fee income. These two increases in fee income were
partially offset by a decrease in loan servicing fees of $1.2 million resulting
from lower average balances of loans serviced for others. The balance was
reduced by repayments of the existing portfolio and fewer loan sales.
ADMINISTRATIVE EXPENSES
Administrative expenses were $244.0 million in 1996 and $215.7 million in 1995.
Each year had nonrecurring expenses that contributed significantly to total
administrative expenses. In 1996, the Bank paid and expensed the $56.3 million
SAIF assessment. In 1995, the Company incurred $37.5 million of one-time
expenses related to the FirstFed Merger. Administrative expenses for 1996,
excluding the SAIF assessment, were $187.8 million as compared to $178.2 million
for 1995, excluding merger-related expenses, a $9.6 million, or 5.4%, increase.
This increase was primarily attributable to increases in compensation and
benefits expense, office occupancy expenses, the amortization of goodwill and
other administrative expenses. These increases were primarily related to
increased retail banking activities along with increased subsidiary operations
relating to brokerage and insurance sales which expanded into the Michigan
market in 1996, offset by a reduction in back office personnel as a result of
the FirstFed Merger. Loans serviced for retail customers increased as Charter
One had a record year in loan originations. See "Loan and Lease Activity" for
further information concerning loan and lease originations and portfolio growth
in 1996. Overall, administrative expenses remained at favorable levels as
illustrated by the 42.2% efficiency ratio, excluding the SAIF assessment, for
1996 as compared to 49.0%, excluding merger-related charges, for 1995.
Administrative expenses for 1995 were $215.7 million, which included the
one-time merger expenses related to the FirstFed Merger of $37.5 million. There
were no comparable merger-related expenses in 1994. Excluding the 1995
merger-related expenses, administrative expenses were $178.2 million as compared
to $176.0 million for 1994, an increase of $2.3 million, or 1.3%. This increase
was primarily due to salaries and employee benefits expenses which increased by
$5.5 million, or 6.6%, which was partially offset by reductions in other
administrative expenses.
FEDERAL INCOME TAX EXPENSE
The provision for federal income taxes was $64.8 million for 1996 as compared to
$19.2 million for 1995. This increase was primarily attributable to an increase
in pretax book income. The effective tax rate was 34% in 1996 and 36% in 1995.
See Note 12 to the Consolidated Financial Statements for a further analysis of
the effective tax rate.
The provision for federal income taxes for 1995 was $19.2 million as compared to
$7.1 million for 1994. The primary reason was the increase in pretax book
income. The effective tax rates for 1995 and 1994 were 36% and 31%,
respectively.
25
<PAGE> 29
ASSET/LIABILITY MANAGEMENT
Interest sensitivity gap ("gap") analysis measures the difference between the
assets and liabilities repricing or maturing within specific time periods. An
asset-sensitive position indicates that there are more rate-sensitive assets
than rate-sensitive liabilities repricing or maturing within specific time
horizons, which would generally imply a favorable impact on net interest income
in periods of rising interest rates and a negative impact in periods of falling
rates. A liability-sensitive position would generally imply a negative impact on
net interest income in periods of rising rates and a positive impact in periods
of falling rates.
Gap analysis has limitations because it cannot measure the effect of interest
rate movements and competitive pressures on the repricing and maturity
characteristics of interest-earning assets and interest-bearing liabilities. In
addition, a significant portion of the Company's adjustable-rate assets have
limits on their maximum yield, whereas most of its interest-bearing liabilities
are not subject to such limitations. As a result, certain assets and liabilities
indicated as repricing within a stated period may in fact reprice at different
times and at different volumes, and certain adjustable-rate assets may reach
their yield limits and not reprice.
26
<PAGE> 30
The following table presents an analysis of the Company's interest-sensitivity
gap position at December 31, 1996. All interest-earning assets and
interest-bearing liabilities are shown based on their contractual maturity or
repricing date adjusted by forecasted prepayment and decay rates. Asset
prepayment and liability decay rates are selected after considering the current
rate environment, industry prepayment and decay rates, the Company's historical
experience, and the repricing and prepayment characteristics of portfolios
acquired through merger.
MATURITY/RATE SENSITIVITY
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------------------------------------------------
OVER
0-6 7-12 1-3 3-5 5-10 10
MONTHS MONTHS YEARS YEARS YEARS YEARS TOTAL
------ ------ ----- ----- ----- ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Real estate mortgage
loans and mortgage-
backed securities:
Adjustable rate ..... $3,114,367 948,473 728,534 183,445 3,234 2,204 4,980,257
Fixed rate .......... 548,370 513,883 1,762,262 1,237,945 1,800,626 697,980 6,561,066
Business loans ........ 76,793 1,224 6,247 8,040 2,604 - 94,908
Consumer loans ........ 373,111 77,633 211,143 155,343 111,520 - 928,750
Lease financings ...... 24,028 24,491 81,882 57,042 56,124 6,589 250,156
Investment securities,
federal funds sold,
interest-bearing
deposits and other
interest-earning assets 357,466 175,503 - 44,345 537 1 577,852
---------- --------- --------- ---------- ---------- ------- ----------
Total ........... 4,494,135 1,741,207 2,790,068 1,686,160 1,974,645 706,774 13,392,989
---------- --------- --------- ---------- ---------- ------- ==========
Interest-bearing
liabilities:
Deposits:
Checking and savings
accounts ........... 69,469 63,911 1,226,929 367,490 - - 1,727,799
Money market accounts 672,488 - 672,485 - - - 1,344,973
Certificates of
deposit ............ 2,336,294 1,181,105 911,770 181,399 157,857 - 4,768,425
FHLB advances ......... 1,641,418 151,159 964,958 410,556 21,895 4,347 3,194,333
Reverse repurchase
agreements .......... 374,994 370,000 804,784 - - - 1,549,778
Other borrowings ...... 16,885 5,257 12,535 22,532 152,267 1,704 211,180
---------- --------- --------- ---------- ---------- ------- ----------
Total 5,111,548 1,771,432 4,593,461 981,977 332,019 6,051 12,796,488
---------- --------- --------- ---------- ---------- ------- ==========
Excess (deficiency) of
interest-earning assets
over interest-bearing
liabilities ............ (617,413) (30,225) (1,803,393) 704,183 1,642,626 700,723
Impact of hedging ....... (12,073) 130,000 (112,499) (5,428) - -
---------- --------- --------- ---------- ---------- -------
Adjusted interest-
sensitivity gap ........ $ (629,486) 99,775 (1,915,892) 698,755 1,642,626 700,723
========== ========= ========= ========== ========== =======
Cumulative excess
(deficiency)
of interest-earning
assets over
interest-bearing
liabilities ............ $ (629,486) (529,711) (2,445,603) (1,746,848) (104,222) 596,501
========== ========= =========== =========== ========== =======
Cumulative
interest-sensitivity
gap as a percentage of
total
assets at December 31,
1996 ................... (4.5%) (3.8%) (17.%) (12.6%) (0.7%) 4.3%
===== ===== ===== ====== ===== ====
Cumulative
interest-sensitivity
gap as a percentage of
total assets at
December 31, 1995 ...... 4.8% 1.0% (8.3%) (6.7%) 0.8% 4.4%
===== ===== ===== ====== ===== ====
</TABLE>
One of the principal operating strategies of Charter One has been to better
match the terms to repricing of its interest rate-sensitive assets and
liabilities to manage the sensitivity of the Company's earnings to changes in
interest rates. Charter One's principal efforts in this strategy include: (i)
originating and retaining adjustable-rate loans with shorter terms or more
frequent repricing than fixed-rate mortgage loans, while offering sufficiently
attractive yields to provide profitable margins over the Company's cost of
funds; and (ii) lengthening the maturities of its interest-bearing liabilities.
Management's goal is to manage the Company's interest rate risk by maintaining
the gap between interest-earning assets and interest-bearing liabilities
repricing within a one-year period to plus or minus 5% of total assets.
As of December 31, 1996, the Company had swaps and caps in place to adjust the
interest rate risk profile of certain borrowings and deposit liabilities. See
Note 11 to the Consolidated Financial Statements for additional information.
27
<PAGE> 31
FINANCIAL CONDITION
Consolidated assets of Charter One Financial, Inc., substantially all held by
Charter One Bank, F.S.B., were $13.9 billion at December 31, 1996, an increase
of $325.7 million, or 2.4%, from December 31, 1995. The increase in assets was
primarily due to growth in the loan and lease portfolio in 1996.
LOANS AND LEASES
Total loans and leases held for investment at December 31, 1996 totaled $8.1
billion, up from $6.7 billion at December 31, 1995. The $1.4 billion, or 21.3%,
increase was primarily due to significant growth in loan originations as the
Bank originated $3.8 billion of new loans and leases in 1996. Which represents a
111.1% increase over the $1.8 billion of loan and lease originations in 1995.
During 1996 the consumer loan portfolio grew by $334.6 million, or 56.3%, over
1995. Over the past few years, management has emphasized growth in the consumer
loan portfolio due to the shorter terms and higher yields. The Bank's consumer
loan portfolio is primarily secured by residential real estate properties. These
loans help the Bank manage its interest rate sensitivity gap. Also to help
manage interest rate sensitivity, the Bank securitized $510.4 million of
fixed-rate mortgage loans which were subsequently sold in June 1996.
The following table summarizes the loan and lease activity for each of the past
three years.
LOAN AND LEASE ACTIVITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Originations:
Real estate:
Permanent:
One-to-four family .................................. $ 2,426,589 1,077,838 1,023,016
Multifamily ......................................... 48,224 29,093 47,430
Commercial .......................................... 74,319 56,743 18,295
----------- ----------- ------------
Total permanent ................................... 2,549,132 1,163,674 1,088,741
----------- ----------- ------------
Construction:
One-to-four family .................................. 320,967 176,503 210,916
Multifamily ......................................... 5,910 10,781 12,003
Commercial .......................................... 17,246 22,922 8,293
----------- ----------- ------------
Total construction ................................ 344,123 210,206 231,212
----------- ----------- ------------
Total real estate loans originated .............. 2,893,255 1,373,880 1,319,953
Consumer line of credit draws ........................... 207,865 146,293 130,132
Consumer ................................................ 428,107 161,635 142,033
Business line of credit draws ........................... 70,143 37,980 76,071
Business ................................................ 44,487 21,290 15,048
Lease financings(1) ..................................... 205,789 82,585 -
----------- ----------- ------------
Total loans and lease financings originated ....... 3,849,646 1,823,663 1,683,237
----------- ----------- ------------
Lease financings purchased in acquisition of
ICX Corporation(1) - 76,912 -
----------- ----------- ------------
Sales and principal reductions:
Loans sold(2) ......................................... 570,317 473,488 177,521
Principal reductions .................................. 1,827,232 1,338,707 1,479,437
----------- ----------- ------------
Total sales and principal reductions .............. 2,397,549 1,812,195 1,656,958
----------- ----------- ------------
Increase before net items ....................... $ 1,452,097 88,380 26,279
=========== =========== ============
- ----------
<FN>
(1) Excludes $29.0 million in operating leases purchased in the acquisition of
ICX in 1995, and $11.0 million and $22.0 million in operating leases
originated subsequent to the purchase in 1996 and 1995, respectively.
(2) Includes $510.4 million, $331.4 million and $28.7 million of loans swapped
for mortgage-backed securities in the years ended December 31, 1996, 1995
and 1994, respectively.
</TABLE>
28
<PAGE> 32
The following table sets forth certain information concerning Charter One's
nonperforming assets as of the past five year ends. The table illustrates there
has been a downward trend in recent years in the balances and ratios of
nonperforming assets. At December 31, 1996, the Bank had no outstanding
commitments to lend additional funds to borrowers whose loans were on nonaccrual
or restructured status. On January 1, 1995, Charter One adopted SFAS No. 114
"Accounting by Creditors for Impairment of a Loan" and SFAS No. 118 "Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures"
which impose certain requirements on the measurement of impaired loans. The
Company had previously measured such loans in accordance with the methods
prescribed in SFAS No. 114 and the Company's method of recording cash receipts
on impaired loans was essentially the same as prescribed by SFAS No. 118.
Therefore, the comparability of the data presented in the tables below has not
been affected by the adoption of SFAS No. 114 and SFAS No. 118.
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonperforming loans and leases:
Nonaccrual loans and leases:
Real estate loans:
One-to-four family ................................ $ 10,264 15,145 18,272 24,314 22,128
Multifamily and commercial ........................ 2,372 3,014 4,548 6,595 9,769
Construction and land ............................. 827 1,463 2,596 2,717 1,911
-------- -------- -------- -------- ---------
Total real estate loans ......................... 13,463 19,622 25,416 33,626 33,808
Consumer ............................................ - 1,525 1,085 1,550 1,585
Business ............................................ 95 - 77 610 2,368
Lease financings .................................... - 27 - - -
-------- -------- -------- -------- ---------
Total nonaccrual loans and leases ............... 13,558 21,174 26,578 35,786 37,761
-------- -------- -------- -------- ---------
Accruing loans and leases delinquent
more than 90 days:
Real estate loans:
One-to-four family ................................ 5,961 2,002 2,781 1,228 3,317
Multifamily and commercial ........................ - 893 855 1,527 705
Construction and land ............................. - - 207 101 208
-------- -------- -------- -------- ---------
Total real estate loans ......................... 5,961 2,895 3,843 2,856 4,230
Consumer ............................................ 544 147 255 744 467
Business ............................................ 58 - 17 222 372
Lease financings .................................... - - - - -
-------- -------- -------- -------- ---------
Total accruing loans and leases
delinquent more than 90-days .................. 6,563 3,042 4,115 3,822 5,069
-------- -------- -------- -------- ---------
Restructured real estate loans ........................ 15,294 18,835 18,479 23,609 31,348
-------- -------- -------- -------- ---------
Total nonperforming loans and leases ............ 35,415 43,051 49,172 63,217 74,178
Real estate acquired through foreclosure
and other repossessed assets .......................... 7,030 11,650 15,379 31,053 33,604
-------- -------- -------- -------- ---------
Total nonperforming assets ...................... $ 42,445 54,701 64,551 94,270 107,782
======== ======== ======== ======== =========
Ratio of:
Nonperforming loans and leases to total
loans and leases ..................................... .44% .65% .75% .96% 1.19%
Nonperforming assets to total assets .................. .31 .40 .44 .65 .79
Allowance for loan and lease losses to:
Nonperforming loans and leases ...................... 186.14 149.67 131.86 102.37 79.51
Total loans and leases before allowance ............. .81 .96 .97 .98 .94
</TABLE>
Nonperforming assets at December 31, 1996 stood at $42.4 million, or .31% of
total assets. That figure was down 22% from year-end 1995 primarily due to
improvement in the levels of nonperforming real estate loans attributable to a
strong regional economy. This has also contributed to the improvement in the
ratio of nonperforming loans and leases to total loans and leases. That ratio
was .44%, .65% and .75% at December 31, 1996, 1995 and 1994, respectively.
Nonperforming assets to total assets has had a similar trend, ending at .31% of
total assets at year-end 1996. While these trends are favorable, there are
inherent risks and uncertainties related to the operation of a financial
institution. Therefore, the possibility exists that an abrupt downturn in the
economic environment in Ohio and/or Michigan could result in higher levels of
nonperforming assets.
29
<PAGE> 33
At December 31, 1996, there were $25.0 million of loans not reflected in the
table above, where known information about possible credit problems of borrowers
caused management to have doubts as to the ability of the borrower to comply
with present loan repayment terms and that may result in disclosure of such
loans in the future. Included in the total is a $15.6 million loan on apartment
buildings. The apartment buildings have experienced past cash flow shortfalls,
but the loan is current.
Although loans may be classified as nonaccruing, many continue to pay interest
on an irregular basis or at levels less than the contractual amounts due. A
summary of income recorded on nonaccruing and restructured loans versus the
potential income based upon full contractual yields for the past three years
follows:
SUMMARY OF INCOME ON NONACCRUING AND RESTRUCTURED LOANS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Income potential based on original contract ..................... $2,959 3,511 4,252
Actual income ................................................... 2,178 2,950 3,401
</TABLE>
ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, beginning of year .................... $ 64,436 64,838 64,715 58,982 50,577
Provision for loan and lease losses ........... 4,001 1,032 2,948 7,549 12,544
Acquired through acquisition .................. - - - 2,022 -
Other ......................................... - 176 - - -
Loans and lease financings charged off:
Mortgage .................................... (1,933) (1,063) (1,094) (1,177) (600)
Consumer .................................... (938) (1,193) (1,783) (2,413) (3,150)
Business .................................... (16) (62) (343) (383) (1,480)
Lease financings ............................ - - - - -
-------- -------- -------- -------- --------
Total charge-offs ......................... (2,887) (2,318) (3,220) (3,973) (5,230)
-------- -------- -------- -------- --------
Recoveries:
Mortgage .................................... 123 615 200 55 919
Consumer .................................... 249 49 137 79 171
Business .................................... - 44 58 1 1
Lease financings ............................ - - - - -
-------- -------- -------- -------- --------
Total recoveries .......................... 372 708 395 135 1,091
-------- -------- -------- -------- --------
Net loan and lease charge-offs ............ (2,515) (1,610) (2,825) (3,838) (4,139)
-------- -------- -------- -------- --------
Balance, end of year .......................... $ 65,922 64,436 64,838 64,715 58,982
======== ======== ======== ======== ========
Net charge-offs to average loans
and leases .................................. .03% .02% .04% .06% .07%
Net charge-offs to provision for
loan and lease losses ....................... 62.86 156.01 95.83 50.84 33.00
</TABLE>
30
<PAGE> 34
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Mortgage ..................................... $ 53,133 51,607 51,879 50,813 44,766
Consumer ..................................... 6,765 7,214 8,239 9,562 10,724
Business ..................................... 5,047 4,883 4,720 4,340 3,492
Lease financings ............................. 977 732 - - -
-------- -------- -------- -------- --------
Total .................................... $ 65,922 64,436 64,838 64,715 58,982
======== ======== ======== ======== ========
Percent of loans and leases to total loans
and leases:
Mortgage ................................... 84.3% 88.3% 91.6% 93.2% 92.5%
Consumer ................................... 11.4 8.8 7.2 5.8 6.5
Business ................................... 1.2 0.9 1.2 1.0 1.0
Lease financings ........................... 3.1 2.0 - - -
-------- -------- -------- -------- --------
Total .................................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======== ========
</TABLE>
Net loan and lease charge-offs remained low in 1996 at only .03% of average loan
and lease balances. The allowance for loan and lease losses as a percentage of
ending loan and lease balances was .81%, .96% and .97% at December 31, 1996,
1995 and 1994, respectively. This level has remained fairly consistent despite
recent improvements in the levels of nonperforming loans. The allowance for loan
and lease losses is maintained at levels believed adequate by management to
absorb estimated future losses inherent in the loan and lease portfolio.
Management believes that the allowance for loan and lease losses has been
recorded in accordance with generally accepted accounting principles. Although
management believes that it uses the best information available to make such
determinations and that the allowance for loan losses was adequate at December
31, 1996, future adjustments to the allowance may be necessary, and net income
could be significantly affected, if circumstances and/or economic conditions
differ substantially from the assumptions used in making the determinations
about the levels of the loan and lease allowance. Any significant downturn in
the Ohio and/or Michigan economy could result in the Bank experiencing increased
levels of nonperforming loans and charge-offs, significant provisions for loan
and lease losses and significant reductions in income. Additionally, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for losses. Such agencies may require
the recognition of additions to the allowance based upon their judgements of
information available to them at the time of their examination.
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
The securities portfolio is comprised primarily of mortgage-backed securities,
including government agency and AAA and AA rated private issues. The following
table details the aggregate carrying value and aggregate fair value at December
31, 1996 of private issue mortgage-backed securities of any single issuer where
the aggregate book value exceeds 10% of year-end shareholders' equity.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------------------
CARRYING FAIR
VALUE VALUE
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
GE Capital Mortgage Services, Inc. ................................... $352,739 343,448
Residential Funding Mortgage Securities I, Inc. ...................... 335,194 332,435
California Federal Bank .............................................. 271,866 264,994
The Prudential Home Mortgage Securities Company, Inc. ................ 230,057 227,558
</TABLE>
Charter One held no investment securities of any single nongovernmental issuer
which were in excess of 10% of shareholders' equity at either December 31, 1996
or 1995.
The present investment policy of the Company provides that new purchases of
mortgage-backed securities have an investment rating of AAA. At December 31,
1996, approximately 80% of the private issue mortgage-backed security portfolio
had an investment rating of AAA and approximately 18% had an investment rating
of AA.
31
<PAGE> 35
Nonmortgage-backed securities are intended to help satisfy the Bank's legal
liquidity requirements and help control interest rate risk. See Notes 3 and 4 to
the Consolidated Financial Statements for further information concerning the
composition of the securities portfolio.
DEPOSITS AND OTHER SOURCES OF FUNDS
Deposits are generally the most important source of the Bank's funds for use in
lending and general business purposes. Deposit inflows and outflows are
significantly influenced by general interest rates and competitive factors.
Consumer and commercial deposits are attracted principally within the Bank's
primary market areas.
The balance of deposits was $7.8 billion at December 31, 1996, a $828.7 million
increase from year-end 1995. The increase primarily resulted from the
acquisition of First Nationwide Bank's 21 branch offices in the Detroit
Metropolitan area. The deposits of the branches totaled $796.7 million and were
assumed for a cost of $57.0 million. The market areas of four First Nationwide
offices directly overlapped our existing branch office market areas and
therefore were consolidated into the existing branch facilities.
In addition to deposits, the Bank derives funds from different borrowing
sources. The primary source of these borrowings is the Federal Home Loan Bank
("FHLB") system. Those borrowings were $3.2 billion at December 31, 1996 and
1995. The FHLB functions as a central bank providing credit for member financial
institutions. As a member of the FHLB of Cincinnati, Charter One Bank is
required to own capital stock in the FHLB and it is authorized to apply for
advances on the security of such stock and certain home mortgages and other
assets, provided certain standards related to creditworthiness have been met.
Advances are made pursuant to several different credit programs, each of which
has its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based upon either a fixed percentage
of the Bank's assets or on the FHLB of Cincinnati's assessment of the Bank's
creditworthiness. See Note 8 to the Consolidated Financial Statements for
further information as to the make-up, maturities and cost associated with these
advances at December 31, 1996.
In addition to FHLB advances, the Company uses reverse repurchase agreements to
fund operations. Reverse repurchase agreements declined by $539.7 million during
1996 as the financial repositioning to a more retail, as opposed to wholesale,
funding mix was accomplished. See Note 9 to the Consolidated Financial
Statements for further information about the Bank's reverse repurchase agreement
portfolio.
The Company uses its portfolio of investment securities, loans and
mortgage-backed securities as collateral for other borrowings. Other borrowings
were $211.2 million at December 31, 1996, an increase of $2.2 million since
December 31, 1995. See Note 10 to the Consolidated Financial Statements for
further information concerning these borrowings.
LIQUIDITY
The Bank's principal sources of funds are deposits, advances from the FHLB of
Cincinnati, reverse repurchase agreements, repayments and maturities of loans
and securities, proceeds from the sale of securities and funds provided by
operations. While scheduled loan, security and interest-bearing deposit
amortization and maturity are relatively predictable sources of funds, deposit
flow and loan and mortgage-backed security repayments are greatly influenced by
economic conditions, the general level of interest rates and competition. The
Bank utilizes particular sources of funds based on comparative costs and
availability. The Bank generally manages the pricing of its deposits to maintain
a steady deposit balance, but from time to time management may decide not to pay
rates on deposits as high as its competition and, when necessary, to supplement
deposits with longer term and/or less expensive alternative sources of funds
such as FHLB advances and reverse repurchase agreements.
The Bank is required by regulation to maintain specific minimum levels of liquid
investments. Regulations currently in effect require the Bank to maintain
average liquid assets at least equal to 5.0% of the sum of its average daily
balance of net withdrawable accounts and borrowed funds due in one year or less.
This regulatory requirement may be changed from time to time to reflect current
economic conditions. The Bank's average regulatory liquidity ratio for the
fourth quarter of 1996 was 5.81%.
Liquidity management is both a daily and long-term responsibility of management.
The Bank adjusts its investments in cash and cash equivalents based upon
management's assessment of: (i) expected loan demand; (ii) projected security
maturities; (iii) expected deposit flows; (iv) yield available on
interest-bearing deposits; and (v)
32
<PAGE> 36
the objectives of its asset/liability management program. Excess liquidity is
generally invested in federal funds sold, U.S. Treasury and agency securities
and commercial paper. If the Bank requires funds beyond its ability to generate
them internally, it has additional borrowing capacity with the FHLB of
Cincinnati and collateral eligible for reverse repurchase agreements. Because
the Bank has a stable retail deposit base, management believes that significant
borrowings will not be necessary to maintain its current liquidity position.
Management anticipates that the Bank will have sufficient funds available to
meet current and future loan commitments. At December 31, 1996, the Bank and its
subsidiaries had outstanding commitments to originate loans and leases of $409.2
million and unfunded lines of credit totaling $471.0 million (a significant
portion of which normally remains undrawn). Certificates of deposit scheduled to
mature in one year or less at December 31, 1996 totaled $3.5 billion. Management
believes that a significant portion of the amounts maturing in 1997 will remain
with the Bank because they are retail deposits. At December 31, 1996, the Bank
had $1.5 billion of advances from the FHLB system and $175 million in reverse
repurchase agreements which mature in 1997. Management intends to review the
need for these borrowings when they mature and believes it has significant
additional borrowing capacity with the FHLB and investment banking firms to meet
any need for replacement borrowings.
CAPITAL AND DIVIDENDS
The Bank is subject to certain regulatory capital requirements. Management
believes that as of December 31, 1996, the Bank meets all capital requirements
to which it is subject. Refer to Note 14 to the Consolidated Financial
Statements for an analysis of the Bank's regulatory capital.
During 1994, the Board of Directors of the Company authorized management to
purchase up to 1.2 million shares of the Company's common stock. As of June 30,
1996, all of the shares had been purchased under this authorization.
On May 15, 1996, the Board of Directors of the Company authorized management to
purchase 5% of the Company's outstanding common stock in an additional buyback
program. As of that date, the Company had 47,354,637 common shares outstanding
(adjusted for the subsequent stock dividend.) Under the authorization, purchases
shall be made from time to time through open market purchases or unsolicited
negotiated transactions. Shares purchased under this authorization will be held
in treasury and will be available for issuance upon the exercise of outstanding
stock options and other corporate purposes.
On July 24, 1996, the Directors of Charter One Financial, Inc. approved a 5%
stock dividend which was distributed September 30, 1996, to shareholders of
record on September 13, 1996.
The Company's common stock trades on the NASDAQ National Market System under the
symbol COFI. As of February 28, 1997 there were approximately 7,300 shareholders
of record.
Quarterly stock prices and dividends declared are shown in the following table.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
--------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
1996(1)
High ................................ $33.57 36.19 40.56 44.75 44.75
Low ................................. 27.14 29.34 32.03 38.13 27.14
Close ............................... 32.14 33.22 40.00 42.00 42.00
Dividends declared and paid ......... .19 .22 .22 .23 .86
1995(1)
High ................................ $21.08 25.71 29.29 31.79 31.79
Low ................................. 17.98 19.05 23.22 26.79 17.98
Close ............................... 19.28 23.33 28.09 29.17 29.17
Dividends declared and paid ......... .16 .18 .18 .19 .71
<FN>
- ----------
(1) Restated to reflect the 5% stock dividend issued September 30, 1996.
</TABLE>
33
<PAGE> 37
Cash dividend payout is continually reviewed by management and the Board of
Directors. The Company intends to continue its policy of paying quarterly
dividends; however, the payment will depend upon a number of factors, including
capital requirements, regulatory limitations, the Company's financial condition,
results of operations and the Bank's ability to pay dividends to its parent,
which in turn will pay dividends to the Company. The Company depends
significantly upon such dividends originating from the Bank to accumulate
earnings for payment of cash dividends to its shareholders and for purchases of
its common stock as described above. See Note 13 to the Consolidated Financial
Statements for a discussion of restrictions on the Bank's ability to pay
dividends.
IMPACT OF BUSINESS COMBINATIONS AND ASSET ACQUISITIONS
As previously discussed, the Company completed the First Nationwide transaction
in 1996.
Also as previously discussed, on October 31, 1995 Charter One completed the
FirstFed Merger. The merger was effected through the issuance of 1.2 shares of
Company common stock for each share of FirstFed common stock resulting in the
issuance of 22.5 million shares of Company common stock. The merger has been
accounted for as a pooling of interests and accordingly, the financial
statements for the Company for all periods prior to the FirstFed Merger have
been restated to include the results of FirstFed. FirstFed paid dividends of
$.46 per share for the 10 months ending October 31, 1995. For the 12 months
ended December 31, 1994, FirstFed paid dividends per share of $.54. All per
share dividend amounts and share prices shown are those of the Company prior to
the FirstFed Merger. See Note 2 to the Consolidated Financial Statements for
further information concerning this merger.
While the FirstFed Merger was accounted for as a pooling of interests,
periodically in the past the Company has completed other acquisitions where the
purchase method of accounting was applied. When the purchase method is used to
account for a business combination, the acquired assets and liabilities are
stated at fair value as of the acquisition date. In the banking industry
discounts and premiums are recorded to make fair value adjustments. These
premiums and discounts are then amortized over the estimated lives of the
related financial instruments. As shown below, net income for each period
presented was affected due to amortization of valuation adjustments recorded in
connection with the Company's acquisitions.
EFFECT OF PURCHASE ACCOUNTING ADJUSTMENTS ON INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
NET GAIN OTHER FEDERAL
INTEREST (LOSS) EXPENSE, INCOME NET
INCOME ON SALE NET TAX INCOME
------- ------- --------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1996 .............................................. $3,281 3 3,194 32 58
1995 .............................................. 3,168 (432) 1,375 476 885
1994 .............................................. 4,814 (3) 466 1,521 2,824
</TABLE>
The estimated effect in future years of amortization of valuation adjustments
recorded in connection with the Company's acquisitions is set forth below:
FORECASTED EFFECT OF PURCHASE ACCOUNTING ADJUSTMENTS ON INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
FEDERAL
INCOME
NET OTHER TAX
INTEREST EXPENSE, EXPENSE NET
INCOME NET (BENEFIT) INCOME
-------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1997 ........................................... $ 549 (5,070) (1,582) (2,939)
1998 ........................................... 388 (5,033) (1,626) (3,019)
1999 ........................................... 217 (4,805) (1,606) (2,982)
2000 ........................................... (44) (4,783) (1,689) (3,138)
2001 ........................................... (31) (4,752) (1,674) (3,109)
Thereafter ..................................... 2,224 (37,646) (12,398) (23,024)
------ --------- --------- ---------
Total ........................................ $ 3,303 (62,089) (20,575) (38,211)
====== ========= ========= =========
</TABLE>
34
<PAGE> 38
Amortization of valuation adjustments can be significantly affected by factors
beyond the Company's control, such as changes in prepayment rates. The actual
effect of these valuation adjustments may be materially different than the
estimated effect disclosed herein.
Unamortized balances of purchase accounting valuation amounts for all purchase
business combinations and purchase of asset transactions are summarized below:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
---- ----
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Net discount on interest-earning assets ................. $ 1,246 7,281
Premiums on interest-bearing liabilities ................ 2,057 3,456
Goodwill ................................................ 64,496 10,602
Other, net .............................................. 154 167
</TABLE>
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented herein have
been prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and results of operations in terms
of historical dollars without considering changes in the relative purchasing
power of money over time because of inflation. Unlike most industrial companies,
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, interest rates have a more significant impact
on a financial institution's performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services. In the current interest
rate environment, liquidity, maturity structure and quality of the Bank's assets
and liabilities are critical to the maintenance of acceptable performance
levels.
ACCOUNTING AND REPORTING DEVELOPMENTS
A discussion of recently issued accounting pronouncements and their impact on
the Company's consolidated financial statements is provided in Note 1 to the
Consolidated Financial Statements.
FOURTH QUARTER RESULTS
The Company had net income of $42.9 million in the fourth quarter of 1996 as
compared to a net loss of $58.4 million in the last quarter of 1995. As
discussed earlier, the fourth quarter of 1995 included merger-related expenses
and charges due to balance sheet repositioning in conjunction with the FirstFed
Merger. Excluding these items, operating earnings for the 1995 period were $34.2
million. Therefore, earnings from operations increased $8.7 million, or 25.5%.
This increase was primarily due to an increase in net interest income of $9.5
million, as an increase of $3.8 million in recurring fee income was offset by
increases of $2.8 million in other expenses and $742,000 in the provision for
loan losses.
Net interest income was $95.3 million for the three months ended December 31,
1996 as compared to $85.8 million in the 1995 period. This $9.5 million, or
11.1%, increase was primarily due to lower balances of other borrowed funds and
an increase in the interest rate spread. The lower balance of other borrowed
funds was due to the Bank's desire to replace wholesale funds added in the
FirstFed Merger with retail deposits and lower costing FHLB advances. The
average balance of savings deposit accounts was $843.7 million higher in the
1996 period when compared to the fourth quarter of 1995 and the average balance
of FHLB advances was $212.8 million higher in the 1996 period. This was offset
by a $1.2 billion decrease in the other borrowed funds average balance. This
shift in categories and ultimate decrease of $120.4 million in the average
balance of interest-bearing liabilities reduced interest expense by $6.0
million. The interest rate spread was 33 basis points higher at 2.59% for the
fourth quarter of 1996 as compared to 2.26% for the fourth quarter of 1995,
primarily due to the lower cost of interest-bearing liabilities, which
contributed $2.8 million to the increase in net interest income. The cost of
interest-bearing liabilities was 5.01% for the fourth quarter of 1996 as
compared to 5.46% for the same period in 1995.
Loan servicing fees, service fees and charges and leasing operations are
collectively referred to as recurring fee income. The fourth quarter of 1996 had
a $3.8 million increase in recurring fee income when compared to the
35
<PAGE> 39
same period in 1995. This was primarily due to an increase in the number of
checking accounts and increased balances of loans serviced for others. The
increase in the number of checking accounts was primarily due to the First
Nationwide acquisition. See Note 2 to the Consolidated Financial Statements for
further information on this acquisition. The increase in loans serviced for
others resulted from $330 million of mortgage loans sold in December 1995 as
part of the FirstFed Merger and another $510 million in seasoned 15-to-30 year
fixed-rate mortgage loans sold in June 1996 in order to maintain the Bank's
desired interest rate risk profile. In both cases, the Bank sold these loans
with servicing retained.
Other expenses for the fourth quarter of 1996 were $49.2 million as compared to
$46.4 million in the fourth quarter of 1995, excluding the merger-related
expenses of $37.5 million. This $2.8 million increase was primarily attributable
to increased costs associated with the increased retail banking activity and the
acquisition of the Michigan offices and deposits of First Nationwide Bank in
June 1996 as mentioned above.
The following table presents summarized quarterly data for each of the years
indicated.
QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
---------- ---------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
1996
Total interest income ..................... $243,048 251,680 254,327 255,423 1,004,478
Net interest income ....................... 92,002 98,907 97,179 95,304 383,392
Provision for loan and lease losses ....... 1,000 1,000 1,001 1,000 4,001
Gains (losses) on loans and
securities and other ..................... 577 (2,115) (71) 3,502 1,893
SAIF assessment(1) ........................ - - 56,258 - 56,258
Net income ................................ 38,450 41,370 5,031 42,871 127,722
Earnings per share(2) ..................... .80 .86 .11 .90 2.67
1995(3)
Total interest income ..................... $273,372 275,535 276,782 261,721 1,087,410
Net interest income ....................... 77,253 76,896 77,869 85,798 317,816
Provision for loan and lease losses ....... 258 258 258 258 1,032
Gains (losses) on loans and
securities and other ..................... 2,095 3,022 3,263 (24,476) (16,096)
Loss on termination of interest rate
exchange agreements ...................... - - - (76,207) (76,207)
Net income (loss) ......................... 29,310 31,045 32,107 (58,430) 34,032
Earnings (loss) per share(4) .............. .61 .65 .67 (1.24) .71
<FN>
- ----------
(1) See Note 21 to the Consolidated Financial Statements for further
information.
(2) Restated to reflect the 5% stock dividend issued September 30, 1996.
(3) The data for the fourth quarter of 1995 includes pretax losses of $101.8
million from charges related to financial repositioning and restructurings.
The after-tax loss for these financial restructurings was $66.1 million.
Also in the fourth quarter of 1995, the Company recorded merger-related
expenses of $37.5 million with an after-tax impact of $26.5 million.
(4) Restated to reflect the 5% stock dividend issued September 30, 1996. Due to
a net loss in the fourth quarter of 1995, the assumed exercise of stock
options is antidilutive.
</TABLE>
36
<PAGE> 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
(AS RESTATED)
<S> <C> <C>
ASSETS
Cash and deposits with banks ............................................... $ 152,301 163,123
Federal funds sold and other ............................................... 118,003 495,248
------------ ------------
Total cash and cash equivalents ....................................... 270,304 658,371
Investment securities available for sale ................................... 243,632 407,427
Mortgage-backed securities:
Available for sale ....................................................... 1,070,705 1,435,589
Held to maturity (fair value of $3,652,547 and $3,961,326) ............... 3,633,369 3,879,160
Loans held for sale - 4,340
Loans and leases, net (including allowance for loan and lease losses
of $65,922 and $64,436) ................................................... 8,100,342 6,674,260
Federal Home Loan Bank stock ............................................... 215,815 178,136
Premises and equipment ..................................................... 114,145 96,581
Accrued interest receivable ................................................ 77,193 73,683
Equipment on operating leases .............................................. 22,599 32,755
Real estate owned .......................................................... 7,337 11,991
Goodwill ................................................................... 64,496 10,602
Other assets ............................................................... 73,904 95,466
------------ ------------
Total assets .......................................................... $ 13,893,841 13,558,361
============ ============
LIABILITIES
Deposits ................................................................... $ 7,841,197 7,012,491
Federal Home Loan Bank advances ............................................ 3,194,333 3,163,144
Reverse repurchase agreements .............................................. 1,549,778 2,089,520
Other borrowings ........................................................... 211,180 209,020
Advance payments by borrowers for taxes and insurance ...................... 39,346 47,738
Accrued interest payable ................................................... 35,298 56,955
Accrued expenses and other liabilities ..................................... 100,985 94,620
------------ ------------
Total liabilities ..................................................... 12,972,117 12,673,488
------------ ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock - $.01 par value per share; 20,000,000 shares
authorized and unissued .................................................. - -
Common stock - $.01 par value per share; 180,000,000 shares
authorized; 47,472,486 and 45,119,014 shares issued ...................... 475 451
Additional paid-in capital ................................................. 321,991 235,889
Retained earnings .......................................................... 637,356 642,197
Less 1,029,763 and 101,488 shares of common stock held in
treasury, at cost ........................................................ (39,615) (3,061)
Net unrealized gain on securities, net of tax expense of
$812 and $4,520 .......................................................... 1,517 9,397
------------ ------------
Total shareholders' equity ............................................ 921,724 884,873
----------- ------------
Total liabilities and shareholders' equity ............................ $ 13,893,841 13,558,361
============ ==========
</TABLE>
See Notes to Consolidated Financial Statements.
37
<PAGE> 41
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(AS RESTATED)
<S> <C> <C> <C>
INTEREST INCOME:
Loans and leases ....................................... $ 602,432 557,936 532,719
Mortgage-backed securities:
Available for sale ................................... 78,143 23,820 64,482
Held to maturity ..................................... 279,832 418,344 364,306
Investment securities available for sale ............... 21,205 59,746 26,122
Other interest-earning assets .......................... 22,866 27,564 18,551
----------- ----------- -----------
Total interest income ............................... 1,004,478 1,087,410 1,006,180
----------- ----------- -----------
INTEREST EXPENSE:
Deposits ............................................... 326,948 346,605 305,494
FHLB advances .......................................... 185,439 177,704 150,744
Other borrowings ....................................... 108,699 245,285 237,969
----------- ----------- -----------
Total interest expense .............................. 621,086 769,594 694,207
----------- ----------- -----------
Net interest income ................................. 383,392 317,816 311,973
Provision for loan and lease losses ...................... 4,001 1,032 2,948
----------- ----------- -----------
Net interest income after provision for
loan and lease losses .............................. 379,391 316,784 309,025
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Loan servicing fees .................................... 11,476 8,951 10,173
Service fees and other charges ......................... 35,631 26,633 24,404
Leasing operations ..................................... 7,421 7,903 -
Net gains (losses):
Loans ................................................ 2,040 1,578 (1,925)
Mortgage-backed securities ........................... 981 (25,570) 4,191
Investment securities ................................ (2,025) 6,010 6,955
Termination of interest rate exchange agreements...... - (76,207) (155,364)
Other gains .......................................... 897 1,886 357
Other .................................................. 717 980 820
----------- ----------- -----------
Total other income (expense) ........................ 57,138 (47,836) (110,389)
----------- ----------- -----------
ADMINISTRATIVE EXPENSES:
Compensation and employee benefits ..................... 90,881 89,141 83,660
Net occupancy and equipment ............................ 27,129 25,015 24,543
Federal deposit insurance premiums ..................... 16,112 17,445 17,503
State taxes ............................................ 7,887 6,273 7,809
Merger expenses ........................................ - 37,528 -
Amortization of goodwill ............................... 2,587 774 621
Other administrative expenses .......................... 43,170 39,567 41,825
----------- ----------- -----------
Administrative expenses before federal deposit
insurance special assessment ...................... 187,766 215,743 175,961
Federal deposit insurance special assessment ........... 56,258 - -
----------- ----------- -----------
Total administrative expenses ....................... 244,024 215,743 175,961
----------- ----------- -----------
Income before federal income taxes and
and extraordinary item ................................. 192,505 53,205 22,675
Federal income taxes ..................................... 64,783 19,173 7,056
----------- ----------- -----------
Income before extraordinary item .................... 127,722 34,032 15,619
Extraordinary item, net of tax benefit of $6,361 ......... - - (12,348)
----------- ----------- -----------
Net income .......................................... $ 127,722 34,032 3,271
=========== =========== ===========
Earnings per common and common equivalent share(1):
Income before extraordinary item ....................... $ 2.67 .71 .32
Extraordinary item ..................................... - - (.26)
----------- ----------- -----------
Net income .......................................... $ 2.67 .71 .06
=========== =========== ===========
Average common and common equivalent shares
outstanding(1) ......................................... 47,916,192 48,151,822 48,237,686
<FN>
- ----------
(1) Per share data has been restated to reflect the 5% stock dividend issued
September 30, 1996.
</TABLE>
See Notes to Consolidated Financial Statements.
38
<PAGE> 42
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
TOTAL
ADDITIONAL NET UNREALIZED SHARE-
COMMON PAID-IN RETAINED TREASURY GAIN (LOSS) HOLDERS'
STOCK CAPITAL EARNINGS STOCK ON SECURITIES EQUITY
--------- ---------- --------- --------- -------------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994 ............. $449 233,926 667,864 902,239
Common stock issued in connection
with stock options exercised,
152,285 shares ..................... 1 983 - - - 984
Purchase of 48,000 shares of
treasury stock ..................... - - - (935) - (935)
Treasury stock reissued, 4,813
common shares at cost, in connection
with stock options exercised ....... - (65) - 94 - 29
Dividends paid ($.56 per share)(1) .. - - (23,405) - - (23,405)
Net unrealized gain (loss) on
securities available for sale,
net of tax benefit ................. - - - - (58,512) (58,512)
Net income .......................... - - 3,271 - - 3,271
---- -------- -------- -------- -------- --------
Balance, December 31, 1994 ........... 450 234,844 647,730 (841) (58,512) 823,671
Purchase of 718,100 shares of
treasury stock ..................... - - - (19,831) - (19,831)
Treasury stock reissued in connection
with stock option exercised,
618,024 shares ..................... - - (9,596) 16,796 - 7,200
Common stock canceled in
connection with the FirstFed Merger,
909 shares ......................... - (26) - - - (26)
Treasury stock reissued in connection
with the acquisition of ACS,
41,775 shares ...................... - - (7) 815 - 808
Common stock issued in connection
with stock options exercised,
88,290 shares ...................... 1 1,071 - - - 1,072
Dividends paid ($.71 per share)(1) .. - - (29,962) - - (29,962)
Change in net unrealized gain (loss)
on securities, net of tax expense
(as restated) ...................... - - - - 67,909 67,909
Net income ......................... - - 34,032 - - 34,032
---- -------- -------- -------- -------- --------
Balance, December 31, 1995
(as restated) ....................... 451 235,889 642,197 (3,061) 9,397 884,873
Stock dividend of 5% issued
September 30, 1996 ................. 23 84,711 (83,757) (977) - -
Purchase of 1,288,425 shares of
treasury stock ..................... - - - (47,697) - (47,697)
Treasury stock reissued in connection
with stock options exercised,
386,120 shares ..................... - - (8,311) 12,120 - 3,809
Common stock issued in connection
with stock options exercised,
101,409 shares ..................... 1 1,391 - - - 1,392
Dividends paid ($.86 per share)(1) .. - - (40,495) - - (40,495)
Change in net unrealized gain
on securities, net of tax expense
(as restated) ...................... - - - - (7,880) (7,880)
Net income .......................... - - 127,722 - - 127,722
---- -------- -------- -------- -------- --------
Balance, December 31, 1996
(as restated) ....................... $475 321,991 637,356 (39,615) 1,517 921,724
==== ======== ======== ======== ======== ========
<FN>
- ----------
(1) Restated to reflect the 5% stock dividend issued September 30, 1996.
</TABLE>
See Notes to Consolidated Financial Statements.
39
<PAGE> 43
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
(AS RESTATED)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................................. $ 127,722 34,032 3,271
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan and lease losses ....................... 4,001 1,032 2,948
Net (gains) losses ........................................ (1,893) 16,096 (9,578)
Accretion of discounts, amortization of premiums,
amortization of goodwill and depreciation, net ........... 9,977 26,360 6,684
Origination of real estate loans held for sale ............ (59,882) (135,456) (137,561)
Proceeds from sale of loans held for sale ................. 61,922 136,655 139,951
Proceeds from sale of mortgage-backed securities
available for sale ....................................... - - 62,008
Loss on termination of interest rate exchange agreements .. 76,207 155,364
Loss on extinguishment of debt ............................ - - 18,708
Other ..................................................... 18,328 10,220 (37,594)
------------ ------------ ------------
Net cash provided by operating activities ............... 160,175 165,146 204,201
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net principal disbursed on loans and leases ................. (1,915,268) (364,950) (66,765)
Proceeds from principal repayments and maturities of:
Mortgage-backed securities held to maturity ............... 729,730 673,991 1,179,950
Mortgage-backed securities available for sale ............. 31,065 32,717 192,112
Investment securities held to maturity .................... - - 1,800
Investment securities available for sale .................. 231,385 864,903 159,849
Proceeds from sale of:
Mortgage-backed securities held to maturity ............... 71,226 - 17,917
Mortgage-backed securities available for sale ............. 832,501 1,188,401 845,215
Investment securities available for sale .................. 255,521 655,601 322,113
Federal Home Loan Bank stock .............................. - - 20,500
Purchases of:
Mortgage-backed securities held to maturity ............... (569,577) (178,010) (1,501,023)
Mortgage-backed securities available for sale ............. - (3,081) (757,769)
Investment securities available for sale .................. (326,252) (1,443,905) (519,832)
Federal Home Loan Bank stock .............................. (30,662) (11,255) (31,883)
Equipment on operating lease .............................. (10,980) (22,011) -
Net cash and cash equivalents (paid) received in connection
with acquisitions .......................................... 731,170 (9,857) 83,489
Other ....................................................... (14,275) (5,014) 21,466
------------ ------------ ------------
Net cash provided by (used in) investing activities ..... 15,584 1,377,530 (32,861)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in short-term borrowings ............ (848,033) (510,697) 212,864
Proceeds from long-term borrowings .......................... 2,920,137 4,194,081 6,848,988
Repayments of long-term borrowings .......................... (2,577,924) (4,713,866) (6,721,256)
Increase (decrease) in, net of acquisitions:
Deposits .................................................. 33,377 (76,238) (277,434)
Advance payments by borrowers for taxes and insurance ..... (8,392) (7,364) 1,362
Payment of dividends on common stock ........................ (40,495) (29,962) (23,405)
Proceeds from issuance of common stock ...................... 1,392 1,072 984
Purchase of treasury stock, net of options exercised ........ (43,888) (12,629) (906)
Net payment to terminate interest rate exchange agreements .. - (70,637) (142,245)
------------ ------------ ------------
Net cash used in financing activities ................... (563,826) (1,226,240) (101,048)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents ...... (388,067) 316,436 70,292
Cash and cash equivalents, beginning of year .................. 658,371 341,935 271,643
------------ ------------ ------------
Cash and cash equivalents, end of year ........................ $ 270,304 658,371 341,935
============ ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
40
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of Charter One Financial, Inc., ("Charter One" or
the "Company"), a unitary savings and loan holding company, and Charter One
Bank, F.S.B. (the "Bank"), conform to generally accepted accounting
principles and prevailing practices within the banking and thrift industry.
A summary of the more significant accounting policies follows:
NATURE OF OPERATIONS
Charter One is a Delaware Corporation organized as a unitary savings and
loan holding company and owns Charter Michigan Bancorp, Inc. which owns all
of the outstanding capital stock of Charter One Bank, F.S.B. The business
of the Bank is providing consumer and business banking services to certain
major markets in Ohio and, after October 1995, in Michigan. At the end of
1996, the Bank was doing business through 172 full service banking branches
and 9 loan production offices. Loans and deposits are primarily generated
from the areas where banking branches are located. The Company's income is
derived predominantly from interest on loans, leases, and securities and,
to a lesser extent, noninterest income. The Company's principal expenses
are interest paid on deposits and borrowings, and normal operating costs.
The Company's operations are principally in the savings industry, which
constitutes a single industry segment. The Bank's subsidiaries engage
principally in equipment leasing, data processing services, real estate
appraisal, sales of tax deferred annuities, property and casualty
insurance, and the development, operation and sale of real estate. The
Bank's subsidiaries are not a significant part of the business of the Bank.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company,
the Bank and its subsidiaries. All significant intercompany transactions
and balances have been eliminated.
SECURITIES
Securities consist of mortgage-backed securities, U.S. Government and
federal agency obligations, floating rate notes, commercial paper and state
and local government obligations. Securities are classified as trading,
available for sale or held to maturity upon their acquisition. Securities
classified as trading would be carried at estimated fair value with the
unrealized holding gain or loss recorded in the statement of income.
Securities classified as available for sale are carried at estimated fair
value with the unrealized holding gain or loss reflected as a component of
shareholders' equity. Securities classified as held to maturity are carried
at amortized cost. Premiums and discounts are recognized in interest income
over the period to maturity by the level yield method. Realized gains or
losses on the sale of debt securities are recorded based on the amortized
cost of the specific securities sold. Realized gains or losses on the sale
of marketable equity securities are recorded based on the average cost.
Security sales are recorded on a trade date basis.
LOANS
Loans intended for sale are carried at the lower of cost or estimated
market value determined on an aggregate basis. Net unrealized losses are
recognized through a valuation allowance by a charge to income.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their
outstanding unpaid principal balances. For balance sheet presentation, the
balances are presented net of deferred fees or costs on originated loans or
unamortized premiums or discounts on purchased loans. Discounts and
premiums are accreted or amortized using the interest method over the
41
<PAGE> 45
remaining period to contractual maturity adjusted for anticipated
prepayments. Unamortized net fees or costs are recognized upon early
repayment of the loans. Unamortized net fees or costs on loans sold are
included in the basis of the loans in calculating gains and losses.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 114, "Accounting by Creditors for Impairment of a
Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan
- Income Recognition and Disclosures," which impose certain requirements on
the measurement of impaired loans. The Company has previously measured such
loans in accordance with the methods prescribed in SFAS No. 114.
Consequently, no additional loss provisions were required by the adoption
of these statements. SFAS No. 114 also requires that impaired loans for
which foreclosure is probable should continue to be accounted for as loans.
At the date of adoption, the balance of in-substance foreclosed loans
reclassified to loans receivable was $1.2 million. The adoption of SFAS No.
114 and SFAS No. 118 did not have a material effect on the Company's
results of operations.
The Company's policy for recognition of interest on impaired loans
including how cash receipts are recorded is essentially unchanged as a
result of the adoption of SFAS Nos. 114 and 118. A loan (including a loan
impaired under SFAS No. 114) is classified as nonaccrual when
collectability is in doubt (this is generally when the borrower is 90 days
past due on contractual principal or interest payments). A loan may be
considered impaired, but remain on accrual status, when the borrower
demonstrates (by continuing to make payments) a willingness to keep the
loan current. When a loan is placed on nonaccrual status, unpaid interest
is reversed and an allowance is established by a charge to interest income
equal to all accrued interest. Income is subsequently recognized only to
the extent that cash payments are received. Loans are returned to accrual
status when, in management's judgment, the borrower has the ability and
intent to make periodic principal and interest payments (this generally
requires that the loan be brought current in accordance with its original
contractual terms).
A loan is considered to be impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all
amounts due according to the contractual terms of the loan agreement. In
general, the Bank considers a loan on income-producing properties to be
impaired when the debt service ratio is less than 1.0 and principal
recovery is in doubt. Loans on non-income producing properties are
considered impaired whenever fair value is less than book value. The Bank
performs a review of all loans over $500,000 to determine if the impairment
criteria have been met. If the impairment criteria have been met, a reserve
is calculated according to the provisions of the SFAS No. 114. For loans
which are individually not significant ($500,000 or less) and represent a
homogeneous population, the Bank evaluates impairment based on the level
and extent of delinquencies in the portfolio and the Bank's prior
charge-off experience with those delinquencies. Such loans include all
mortgage loans secured by 1-4 family residential property, all consumer
loans and certain multifamily real estate loans, non-residential real
estate loans, business loans and leases. The Bank charges principal off at
the earlier of (i) when a total loss of principal has been deemed to have
occurred as a result of the book value exceeding the fair value or net
realizable value, or (ii) when collection efforts have ceased.
LEASE ACCOUNTING
The Company classifies leases at the inception of the lease in accordance
with SFAS No. 13, "Accounting for Leases." Estimated residual values are
reviewed at least annually and reduced if necessary.
Direct Financing Leases - At lease inception, the present values of future
rentals and of the residual are recorded as net investment in direct
financing leases. Unearned interest income is amortized to interest income
over the lease term to produce a constant percentage return on the
investment.
Sales-Type Leases - At the inception of the lease, the present value of
future rentals is recorded as equipment sales. Equipment cost less the
present value of the residual is recorded as cost of equipment sold.
Accordingly, a dealer profit is recognized at lease inception. The present
values of future rentals and of the residual are recorded as net investment
in sales-type leases. Unearned income is amortized to interest income over
the lease term to produce a constant percentage return on the investment.
Leveraged Leases - Income on leveraged leases is recognized on a constant
rate of return on the outstanding investment in the lease, net of the
related deferred tax liability.
42
<PAGE> 46
Operating Leases - Operating lease revenue includes monthly rentals. The
cost of equipment is recorded as equipment on operating leases and is
depreciated over the initial and succeeding lease terms, if any, to an
estimated residual value.
Initial Direct Costs - Sales commissions and other direct costs incurred in
direct financing and operating leases are capitalized and recorded as part
of the net investment in leases and of the equipment on operating leases
and are amortized over the lease term.
NONPERFORMING LOANS AND LEASES
Loans and leases considered to be nonperforming include nonaccrual loans
and leases, accruing loans and leases delinquent more than 90 days, and
restructured loans. Loans and leases are classified as nonaccrual when, in
management's judgment, the borrower no longer has the ability and intent to
make periodic interest and principal payments. Loans and leases are
classified as accruing loans or leases delinquent more than 90 days when
the loan or lease is more than 90 days past due and, in management's
judgment, the borrower has the ability and intent to make periodic interest
and principal payments. Loans are classified as restructured when
concessions are made to borrowers with respect to the principal balance,
interest rate or the terms due to the inability of the borrower to meet the
obligation under the original terms.
ALLOWANCE FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established at a level believed
adequate by management to absorb estimated losses inherent in the loan and
lease portfolio. Management's determination of the adequacy of the
allowance is based upon estimates derived from an analysis of individual
credits, prior and current loss experience, loan and lease portfolio
delinquency levels, overall growth in the loan and lease portfolio and
current economic conditions. Consequently, these estimates are particularly
susceptible to changes that could result in a material adjustment to
results of operations. The provision for loan and lease losses represents a
charge against current earnings in order to maintain the allowance for loan
and lease losses at an appropriate level. Management believes that the
allowance for loan and lease losses has been recorded in accordance with
generally accepted accounting principles.
PREMISES AND EQUIPMENT
Premises and equipment and real estate held for investment are stated at
cost less accumulated depreciation and amortization. Depreciation is
computed using the straight-line method over the useful lives of the
related assets.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Interest rate exchange agreements ("swaps"), interest rate floor agreements
("floors"), interest rate collar agreements ("collars"), and interest rate
cap agreements ("caps") used in asset/liability management activities are
accounted for using the accrual method. The net interest received or paid
on swaps, floors, collars and caps is recognized over the lives of the
respective contracts as an adjustment to interest expense. Fees paid or
received at inception of the agreements are amortized or accreted to
interest expense over the lives of the related agreements. Gains and losses
on terminated agreements are deferred and amortized to interest expense
over the remaining original term of the applicable agreement. If the
assigned liability is eliminated, the gain or loss on the terminated
agreement is recognized immediately.
In the ordinary course of business, the Company enters into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commercial letters of credit, standby letters of credit and
commitments to purchase or sell assets. The financial instruments are
recorded in the financial statements when they are funded or the related
fees are incurred or received.
REAL ESTATE OWNED
Real estate owned, including property acquired in settlement of foreclosed
loans, is carried at the lower of cost or estimated fair value less
estimated cost to sell at the date of foreclosure. Costs relating to the
development and improvement of real estate owned are capitalized, whereas
costs relating to holding and maintaining the property are charged to
expense.
43
<PAGE> 47
GOODWILL
Goodwill represents the purchase price of acquired operations in excess of
the fair value of their net identifiable assets at the date of acquisition
and is being amortized using the straight-line method over 15 years.
Management reviews intangible assets for possible impairment if there is a
significant event that detrimentally affects operations.
LOAN FEES
Loan origination fees received for loans, net of direct origination costs,
are deferred and amortized to interest income over the contractual lives of
the loans using the level yield method. Fees received for loan commitments
that are expected to be drawn, based on the Bank's experience with similar
commitments, are deferred and amortized over the lives of the loans using
the level yield method. Fees for other loan commitments are deferred and
amortized over the loan commitment period on a straight-line basis.
Unamortized deferred loan fees or costs related to loans paid off are
included in income. Unamortized net fees or costs on loans sold are
included in the basis of the loans in calculating gains and losses.
Amortization of net deferred fees is discontinued for loans that are deemed
to be nonperforming.
FEDERAL INCOME TAXES
The Company and its wholly owned subsidiaries file a consolidated federal
income tax return. The provision for federal income taxes is based upon
earnings reported for financial statement purposes rather than amounts
reported on the Company's income tax returns. Deferred income taxes, which
result from temporary differences in the recognition of income and expense
for financial statement and tax return purposes, are included in the
calculation of income tax expense. The effect on deferred tax assets and
liabilities of a change in tax rate is recognized in income in the period
that includes the enactment date.
STATEMENTS OF CASH FLOWS
For purposes of the statement of cash flows, the Company considers all
highly liquid investments with a term of three months or less to be cash
equivalents. Cash flows from interest rate swaps are classified based on
the on-balance-sheet assets or liabilities hedged. Federal Reserve Board
regulations require depository institutions to maintain certain minimum
reserve balances. These reserves, which consisted of vault cash and
deposits at the Federal Reserve Bank, totaled $85.6 million and $67.8
million at December 31, 1996 and 1995, respectively.
EARNINGS PER SHARE
Earnings per share of common stock is based on the weighted average number
of common shares and common share equivalents outstanding during the year.
All shares and per share data has been restated to reflect the 5% stock
dividend issued September 30, 1996.
NEW ACCOUNTING STANDARDS
On January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of." This statement requires that long-lived assets and certain identified
intangibles held and used by an entity, along with goodwill related to
those assets, be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. The adoption of this statement has not had a material effect
on the Company's financial condition or results of operations.
On January 1, 1996, the Company also adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights." SFAS No. 122 amends SFAS No. 65, "Accounting
for Certain Mortgage Banking Activities," to require that a company
recognize, as a separate asset, rights to service mortgage loans for
others, regardless of how those servicing rights are acquired. A company
that acquires mortgage servicing rights through either the purchase or
origination of mortgage loans and sells or securitizes those loans with the
servicing rights retained should allocate the total cost of the mortgage
loans to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based upon their relative values, if it is practicable to
estimate those fair values. This statement also requires that a company
periodically assess its capitalized mortgage servicing rights for
44
<PAGE> 48
impairment based upon the fair value of those rights. The adoption of this
statement has not had a material effect on the Company's financial
condition or results of operations. SFAS 122 will be superseded by SFAS
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities," as described below.
Effective January 1, 1996, Charter One adopted SFAS No. 123, "Accounting
for Stock-Based Compensation," which prescribes financial accounting and
reporting standards for stock-based employee compensation plans. The
statement defines a fair value based method of accounting for employee
stock options or similar equity instruments and encourages all entities to
adopt that method of accounting for all employee stock compensation plans.
However, the statement also allows an entity to continue to measure
compensation cost for these plans using an intrinsic value based method of
accounting prescribed by Accounting Principles Board Opinion ("APB") No.
25. Entities electing to retain the accounting treatment under APB No. 25
must make pro forma footnote disclosures of net income and earnings per
share as if the fair value based method of accounting defined in SFAS No.
123 has been applied. Management has elected to continue using the APB No.
25 accounting method and include pro forma disclosures. See Note 17 to the
Consolidated Financial Statements.
In June 1996, the FASB issued SFAS No. 125. SFAS No. 125 amends portions of
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," amends and extends to all servicing assets and liabilities the
accounting standards for mortgage servicing rights now in SFAS No. 65, and
supersedes SFAS No. 122. SFAS No. 125 provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers
that are secured borrowings. Those standards are based upon consistent
application of a financial components approach that focuses on control. The
statement also defines accounting treatment for servicing assets and other
retained interests in the assets that are transferred. SFAS No. 125 is
effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996 and is to
be applied prospectively. The FASB has recently issued SFAS No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement No.
125," that defers the effective date of certain provisions of SFAS No. 125
related to secured borrowings and collateral, repurchase agreements, dollar
rolls, securities lending, and similar transactions until after December
31, 1997. Management has not completed the process of evaluating this
statement and therefore has not determined the impact, if any, that
adopting this statement will have on the financial position and results of
operations.
RECLASSIFICATIONS
Certain items in the consolidated financial statements for 1995 and 1994
have been reclassified to conform to the 1996 presentation.
2. BUSINESS COMBINATIONS, ASSET ACQUISITIONS AND DIVESTITURES
On June 28, 1996, the Company completed the acquisition of First Nationwide
Bank's 21 branch offices in the Detroit Metropolitan area. The market areas
of four First Nationwide offices directly overlapped those of existing
branch offices and therefore were consolidated into the existing branch
facilities. The deposits of the branches totaled $796.7 million and were
assumed for a cost of $57.0 million. Such cost has been reflected as
goodwill in the accompanying financial statements.
On October 31, 1995, the Company completed a merger with FirstFed Michigan
Corporation ("FirstFed"), the holding company for First Federal of
Michigan, a federally chartered savings and loan association (the "FirstFed
Merger.") The FirstFed Merger was effected through the issuance of 1.2
shares of Company common stock for each share of FirstFed common stock
resulting in the issuance of 22,506,201 shares of Company common stock. The
merger has been accounted for as a pooling of interests and, accordingly,
the financial statements of the Company for all periods prior to the merger
have been restated to include the results of FirstFed. FirstFed paid
dividends of $8,612,000 for the 10 months ended October 31, 1995 and
$10,079,000 in 1994. All per share dividend amounts are those of the
Company prior to the merger.
Total assets and shareholders' equity of FirstFed as of October 31, 1995
(unaudited) were $7,675,952,000 and $417,555,000, respectively. Total
income and net income of the Company and FirstFed after restatement to
conform the adoption dates of changes in accounting practices and
reclassifications to conform presentation included in the 1995 and 1994
results of operations are as follows:
45
<PAGE> 49
<TABLE>
<CAPTION>
TOTAL INCOME NET INCOME (LOSS)
---------------------------------- ------------------------------------
JANUARY 1, 1995 JANUARY 1, 1995
to YEAR ENDED to YEAR ENDED
OCTOBER 31, 1995 DECEMBER 31, 1994 OCTOBER 31, 1995 DECEMBER 31, 1994
---------------- ---------------------------------- -----------------
(DOLLARS IN THOUSANDS)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Company ......................... $ 420,528 423,686 54,684 67,613
FirstFed ........................ 448,022 472,105 (31,707) (64,342)
---------- --------- --------- --------
Total ........................ $ 868,550 895,791 22,977 3,271
========== ========= ========= ========
</TABLE>
A reconciliation of amounts previously reported by the Company and FirstFed
to the amounts included in the restated statements of the Company for 1994
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1994
--------------------------------
NET INCOME
TOTAL INCOME (LOSS)
-------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
As reported by the Company ................................... $ 423,686 67,613
As reported by FirstFed ...................................... 470,302 (96,290)
Adjustment to conform adoption date of
accounting change .......................................... - 31,948
Reclassifications to conform presentation .................... 1,803 -
---------- --------
Total, as restated ......................................... $ 895,791 3,271
========== ========
</TABLE>
The adjustment to conform the adoption date of the accounting change shown
in the table above is made to conform FirstFed's adoption date of an
accelerated method of accounting for goodwill from January 1, 1994 to
January 1, 1990.
In January 1995, the Company acquired a leasing company (ICX Corporation)
and purchased a controlling interest in a computer service bureau
(Accredited Computer Services) in which it previously had an equity
investment. ICX Corporation had $135.8 million in assets, primarily
financing leases and assets held under operating leases. Accredited
Computer Services had $2.7 million in assets comprised primarily of
computer equipment.
3. INVESTMENT SECURITIES
Investment securities classified as available for sale at December 31,
1996, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury and agency securities ........................ $ 238,195 550 610 238,135
Corporate notes and commercial paper ....................... 1,123 2,984 - 4,107
Other ...................................................... 1,389 1 - 1,390
--------- ------- ----- ---------
Total ................................................... $ 240,707 3,535 610 243,632
========= ======= ===== =========
</TABLE>
Investment securities classified as available for sale at December 31,
1995, are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-----------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ------- ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
U.S. Treasury and agency securities ........................ $ 375,263 1,969 - 377,232
Corporate notes and commercial paper ....................... 27,584 2,449 - 30,033
Other ...................................................... 162 - - 162
--------- ------- ------ ----------
Total ................................................... $ 403,009 4,418 - 407,427
========= ======= ====== ==========
</TABLE>
46
<PAGE> 50
The weighted average interest rate on investment securities was 6.89% and
6.76% at December 31, 1996 and 1995, respectively.
Investment securities available for sale by contractual maturity, repricing
or expected call date are shown below:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------
AMORTIZED FAIR AVERAGE
COST VALUE RATE
--------- --------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Due in one year or less ........................................ $ 186,095 186,570 7.06%
Due after one year through two years ........................... 1,000 1,075 6.72
Due after two years through five years ......................... 44,345 43,745 6.17
Due after five years through ten years ......................... 540 531 6.10
Due after ten years ............................................ 8,727 11,711 6.96
--------- ---------
Total ....................................................... $ 240,707 243,632 6.89%
========= =========
</TABLE>
At December 31, 1996 and 1995, total adjustable-rate investment securities
were $8.6 million and $8.9 million, respectively.
Gains on sales were $6.0 million and $7.9 million for the years ended
December 31, 1995 and 1994, respectively. Losses were $2.0 million and $1.0
million for the years ended December 31, 1996 and 1994, respectively.
4. MORTGAGE-BACKED SECURITIES (AS RESTATED)
The amortized cost, unrealized gains and losses of mortgage-backed
securities and the fair values at December 31, 1996 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- -------- -------- -----------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
Participation certificates:
Government agency issues:
FHLMC ........................................... $ 13,404 6 75 13,335
Collateralized mortgage obligations:
Government agency issues:
FHLMC ........................................... 347,869 2,379 90 350,158
FNMA ............................................ 260,884 3,811 13 264,682
Private issues .................................... 446,901 1,630 6,001 442,530
----------- -------- -------- -----------
Total mortgage-backed securities
available for sale ............................ 1,069,058 7,826 6,179 1,070,705
----------- -------- -------- -----------
HELD TO MATURITY
Participation certificates:
Government agency issues:
FNMA ............................................ 1,246,398 11,202 10,515 1,247,085
FHLMC ........................................... 636,228 18,006 381 653,853
GNMA ............................................ 188,057 4,232 421 191,868
Private issues .................................... 407,564 2,757 8,943 401,378
Collateralized mortgage obligations:
Government agency issues:
FNMA ............................................ 162,646 8,418 466 170,598
FHLMC ........................................... 82,433 4,883 247 87,069
Private issues .................................... 910,043 5,131 14,478 900,696
----------- -------- -------- -----------
Total mortgage-backed securities
held to maturity .............................. 3,633,369 54,629 35,451 3,652,547
----------- -------- -------- -----------
Total ....................................... $ 4,702,427 62,455 41,630 4,723,252
=========== ======== ======== ===========
</TABLE>
47
<PAGE> 51
At December 31, 1995, the amortized cost, unrealized gains and losses of
mortgage-backed securities and the fair values were as follows:
<TABLE>
DECEMBER 31, 1995
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- --------- -------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
Participation certificates:
Government agency issues:
FNMA ...................................... $ 329,317 196 2,366 327,147
FHLMC ..................................... 20,307 85 - 20,392
Private issues .............................. 116 - - 116
Collateralized mortgage obligations:
Government agency issues:
FNMA ...................................... 262,206 4,413 25 266,594
FHLMC ..................................... 348,830 3,759 79 352,510
Private issues .............................. 464,604 4,624 398 468,830
----------- --------- -------- -----------
Total mortgage-backed securities
available for sale ...................... 1,425,380 13,077 2,868 1,435,589
----------- --------- -------- -----------
HELD TO MATURITY
Participation certificates:
Government agency issues:
FNMA ...................................... 1,546,206 27,541 1,570 1,572,177
FHLMC ..................................... 891,638 30,613 26 922,225
GNMA ...................................... 224,938 5,863 - 230,801
Private issues .............................. 498,631 4,275 3,911 498,995
Collateralized mortgage obligations:
Government agency issues:
FNMA ...................................... 180,013 9,108 3 189,118
FHLMC ..................................... 83,708 5,147 106 88,749
Private issues .............................. 454,026 6,808 1,573 459,261
----------- --------- -------- -----------
Total mortgage-backed securities
held to maturity ........................ 3,879,160 89,355 7,189 3,961,326
----------- --------- -------- -----------
Total ................................. $ 5,304,540 102,432 10,057 5,396,915
=========== ========= ======== ===========
</TABLE>
In July 1996, the Bank sold $510.4 million of FNMA fixed-rate participation
certificates which were made up of seasoned 15- to 30-year fixed-rate
mortgage loans originated by the Bank and swapped to FNMA for participation
certificates in June 1996. The sale resulted in a $289,000 net loss and
recognition of $2.7 million of originated mortgage servicing rights, both
of which were recorded on the trade date in June 1996. Recognition of the
servicing rights was in accordance with SFAS No. 122 which Charter One
adopted as of January 1, 1996.
In September 1996, the Bank reclassified $10.9 million of mortgage-backed
securities from held to maturity to available for sale in response to
significant deterioration in the issuer's creditworthiness uncovered during
a routine review of the portfolio. Subsequently, $8.1 million of these
securities were sold for a loss of $1.4 million, which was recorded in the
third quarter of 1996.
In December 1996, the Bank sold $68.7 million of mortgage-backed securities
held to maturity with outstanding balances less than 15% of the principal
outstanding at acquisition. A $2.6 million gain was recorded on the sale.
On November 15, 1995, the FASB staff issued a special report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in
Debt and Equity Securities." In accordance with provisions in that special
report, management chose to reclassify certain securities from the
available for sale portfolio to the held to maturity portfolio. At December
31, 1995, the date of the transfer, the fair value of those securities was
$77.3 million and the unrealized loss on those securities was $2.3 million.
Such loss will be amortized through equity over the remaining life of the
securities.
48
<PAGE> 52
Additionally, in accordance with implementation of the same special
report, management chose to reclassify certain securities that were
classified as held to maturity to the available for sale portfolio. At
December 31, 1995, the date of the transfer, the amortized cost of those
securities was $1.1 billion and the unrealized gain net of tax on
those securities was $40.5 million. In 1994, certain of those securities
had been transferred from available for sale to held to maturity with an
unrealized loss of $50.2 million.
During the fourth quarter of 1995, management also chose to reclassify
$945.7 million of fixed, low-rate mortgage-backed securities from held to
maturity to available for sale. This transfer was made as a component of
the FirstFed Merger repositioning in order to maintain the Company's
existing interest rate risk position. The mortgage-backed securities were
sold and a loss on the sale of $17.5 million was recorded in the fourth
quarter of 1995.
Sales of mortgage-backed securities available for sale and held to maturity
resulted in gains of $6.3 million in 1996, $1.8 million in 1995 and $10.1
million in 1994. Losses, including write-downs to fair value, were $5.3
million in 1996, $27.4 million in 1995 and $5.9 million in 1994.
Mortgage-backed securities are classified by type of interest payment as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------
1996 1995
----------------------------------- ----------------------------------
Amortized FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE RATE COST VALUE RATE
----------- ----------- ------ ----------- ----------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE
Adjustable rate:
Collateralized
mortgage obligations ....... $ 1,054,361 1,056,087 6.94% $ 1,072,890 1,085,208 7.23%
----------- ----------- ----------- -----------
Total adjustable rate ..... 1,054,361 1,056,087 6.94 1,072,890 1,085,208 7.23
----------- ----------- ----------- -----------
Fixed rate:
Participation
certificates ............... 13,404 13,335 6.03 349,740 347,655 6.23
Collateralized
mortgage obligations ....... 1,293 1,283 5.09 2,750 2,726 5.30
----------- ----------- ----------- -----------
Total fixed rate ......... 14,697 14,618 5.94 352,490 350,381 6.22
----------- ----------- ----------- -----------
Total available for
sale ............... 1,069,058 1,070,705 6.93 1,425,380 1,435,589 6.98
----------- ----------- ----------- -----------
HELD TO MATURITY
Adjustable rate:
Participation
certificates ............... 1,019,324 1,026,902 7.16 1,279,124 1,297,319 7.08
Collateralized
mortgage obligations ....... 301,866 317,055 7.23 357,816 372,972 7.48
----------- ----------- ----------- -----------
Total adjustable rate .... 1,321,190 1,343,957 7.18 1,636,940 1,670,291 7.17
----------- ----------- ----------- -----------
Fixed rate:
Participation
certificates ............... 1,458,923 1,467,282 7.51 1,882,289 1,926,879 7.56
Collateralized
mortgage obligations ....... 853,256 841,308 7.15 359,931 364,156 7.32
----------- ----------- ----------- -----------
Total fixed rate ......... 2,312,179 2,308,590 7.38 2,242,220 2,291,035 7.52
----------- ----------- ----------- -----------
Total held to
maturity ............. 3,633,369 3,652,547 7.31 3,879,160 3,961,326 7.37
----------- ----------- ----------- -----------
Total mortgage-backed
securities ..................... $ 4,702,427 4,723,252 7.22% $ 5,304,540 5,396,915 7.27%
=========== =========== =========== ===========
</TABLE>
49
<PAGE> 53
Adjustable-rate mortgage-backed securities are further classified by type
of repricing index as follows:
<TABLE>
<CAPTION>
1996
---------------------------------
AMORTIZED FAIR AVERAGE
COST VALUE RATE
---------- ----------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Available for sale:
Collateralized mortgage obligations:
Six-month LIBOR ..................................... $1,024,510 1,030,016 6.93%
Other ............................................... 29,851 26,071 7.27
---------- -----------
Total adjustable rate available for sale ............ 1,054,361 1,056,087 6.94
---------- -----------
Held to maturity:
Participation certificates:
One-year constant maturity treasury ................. 443,109 454,117 7.39
FHLB 11th District cost of funds .................... 410,859 406,594 6.62
Other ............................................... 165,356 166,191 7.88
Collateralized mortgage obligations:
One-month LIBOR ..................................... 286,167 301,410 7.23
Other ............................................... 15,699 15,645 7.24
---------- -----------
Total adjustable rate held to maturity ............ 1,321,190 1,343,957 7.18
---------- -----------
Total adjustable rate ........................... $2,375,551 2,400,044 7.07%
========== ===========
</TABLE>
The weighted average lifetime cap rate of the adjustable-rate
collateralized mortgage obligation portfolio and the adjustable-rate
participation certificate portfolio were 9.27% and 11.87%, respectively, at
December 31, 1996.
5. LOANS AND LEASES
Loans and leases held for investment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Real Estate:
Permanent:
One-to-four family .................................. $ 6,072,927 5,140,857
Multifamily ......................................... 290,195 359,056
Commercial .......................................... 348,787 368,372
Construction:
One-to-four family .................................. 268,766 132,776
Multifamily ......................................... 14,517 11,495
Commercial .......................................... 19,122 38,592
----------- -----------
Total real estate ................................. 7,014,314 6,051,148
Consumer ................................................ 929,204 594,609
Business ................................................ 100,302 65,747
Lease financings ........................................ 251,133 131,352
----------- -----------
Total loans and leases .............................. 8,294,953 6,842,856
----------- -----------
Less:
Loans in process .................................... 134,880 83,845
Unamortized net discount ............................ 1,169 4,150
Allowance for loan and lease losses ................. 65,922 64,436
Deferred loan (costs)/fees, net ..................... (7,360) 16,165
----------- -----------
Total ............................................. 194,611 168,596
----------- -----------
Loans and leases, net ........................... $ 8,100,342 6,674,260
=========== ===========
</TABLE>
Loans with adjustable rates included above totaled $3.0 billion and $2.3
billion at December 31, 1996 and 1995, respectively. Substantially all such
loans have contractual interest rates that increase or decrease at periodic
intervals no greater than three years, or have original terms to maturity
of three years or less. Adjustable-rate loans reprice primarily based upon
U.S. Treasury security rates.
50
<PAGE> 54
The Bank's primary lending areas are within the states of Ohio and
Michigan. At December 31, 1996 and 1995, $7.6 billion and $6.3 billion,
respectively, of the Bank's gross loans were to borrowers located within
these two states. Although the Bank has a diversified loan portfolio, its
borrowers' ability to honor their contracts is substantially dependent upon
general economic conditions of the region.
The Bank originates or purchases commercial real estate and business loans.
These loans are considered by management to be of somewhat greater risk of
uncollectibility than single-family residential real estate loans due to
the dependency on income production or future development of real estate.
The following table sets forth the Bank's commercial real estate and
commercial construction loan portfolios by type of collateral.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------
1996 1995
---------------------- ----------------------
PERCENT PERCENT
OF OF
AMOUNT TOTAL AMOUNT TOTAL
---------- ------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Strip shopping centers ......... $ 133,758 36.4% $ 139,905 34.4%
Office buildings ............... 54,835 14.9 63,573 15.6
Warehouses ..................... 53,439 14.5 57,800 14.2
Developed and undeveloped land . 54,891 14.9 57,290 14.1
Hotel property ................. 24,960 6.8 36,939 9.1
Mobile home parks .............. 19,774 5.4 18,630 4.6
Other .......................... 26,252 7.1 32,827 8.0
---------- ------- --------- -------
Total $ 367,909 100.0% $ 406,964 100.0%
========== ======= ========= =======
</TABLE>
Business loans include loans to companies located in Ohio and Michigan
totaling $99.4 million and $64.0 million at December 31, 1996 and 1995,
respectively.
Business loans are collateralized by accounts receivable, inventory and
other assets used in the borrowers' business. Substantially all of the
consumer loans, including consumer lines of credit, are secured by equity
in the borrowers' residence.
At December 31, 1996, 1995 and 1994, loans serviced for the benefit of
others, not included in the detail above, totaled $1.5 billion, $1.2
billion and $883 million, respectively. Included in these totals were loans
sold on a recourse basis of $17.0 million, $23.0 million and $29.4 million,
respectively. Custodial escrow balances maintained in connection with the
foregoing loan servicing were $26.1 million and $18.6 million at December
31, 1996 and 1995, respectively.
The Company normally has outstanding a number of commitments to extend
credit. At December 31, 1996, there were outstanding commitments to
originate $217.9 million of fixed-rate mortgage loans and other loans and
leases and $191.3 million of adjustable-rate loans, all at market rates.
Terms of the commitments extend up to nine months, but are generally less
than two months.
At December 31, 1996, there were also outstanding unfunded consumer lines
of credit of $434.5 million and business lines of credit of $36.4 million.
The Company does not expect all of these lines to be used by the borrowers.
A summary of the investment in lease financings is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Direct financing leases ................. $ 167,623 76,713
Sales-type .............................. 69,334 54,639
Leveraged leases ........................ 14,176 -
---------- ---------
Total lease financings ............... $ 251,133 131,352
========== =========
</TABLE>
51
<PAGE> 55
The components of the investment in lease financings are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Total future minimum lease rentals ............................................... $224,654 125,773
Estimated residual value of leased equipment ..................................... 86,947 32,451
Initial direct costs ............................................................. 2,597 987
Less unearned income on minimum lease rentals and estimated residual value
of leased equipment ............................................................ (63,065) (27,859)
--------- ---------
Total lease financings ....................................................... $251,133 131,352
========= =========
</TABLE>
At December 31, 1996, future minimum lease rentals on direct financing,
sales type and leveraged leases are as follows: $61.0 million in 1997;
$49.9 million in 1998, $38.6 million in 1999; $28.0 million in 2000; $21.3
million in 2001, and $25.8 million thereafter.
At December 31, 1996, future minimum lease rentals on noncancelable
operating leases are as follows: $12.4 million in 1997; $3.0 million in
1998; $214,000 in 1999, and $88,000 in 2000.
ALLOWANCE FOR LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of year ...................... $ 64,436 64,838 64,715
Provision ..................................... 4,001 1,032 2,948
Amounts charged off ........................... (2,887) (2,318) (3,220)
Recoveries .................................... 372 708 395
Other ......................................... - 176 -
-------- -------- --------
Balance, end of year ............................ $ 65,922 64,436 64,838
======== ======== ========
</TABLE>
Nonperforming loans and leases were $35.4 million, $43.1 million and $49.2
million at December 31, 1996, 1995 and 1994, respectively.
As of December 31, 1996, the total investment in impaired loans was $10.4
million. The entire $10.4 million was subject to allowances for credit
losses of $615,000 as of December 31, 1996. The average recorded investment
in impaired loans during 1996 was $11.5 million, and interest income
recognized in 1996 was $807,000. The interest income potential based upon
the original terms of the contracts for these impaired loans was $1.0
million for 1996.
As of December 31, 1995, the total investment in impaired loans was $1.7
million. The entire $1.7 million was subject to allowances for credit
losses of $1.0 million as of December 31, 1995. The average recorded
investment in impaired loans during 1995 was $1.7 million, and interest
income recognized in 1995 was $114,000. The interest income potential based
upon the original terms of the contracts for these impaired loans was
$160,000 for 1995.
6. REAL ESTATE OWNED
Real estate owned consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Acquired in settlement of loans ....................... $7,030 11,650
Held for investment and acquired for development ...... 307 341
------ --------
Total ............................................... $7,337 11,991
====== ========
</TABLE>
52
<PAGE> 56
7. DEPOSITS
Deposits consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1996 1995
----------------------- ------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
----------- ----- ------------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Checking accounts:
Interest-bearing .................................... $ 558,753 1.86% $ 513,933 1.98%
Noninterest-bearing ................................. 300,685 - 220,029 -
Savings accounts ...................................... 868,361 2.42 1,007,178 2.41
Money market accounts ................................. 1,344,973 3.52 829,087 3.19
Certificates of deposit ............................... 4,766,369 5.85 4,438,831 5.97
----------- ------------
Total deposits .................................... 7,839,141 4.56 7,009,058 4.65
Plus unamortized premium on
deposits purchased .................................. 2,056 3,433
----------- ------------
Total deposits, net ............................... $ 7,841,197 $ 7,012,491
=========== ============
Including the annualized effect of applicable swaps,
floors and amortization of deferred gains on
terminated swaps .................................... 4.48% 4.61%
</TABLE>
A summary of certificates of deposit by maturity follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------
(DOLLARS IN
THOUSANDS)
<S> <C>
Within 12 months ............................................... $ 3,489,052
12 months to 24 months ......................................... 686,145
24 months to 36 months ......................................... 241,609
36 months to 48 months ......................................... 99,320
Over 48 months ................................................. 250,243
-----------
Total ........................................................ $ 4,766,369
===========
</TABLE>
At December 31, 1996, the Bank had no brokered certificates of deposit.
8. FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances at December 31, 1996, are secured by
Charter One's investment in the stock of the Federal Home Loan Bank, as
well as certain real estate loans aggregating $4.5 billion and
mortgage-backed securities aggregating $641 million. FHLB advances are
composed of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1996 1995
------------------------- -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
----------- ----- ----------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Fixed-rate advances .................................... $ 1,791,332 5.99% $ 1,310,122 5.78%
Variable-rate advances ................................. 1,403,000 5.56 1,853,000 5.87
---------- ----------
Total advances ....................................... 3,194,332 5.80 3,163,122 5.84
Unamortized premium .................................... 1 22
---------- ----------
Total advances, net .................................. $ 3,194,333 $ 3,163,144
========== ==========
Including the annualized effect of
applicable swaps, caps and amortization
of deferred gains on terminated swaps ................ 5.81% 5.90%
</TABLE>
53
<PAGE> 57
The variable-rate advances reprice based upon three-month LIBOR at
three-month intervals, and included $83 million with a 6.00% LIBOR cap, and
$573 million which are callable, at par, by the FHLB.
Charter One has also entered into stand-alone interest rate cap agreements
applicable to certain variable-rate and short-term fixed-rate FHLB
advances. Reference is made to Note 11, "Interest Rate Risk Management,"
for additional discussion.
FHLB advances mature as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------------
FIXED-RATE ADVANCES VARIABLE-RATE ADVANCES
-------------------------- -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
----------- ------ ----------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Maturing in:
1997 ................................................ $ 387,300 5.94% $ 1,128,000 5.55%
1998 ................................................ 285,000 6.50 75,000 5.59
1999 ................................................ 475,000 6.23 200,000 5.60
2000 ................................................ 400,000 5.98
2001 ................................................ 205,000 4.88
2005 ................................................ 5,000 6.52
2006 ................................................ 319 3.98
2007 ................................................ 31,868 5.82
2009 ................................................ 525 5.00
2010 ................................................ 509 1.00
2011 ................................................ 658 3.50
2016 ................................................ 153 3.75
---------- ----------
Total ............................................. 1,791,332 5.99% 1,403,000 5.56%
Unamortized premium .................................. 1 -
---------- ----------
Total FHLB advances, net .......................... $ 1,791,333 $ 1,403,000
========== ==========
</TABLE>
Certain advances require periodic amortization of principal. At December
31, 1996, scheduled repayments of advances are as follows: $1.5 billion in
1997, $362.4 million in 1998, $677.5 million in 1999, $402.7 million in
2000, $207.8 million in 2001, and $26.3 million thereafter.
At December 31, 1996, $200 million of the fixed rate agreements maturing in
2001 are convertible, at the counterparty's option, to a floating rate of
three-month LIBOR, beginning in February 1999 and quarterly thereafter.
54
<PAGE> 58
9. REVERSE REPURCHASE AGREEMENTS
Securities sold under agreements to repurchase are composed of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Short term:
Mortgage-backed securities of $822 million, with fair value approximating
$844 million, sold with agreements to repurchase the same securities, with
a weighted average interest rate of 5.86% and matured in 1996 .............. $ - 798,783
U.S. Treasury securities of $50 million, with fair value approximating
$50 million, sold with agreements to repurchase the same securities, with
a weighted average interest rate of 5.82% and matured in 1996 .............. - 49,250
----------- -----------
Total short term ....................................................... - 848,033
----------- -----------
Long term:
Mortgage-backed securities of $1.6 billion, with fair value approximating
$1.7 billion, sold with agreements to repurchase the same securities.
(1995-$1.3 billion sold with fair value of $1.3 billion):
With a weighted average interest rate of 5.95% at December 31,
1995, resetting quarterly based on three-month LIBOR and capped at
6.06% through 1996, due in 1998, and converted to fixed-rate in 1996 .... - 491,487
With an interest rate of 5.67% and 6.17% at December 31, 1996 and
1995, respectively, resetting quarterly based on three-month LIBOR
and capped at 6.06%, due in 1997 ........................................ 175,000 175,000
With a weighted average interest rate of 4.96%, due in 1996,
callable by the Company at par .......................................... - 275,000
With a weighted average interest rate of 5.89% and 5.44% at December 31,
1996 and 1995, respectively, due in 1998 ................................ 804,778 200,000
With a weighted average interest rate of 5.16% and 5.84% at December 31,
1996 and 1995, respectively, due in 1999 ................................ 570,000 100,000
----------- -----------
Total long term ...................................................... 1,549,778 1,241,487
----------- -----------
$ 1,549,778 2,089,520
=========== ===========
Weighted average interest cost including amortization of fees ................. 5.62% 5.80%
====== ======
Weighted average interest cost including the annualized effect of the
applicable swaps, caps and amortization of deferred net gains
on terminated swaps ......................................................... 5.59% 5.68%
====== ======
</TABLE>
At December 31, 1996 and 1995, $200 million of the fixed-rate agreements
maturing in 1998 were convertible, at the counterparty's option, to a
floating rate of three-month LIBOR, beginning in June 1997 and quarterly
thereafter.
At December 31, 1996, $150 million of the fixed-rate agreements maturing in
1999 were convertible, at the counterparty's option, to a floating rate of
three-month LIBOR, beginning in October 1997 and quarterly thereafter.
At December 31, 1996, $120 million and $100 million of the fixed-rate
agreements maturing in 1999 were convertible, at the counterparty's option,
to a floating rate of three-month LIBOR less 10 basis points, beginning in
August 1997 and October 1997 respectively, and quarterly thereafter.
The securities sold under agreements to repurchase were delivered to the
primary dealers who arranged, or were party to, the transactions. They may
have sold, loaned, or otherwise disposed of such securities to other
parties and have agreed to resell the same securities back to the Company
at maturity of the agreements.
At December 31, 1996 there were no amounts at risk with any counterparties
exceeding 10% of shareholders' equity. The amount at risk is equal to the
excess of the carrying value of the securities sold under agreements to
repurchase over the amount of the repurchase liability.
55
<PAGE> 59
The maximum month-end balance of outstanding agreements to repurchase the
same securities was $2.0 billion in 1996 and $3.6 billion in 1995. The
average balance was $1.6 billion and $3.2 billion during 1996 and 1995,
respectively.
10. OTHER BORROWINGS
Other borrowings consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Zero coupon bonds of $407 million due February 2005,
with yield to maturity of 11.39% ............................................. $ 162,435 145,684
Mortgage loan sale agreement ................................................... 9,902 10,351
Variable-rate bonds, due December 1, 2015, interest payable semi-
annually at 4.75% with a ceiling of 9.5% ..................................... 10,000 10,000
Installment obligations without recourse ....................................... 23,157 35,663
Other .......................................................................... 5,686 7,322
---------- ---------
Total ..................................................................... $ 211,180 209,020
========== =========
</TABLE>
The zero coupon bonds are collateralized by mortgage-backed securities of
$359 million and $354 million at December 31, 1996 and 1995, respectively.
The installment obligations are collateralized by leased equipment and
future lease revenues. The Company assigned the rentals under many leases
on a nonrecourse basis. In the event of a default by a lessee, there is no
recourse against the Company.
11. INTEREST RATE RISK MANAGEMENT
The Company utilizes various types of interest rate contracts in managing
its interest rate risk on certain of its deposits and FHLB advances. The
Company has utilized fixed payment swaps to convert certain of its
floating-rate or short-term, fixed-rate liabilities into longer term, fixed
rate instruments. Under these agreements, the Company has agreed to pay
interest to the counterparty on a notional principal amount at a fixed rate
defined in the agreement, and receive interest at a floating rate indexed
to LIBOR. The amounts of interest exchanged are calculated on the basis of
notional principal amounts. The Company also utilizes fixed receipt swaps
to convert certain of its longer-term callable certificates of deposit into
short-term variable instruments. Under these agreements the Company has
agreed to receive interest from the counterparty on a notional amount at a
fixed rate defined in the agreement, and to pay interest at a floating rate
indexed to LIBOR.
Information on the swaps, by maturity date, follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------
1996 1995
--------------------------- -----------------------------
NOTIONAL RECEIVING PAYING NOTIONAL RECEIVING PAYING
PRINCIPAL INTEREST INTEREST PRINCIPAL INTEREST INTEREST
AMOUNT RATE RATE AMOUNT RATE RATE
--------- ------ ------ --------- ----- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
FIXED PAYMENT AND VARIABLE RECEIPT
1999 ................................. $ 100,000 5.77% 10.09% $ 100,000 6.02% 10.09%
======== ====== ====== ======== ===== ======
VARIABLE PAYMENT AND FIXED RECEIPT
1997 ................................. $ 45,000 6.30% 5.63%
1998 ................................. $ 115,000 6.40% 5.53% - - -
2000 ................................. 110,000 7.06 5.54 110,000 7.08 5.63
2001 ................................. 140,000 7.28 5.53 - - -
-------- ------ ------ --------- ----- ------
Total ............................. $ 365,000 6.93 % 5.53% (1)$ 155,000 6.86% 5.63%(1)
======== ====== ====== ========= ===== ======
- ------------------------------------
<FN>
(1) Rates are based upon LIBOR.
</TABLE>
56
<PAGE> 60
The Company also utilized swaps to hedge a special class of certificates of
deposit. These swaps provide for the receipt of variable interest based
upon changes in the S&P 500 Index, and the payment of either fixed or
variable interest. The notional principal amount outstanding at December
31, 1996 of these agreements was $32.2 million with a weighted average
receipt rate of 19.58% and payment rate of 5.59% at that date. As of
December 31, 1995, the outstanding principal was $24.2 million with receipt
and pay rates of 14.28% and 5.85% respectively.
In March 1995, the Company entered into $300 million of four-year interest
rate floor agreements maturing in March 1999, which provide for receipt of
interest when six-month LIBOR falls below 6.00%. The Company receives the
difference between 6.00% and LIBOR at the time of repricing, calculated on
the $300 million notional amount. At December 31, 1996, interest received
based on a 5.80% LIBOR rate was partially offset by a .07% per annum fee
cost.
In the fourth quarter of 1995, as part of a balance sheet repositioning due
to the merger with FirstFed, the Company terminated $600 million of swaps
which were scheduled to mature in 1999, resulting in a pretax loss of $72.0
million. The loss was recognized immediately in the statement of
operations, as the liabilities to which the agreements were assigned were
eliminated in connection with the repositioning. The Company also
terminated a $150 million swap which resulted in a gain of $1.0 million.
The gain was deferred and is being amortized straight line over the
original life of the agreement, as the liability to which it was assigned
remains outstanding. An additional pretax loss of $4.2 million was also
recognized in the fourth quarter of 1995 when $800 million of 8% interest
rate caps were terminated and the corresponding liabilities were
eliminated.
The unamortized net gains on terminated swaps were deferred if the
liabilities to which they were assigned remained outstanding. The gains are
being amortized over the original lives of the agreements. The unamortized
net gain on terminated swaps was $2.1 million at December 31, 1996.
Amortization of deferred net gains against interest expense totaled $6.1
million, $6.8 million and $6.6 million in 1996, 1995 and 1994,
respectively. Amortization of the $2.1 million of remaining deferred net
gains at December 31, 1996, is expected to be $1.1 million in 1997,
$643,000 in 1998, and $313,000 in 1999.
The interest rate exchange agreements have been entered into with three
nationally recognized primary dealers. The payments on these agreements
have been collateralized with $23.4 million of mortgage-backed securities
at December 31, 1996, held by the counterparties. In the event of a
counterparty default, the Company is subject to risk to the extent that the
value of the collateral exceeds the Company's net obligations under the
agreements, and to the extent that any agreements have to be replaced under
market conditions which are not favorable to the Company. The Company does
not currently anticipate a default by any of the counterparties.
The Company has entered into caps with primary dealers to limit its
exposure to rising rates on certain of its variable-rate and short-term,
fixed-rate liabilities. These stand-alone agreements supplement the cap
provisions which have been incorporated into some of the Company's
borrowings. The agreements provide for receipt of interest when three-month
LIBOR exceeds an agreed-upon base rate. The Company receives a rate of
interest equal to the excess of three-month LIBOR at the time of repricing
over the 6.00% base rate, calculated on a notional principal amount. The
agreements reprice quarterly. Fees paid at inception of the agreements are
being amortized over the terms of the agreements. Unamortized fees totaled
$328,000 at December 31, 1996.
Outstanding caps are described in the following table:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
1996 1995
--------------------------------------- ----------------------------------------
PER PER
NOTIONAL INTEREST ANNUM NOTIONAL INTEREST ANNUM
PRINCIPAL BASE RATE COST OF PRINCIPAL BASE RATE COST OF
MATURING IN AMOUNT RATE RECEIVED FEE AMOUNT RATE RECEIVED FEE
------------ --------- -------- --------- -------- --------- -------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1996 ..................... $ 200,000 6.00% -% .21%
1997 ..................... $ 650,000 6.00% -% .31% 650,000 6.00 - .31%
--------- ----- ----- ----- --------- ----- ----- -----
Total ................. $ 650,000 6.00% -% .31% $ 850,000 6.00% -% .28%
========= ===== ===== ===== ========= ===== ===== =====
</TABLE>
57
<PAGE> 61
The Company is exposed to credit loss in the event of nonperformance by the
counterparties to the swaps, floors and caps. The Company, however, does
not currently anticipate nonperformance by the counterparties.
The cost of interest rate exchange, cap, floor and collar positions,
including amortization of gains and losses on terminated positions, was
included in interest expense as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest expense:
Deposits ................................................... $(9,515) 18,745 41,561
FHLB advances .............................................. 1,760 2,201 2,202
Reverse repurchase agreements .............................. (2,048) 30,914 73,014
------- ------- --------
Total ................................................... $(9,803) 51,860 116,777
======= ======= ========
</TABLE>
12. FEDERAL INCOME TAXES
In accordance with SFAS No. 109, deferred income tax assets and liabilities
are computed annually for differences between financial statement and tax
basis of assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted tax laws and rates applicable to
periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred
tax assets to the amount expected to be realized. Income tax expense is the
tax payable or refundable for the period adjusted for the change during the
period in deferred tax assets and liabilities.
The provision for federal income taxes consists of the following
components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Current .............................................. $ 32,222 26,581 (4,806)
Deferred ............................................. 32,561 (7,408) 11,862
------- ------- -------
Total ............................................. $ 64,783 19,173 7,056
======= ======= =======
</TABLE>
A reconciliation from tax at the statutory rate to the income tax provision
is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1996 1995 1994
------------------ ------------------ ------------------
DOLLARS RATE DOLLARS RATE DOLLARS RATE
------- ---- ------- ---- ------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Tax at statutory rate ........................... $ 67,377 35.0% $ 18,622 35.0% $ 7,937 35.0%
Increase (decrease) due to:
Bad debt deduction ............................ - - - 4,000 17.6
Purchase accounting ........................... - - - (3,877) (17.1)
Other ......................................... (2,594) (1.3) 551 1.0 (1,004) (4.5)
------- ---- ------- ---- ------- -----
Income tax provision ........................ $ 64,783 33.7% $ 19,173 36.0% $ 7,056 31.0%
======= ==== ======= ==== ======= =====
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows. No valuation allowance was considered necessary.
58
<PAGE> 62
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets:
Book allowance for loan losses .............................. $ 21,201 21,483 22,323
Accrued and deferred compensation ........................... 4,258 3,062 2,661
Allowance for uncollected interest .......................... 823 946 970
Net unrealized loss on securities ........................... - 15,978 30,647
Other ....................................................... 5,250 20,566 19,088
-------- ------- -------
Total deferred tax assets ................................ 31,532 62,035 75,689
-------- ------- -------
Deferred tax liabilities:
Leasing activities, net ..................................... 22,831 5,422 -
FHLB stock dividends ........................................ 15,124 12,668 10,928
Tax allowance for loan losses ............................... 5,840 7,987 9,094
Net unrealized gain on securities ........................... 4,565 - -
Depreciation ................................................ 3,783 2,690 6,318
Purchase accounting ......................................... 894 1,738 1,647
Mark-to-market .............................................. 339 678 2,295
Other ....................................................... 3,384 2,976 914
-------- ------- -------
Total deferred tax liabilities ........................... 56,760 34,159 31,196
-------- ------- -------
Net deferred tax asset (liability) ..................... $ (25,228) 27,876 44,493
======== ======= =======
</TABLE>
During 1996, legislation was passed that repealed Section 593 of the
Internal Revenue Code for taxable years beginning after December 31, 1995.
Section 593 allowed thrift institutions, including Charter One, to use the
percentage-of-taxable income bad debt accounting method, if more favorable
than the specific charge-off method, for federal income tax purposes. The
excess reserves (deduction based on the percentage-of-taxable income less
the deduction based on the specific charge-off method) accumulated
post-1987 are required to be recaptured ratably over a six-year period
beginning in 1996. The recapture has no effect on the Company's statement
of operations as taxes were provided for in prior years in accordance with
SFAS 109, "Accounting for Income Taxes." The timing of this recapture may
be delayed for a one or two-year period to the extent that Charter One
originates more residential loans than the average originations in the past
six years. Charter One will meet the origination requirement for 1996 and,
therefore, will delay recapture at least until the six-year period
beginning in 1997. The recapture amount of $17.1 million will result in
payments totaling $6.0 million which has been previously accrued. The
pre-1988 reserve provisions are subject only to recapture requirements in
the case of certain excess distributions to, and redemptions of
shareholders or if the Bank no longer qualifies as a "bank". Tax bad debt
deductions accumulated prior to 1988 by the Bank are approximately $168
million. No deferred income taxes have been provided on these bad debt
deductions and no recapture of these amounts is anticipated.
13. SHAREHOLDERS' EQUITY
The Bank may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause shareholders' equity to be reduced
below applicable regulatory capital maintenance requirements or if such
declaration and payment would otherwise violate regulatory requirements. At
December 31, 1996, approximately $155.9 million of the Company's retained
earnings was available to pay dividends to shareholders, to purchase
shares, or to be used for other corporate purposes.
During 1994, the Board of Directors of the Company authorized management to
purchase up to 1.2 million shares of its outstanding common stock. As of
June 30, 1996, all of the shares had been purchased under this
authorization.
On May 15, 1996, the Board of Directors of the Company authorized
management to purchase 5% of the Company's outstanding common stock in an
additional buyback program. As of that date, the Company had 47,354,637
common shares outstanding (adjusted for subsequent stock dividend). Under
the authorization, repurchases are to be made from time to time through
open market purchases or unsolicited negotiated transactions. Shares
purchased under this authorization will be held in treasury and will be
available for issuance upon the exercise of outstanding stock options and
for other corporate purposes.
59
<PAGE> 63
Under these two buyback programs, 1,288,425 shares of stock were
repurchased in 1996 for an aggregate price of $47.7 million, and 718,100
shares were purchased in 1995 for an aggregate price of $19.8 million.
On July 24, 1996, the Board of Directors of Charter One Financial, Inc.
approved a 5% stock dividend which was distributed September 30, 1996, to
shareholders of record on September 13, 1996.
14. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. The
regulations require the Bank to meet specific capital adequacy guidelines
and the regulatory framework for prompt corrective action that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Bank's capital classification is also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of total
risk-based, Tier 1 risk-based, Tier 1 leverage and tangible capital as set
forth in the tables below.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
--------------------------------------------------------------------
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- --------------------- ------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk-weighted assets) ....... $ 741,904 10.62% $559,080 8.0% $698,850 10.0%
Tier 1 capital (to risk-weighted assets) ...... 679,967 9.73 N/A N/A 419,310 6.0
Tier 1 capital (to adjusted tangible assets)... 679,967 5.00 407,700 3.0 679,500 5.0
Tangible capital (to adjusted
tangible assets) ............................ 679,967 5.00 203,850 1.5 N/A N/A
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1995
--------------------------------------------------------------------
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- --------------------- ------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk-weighted assets) ........ $ 875,176 14.29% $489,835 8.0% $612,294 10.0%
Tier 1 capital (to risk-weighted assets) ....... 822,670 13.44 N/A N/A 367,376 6.0
Tier 1 capital (to adjusted tangible assets) ... 822,670 6.11 404,053 3.0 673,422 5.0
Tangible capital (to adjusted
tangible assets) ............................. 822,670 6.11 202,027 1.5 N/A N/A
</TABLE>
As of December 31, 1996, the most recent notification from the Office of
Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for Prompt Corrective Action. To be 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 table above.
There are no conditions or events since that notification that have changed
the Bank's category.
Management believes, as of December 31, 1996, that the Bank meets all
capital requirements to which it is subject. Events beyond management's
control, such as fluctuations in interest rates or a downturn in the
economy in areas in which the Bank's loans and securities are concentrated,
could adversely affect future earnings and, consequently, the Bank's
ability to meet its future capital requirements.
60
<PAGE> 64
15. STOCK PURCHASE RIGHTS
Each share of the Company's common stock outstanding entitles the
shareholder to one stock purchase right. Each right will entitle the
registered holder to purchase one one-hundredth of a share of a new series
of preferred stock at a price of $40.00 (subject to adjustment). The rights
have additional provisions which, subject to the approval of the Board of
Directors, (1) will entitle the holder to purchase the Company's authorized
and unissued common stock at a price below its market value (as defined in
the agreement) in the event that any person or group acquires 20% or more
of the common stock of the Company without the consent of the Company, and
(2) will entitle the holder to purchase shares of common stock of the
acquiring company at a price below the market value (as defined in the
agreement) in the event that the Company is acquired in a merger or other
business combination transaction or 50% or more of its consolidated assets
or earnings power (as defined) are sold.
The rights expire on December 1, 1999, and may be redeemed by the Company
for $.01 per right at any time prior to an acquisition of 20% or more of
the common stock of the Company and thereafter under certain circumstances,
including in connection with a business combination consented to by the
Company. There are 46,442,723 rights outstanding at December 31, 1996 and
600,000 shares of preferred stock reserved for these rights.
16. BENEFIT PLANS
EMPLOYEE STOCK OWNERSHIP AND PENSION PLANS
The Company has an Employee Stock Ownership Plan ("ESOP") and had a
noncontributory defined benefit pension plan ("Pension Plan") through April
30, 1994. Effective April 30, 1994, the Bank's Board of Directors approved
an amendment to provide for 100% vesting of accrued benefits and to freeze
benefits accrued under the Pension Plan. The effect of this curtailment was
not material. The Pension Plan was terminated and all assets were
distributed in the fourth quarter of 1995. FirstFed also had a
noncontributory defined benefit pension plan ("FirstFed Pension Plan").
Effective October 31, 1995, the FirstFed Board of Directors approved an
amendment to provide for 100% vesting of accrued benefits and to freeze
benefits accrued under the FirstFed Pension Plan in anticipation of
termination. The effect of this curtailment was not material.
Benefits accrued through October 31, 1995 under the FirstFed Pension Plan
will be paid to plan participants in the form of annuity contracts or lump
sum payments, at the participant's option. Assets remaining after
distribution of the accrued benefits will be allocated among participants
at October 31, 1995, and distributed in the same manner as accrued
benefits.
The Company's funding policy for the ESOP is to make discretionary
contributions to the plan. Contributions to the ESOP were $1.6 million,
$250,000, and $2 million for the years ended December 31, 1996, 1995 and
1994, respectively. The Company's funding policy prior to the freeze of
Pension Plan benefits was to contribute to the Pension Plan amounts
necessary, after consideration of ESOP contributions, to satisfy the
funding requirements of federal law and regulations. The funding policy for
the FirstFed Pension Plan was to contribute amounts necessary to satisfy
the funding requirements of federal law and regulations.
ESOP assets consist principally of Company stock. At December 31, 1996 and
1995, the ESOP held approximately 3.1% and 3.4%, respectively, of the total
outstanding shares of Company stock. The FirstFed Pension Plan assets
consisted principally of fixed-income and listed equity securities.
The Bank has a trusteed employee savings plan covering substantially all
salaried employees. Under the terms of the Trust Agreement, the Bank's
annual contribution to the plan is based on matching contributions of
participating employees up to 9% of base salary. Contributions totaled $1.6
million and $757,000 for the years ended December 31, 1996 and 1995,
respectively. The Bank may terminate the plan at any time.
In the past, FirstFed voluntarily provided health care and life insurance
benefits to substantially all retired employees, on an unfunded,
noncontributory basis. The cost of providing these benefits was expensed as
paid. In 1992, the plan was amended for employees retiring after September
30, 1992, and now requires the employees to pay the full cost of health
care benefits after retirement. In 1993, FirstFed adopted SFAS No.
61
<PAGE> 65
106, "Employers' Accounting for Postretirement Benefits Other than
Pensions." SFAS No. 106 requires that the cost of providing such benefits
be recognized over the employee's service periods rather than on a cash
basis. FirstFed elected to amortize the accumulated postretirement benefit
obligation of $9.3 million over 20 years.
Net periodic postretirement benefit cost included the following components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Service cost - benefits earned during the period ..................... $ - 10 16
Interest cost on accumulated postretirement benefit obligation ....... 563 714 694
Amortization of unrecognized transition obligation ................... 410 464 464
Curtailment loss ..................................................... 196 - -
Amortization of net loss ............................................. - - 9
------ ----- -----
Total ............................................................. $1,169 1,188 1,183
===== ===== =====
</TABLE>
The following table sets forth the amount reported in the Company's
consolidated statements of financial condition:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees ........................................................................ $(8,047) (8,939)
Fully eligible active plan participants ......................................... - (136)
Other active plan participants .................................................. - (169)
------- -------
Total ........................................................................ (8,047) (9,244)
Plan assets at fair value ......................................................... - -
------- -------
Accumulated postretirement benefit obligation in excess of plan assets ............ (8,047) (9,244)
Unrecognized net (gain) loss ...................................................... (240) 129
Unrecognized transition obligation ................................................ 6,565 7,893
------- -------
Accrued postretirement benefit cost included in other liabilities .............. $(1,722) (1,222)
======= =======
</TABLE>
A discount rate of 7.50% was used to measure the accumulated postretirement
benefit obligation as of December 31, 1996. The rate of increase in health
care costs was assumed to be 9.38% in 1997, grading down uniformly to 5.50%
in 2003 and all years thereafter. A 1.00% increase in the health care cost
trend rate assumptions would increase the December 31, 1996, accumulated
postretirement benefit obligation by $604,400 and would increase the
aggregate of the service and interest cost components of 1996 net periodic
postretirement benefit cost by $40,700.
17. STOCK OPTION PLANS
At December 31, 1996, the Company has five stock option plans under which
3,370,074 shares of common stock are reserved for grant to directors,
officers and key employees. The Plans provide that option prices will not
be less than the fair market value of the stock at the grant date. The date
on which the options are first exercisable is determined by the Stock
Option Committee of the Board of Directors (the "Committee"). The options
expire no later than 10 years from the grant date. The Company applies APB
No. 25 and related interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its stock option
plans. Had compensation cost of the Company's five stock option plans been
determined based on the fair value at the grant dates for awards under
those plans consistent with the method of SFAS No. 123, the Company's net
income and earnings per share would have been reduced to the pro forma
amounts indicated below:
62
<PAGE> 66
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
Net income:
<S> <C> <C>
As reported ........................................... $127,722 34,032
Pro forma ............................................. 124,675 33,935
Earnings per share:
As reported ........................................... 2.67 .71
Pro forma ............................................. 2.60 .70
</TABLE>
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1995 and 1996,
respectively: dividend yield of 2.5% for all years; expected volatility of
34% for the 1995 option grants and 31 to 34% percent for the 1996 grants;
risk-free interest rates of 6.48 to 7.71 percent for the 1995 option grants
and 5.48% to 6.56% for the 1996 grants; and expected lives of seven years
for both plans.
The following is an analysis of the stock option activity for each of the
years in the three-year period ended December 31, 1996 and the stock
options outstanding at the end of the respective periods. Amounts have been
restated to reflect the 5% stock dividend.
<TABLE>
<CAPTION>
EXERCISE PRICE
-----------------------------------
NUMBER
OF SHARES PER SHARE TOTAL
------------ ---------------- ------------
<S> <C> <C> <C> <C>
Outstanding at January 1, 1994 ..................... 2,404,458 $ 2.97 -$ 19.84 $ 26,128,084
Granted ............................................ 28,350 19.29 - 21.55 571,500
Exercised .......................................... (157,339) 3.39 - 14.76 (915,122)
Canceled - stock appreciation rights exercised ..... (4,410) 6.15 (27,125)
Forfeited .......................................... (13,316) 2.97 - 18.20 (208,679)
------------ ------------
Outstanding at December 31, 1994 ................... 2,257,743 2.97 - 21.55 25,548,658
Granted ............................................ 72,450 18.33 - 25.48 1,401,375
Exercised .......................................... (737,217) 3.39 - 19.29 (8,231,201)
Canceled - stock appreciation rights exercised ..... (3,969) 6.15 (24,413)
Forfeited .......................................... (29,317) 14.76 - 18.20 (441,058)
------------ ------------
Outstanding at December 31, 1995 ................... 1,559,690 2.97 - 25.48 18,253,361
Granted ............................................ 1,591,057 28.33 - 42.00 45,419,678
Exercised .......................................... (501,568) 3.39 - 21.55 (5,052,015)
Forfeited .......................................... (75,936) 16.80 - 28.33 (1,965,169)
------------ ------------
Outstanding at December 31, 1996 ................... 2,573,243 $ 2.97 -$ 42.00 $ 56,655,855
============ ======= ======= ============
Exercisable at December 31, 1996 ................... 929,854 $ 2.97 -$ 25.48 $ 10,856,983
============ ======= ======= ============
Shares available for future grants
at December 31, 1996 .............................. 796,831
============
</TABLE>
As of December 31, 1996, the weighted-average exercise price for options
outstanding was $22.02 with a weighted average remaining contractual life
of 7.4 years.
Stock appreciation rights may be granted alone or in conjunction with
options granted to officers and key employees. Upon exercise, the payment
may be made in cash, shares or partly in each. The Company accrues
compensation expense for the amount by which the market value of the shares
exceed the exercise price of the appreciation rights. All appreciation
rights expire on January 29, 1998. Costs of the appreciation rights are
accrued and charged to salaries and employee benefits expense.
The following is an analysis of the stand-alone stock appreciation rights
activity for each of the years in the three-year period ended December 31,
1996 and the stock appreciation rights outstanding at the end of the
respective periods. Amounts have been restated to reflect the 5% stock
dividend.
63
<PAGE> 67
<TABLE>
<CAPTION>
EXERCISE PRICE
NUMBER ----------------------------
OF RIGHTS PER SHARE TOTAL
--------- --------- -----
<S> <C> <C> <C>
Outstanding at December 31, 1993 ........................... 170,104 $3.39 $ 576,000
Exercised .................................................. (42,526) 3.39 (144,000)
---------- ----------
Outstanding at December 31, 1994 ........................... 127,578 3.39 432,000
Exercised .................................................. (67,923) 3.39 (230,000)
---------- ----------
Outstanding at December 31, 1995 ........................... 59,655 3.39 202,000
Exercised .................................................. (6,498) 3.39 (22,000)
---------- ----- ----------
Outstanding at December 31, 1996 ........................... 53,157 $3.39 $ 180,000
========== ===== ==========
Exercisable at December 31, 1996 ........................... 53,157 $3.39 $ 180,000
========== ===== ==========
</TABLE>
The Committee may also award restricted shares of common stock and
performance units to officers and key employees. The terms of the grants
are determined by the Committee at the date of the award. As of December
31, 1996 no awards of restricted shares of common stock or performance
units had been made.
INCENTIVE COMPENSATION PLAN
The Bank maintains an incentive compensation plan (the "Incentive Plan")
which provides for annual cash bonuses to certain management employees as a
means of recognizing achievement on the part of such employees. The bonuses
are determined based on a combination of the Bank's and the individual
employee's performance during the year. Amounts are accrued and charged to
expense during the year pursuant to the Incentive Plan.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments have been determined by
the Company using available market information and appropriate valuation
methodologies. Considerable judgment is required in interpreting market
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts that the
Company could realize in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
Cash, Cash Equivalents, Accrued Interest Receivable and Payable and Advance
Payments by Borrowers for Taxes and Insurance - The carrying amount as
reported in the Consolidated Statement of Financial Condition is a
reasonable estimate of fair value.
Mortgage-Backed and Investment Securities - Fair values are based on quoted
market prices, dealer quotes and prices obtained from independent pricing
services.
Loans and Leases - The fair value is estimated by discounting the future
cash flows using the current market rates for loans and leases of similar
maturities with adjustments for market and credit risks.
Federal Home Loan Bank Stock - The fair value is estimated to be the
carrying value which is par. All transactions in the capital stock of the
Federal Home Loan Bank are executed at par.
Deposits - The fair value of demand deposits, savings accounts and money
market deposit accounts is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit is estimated
using rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank Advances, Reverse Repurchase Agreements, and Other
Borrowings - Rates currently available to the Bank for borrowings with
similar terms and remaining maturities are used to estimate fair value of
existing borrowings.
Interest Rate Swap, Cap and Floor Agreements - The fair value is estimated
as the difference in the present value of future cash flows between the
Company's existing agreements and current market rate agreements of the
same duration.
64
<PAGE> 68
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since
that date and, therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------ ------------------------
CARRYING FAIR CARRYING Fair
VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
(AS RESTATED) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents ................ $ 270,304 270,304 658,371 658,371
Investment securities .................... 243,632 243,632 407,427 407,427
Mortgage-backed securities ............... 4,704,074 4,723,252 5,314,749 5,396,915
Loans and leases ......................... 8,100,342 8,169,149 6,678,600 6,739,819
Federal Home Loan Bank stock ............. 215,815 215,815 178,136 178,136
Accrued interest receivable .............. 77,193 77,193 73,683 73,683
Liabilities:
Deposits:
Checking, savings and money
market accounts ...................... 3,072,772 3,072,772 2,570,227 2,570,227
Certificates of deposit ................ 4,768,425 4,775,352 4,442,264 4,472,956
Federal Home Loan Bank advances .......... 3,194,333 3,185,864 3,163,144 3,169,582
Reverse repurchase agreements ............ 1,549,778 1,546,397 2,089,520 2,088,142
Other borrowings ......................... 211,180 256,613 209,020 300,156
Advance payments by borrowers for
taxes and insurance .................... 39,346 39,346 47,738 47,738
Accrued interest payable ................. 35,298 35,298 56,955 56,955
Off-Balance-Sheet Items:
Interest rate swaps in a net
receivable position .................... - 9,259 - 5,450
Interest rate swaps in a net
payable position ....................... - (7,191) - (12,243)
Interest rate cap and floor agreements ... - 1,325 - (1,738)
</TABLE>
19. STATEMENTS OF CASH FLOWS SUPPLEMENTAL DISCLOSURE
Supplemental disclosures of cash flow information are summarized below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest on deposits and borrowings ................................ $ 644,379 707,868 639,066
Income taxes ....................................................... 34,000 2,280 29,360
Supplemental schedule of noncash activities:
Loans exchanged for mortgage-backed securities ....................... 510,435 331,426 28,692
Securities transferred from held to maturity to
available for sale ................................................. 10,861 1,961,199 17,413
Securities transferred from available for sale to
held to maturity ................................................... - 79,618 1,032,733
Securities transferred from held for sale to trading classification .. - - 33,213
Transfers from loans to real estate owned ............................ 6,712 5,702 5,083
</TABLE>
65
<PAGE> 69
20. PARENT COMPANY FINANCIAL INFORMATION
The summarized financial statements of Charter One Financial, Inc. (parent
company only) as of December 31, 1996 and 1995 and for the years ended
December 31, 1996, 1995 and 1994 follow:
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
---- ----
(DOLLARS IN THOUSANDS)
(AS RESTATED)
<S> <C> <C>
Assets:
Deposits with subsidiary .................................................. $ 67 28,596
Cash equivalents .......................................................... 36,551 -
Investment in subsidiary, at equity ....................................... 874,026 855,292
Securities and other ...................................................... 11,257 1,446
---------- ----------
Total .................................................................. $ 921,901 885,334
========== ==========
Liabilities:
Total liabilities ......................................................... $ 177 461
---------- ----------
Shareholders' equity:
Common stock .............................................................. 475 451
Additional paid-in capital ................................................ 321,991 235,889
Retained earnings ......................................................... 637,356 642,197
Treasury stock, at cost ................................................... (39,615) (3,061)
Net unrealized gain (loss) on securities, net of tax expense/benefit ...... 1,517 9,397
---------- ----------
Total shareholders' equity .............................................. 921,724 884,873
---------- ----------
Total ................................................................ $ 921,901 885,334
========== ==========
</TABLE>
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Income:
Dividends from subsidiary ........................................... $ 100,000 47,500 36,250
Interest and dividends on securities ................................ 2,081 2,068 857
--------- -------- ---------
Total income ..................................................... 102,081 49,568 37,107
Expenses .............................................................. 998 12,064 1,120
--------- -------- ---------
Income before undistributed net earnings of subsidiary .............. 101,083 37,504 35,987
Equity in undistributed net (loss) earnings of subsidiary ........... 26,639 (3,472) (32,716)
--------- -------- ---------
Net income ....................................................... $ 127,722 34,032 3,271
========= ======== =========
</TABLE>
66
<PAGE> 70
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ...................................................... $ 127,722 34,032 3,271
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net loss (earnings) of subsidiary ... (26,639) 3,472 32,716
Other ....................................................... (343) 2,350 (658)
---------- ---------- ---------
Net cash provided by operating activities ................. 100,740 39,854 35,329
---------- ---------- ---------
Cash flows from investing activities:
Purchase of securities .......................................... (44,362) (233,756) (1,374)
Maturity of securities .......................................... 34,635 247,900 1,800
---------- ---------- ---------
Net cash provided by (used in) investing activities .......... (9,727) 14,144 426
---------- ---------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock .......................... 1,392 1,072 984
Payment of dividends on common stock ............................ (40,495) (29,962) (23,405)
Net purchases of treasury stock ................................. (43,888) (11,823) (906)
---------- ---------- ---------
Net cash used in financing activities ........................ (82,991) (40,713) (23,327)
---------- ---------- ---------
Increase in deposits with subsidiary and
cash equivalents ......................................... $ 8,022 13,285 12,428
========== ========== =========
</TABLE>
21. SAVINGS ASSOCIATION INSURANCE FUND ASSESSMENT
On September 30, 1996, the President signed into law an omnibus
appropriations act for fiscal year 1997 that included, among other things,
the recapitalization of the Savings Association Insurance Fund ("SAIF") in
a section entitled the Deposit Insurance Funds Act of 1996 ("ACT"). The Act
included a provision where all insured depository institutions would be
charged a one-time special assessment on their SAIF assessable deposits as
of March 31, 1995. The Company recorded a pretax charge of $56.3 million
($37.1 million after tax), which represented 65.7 basis points of the March
31, 1995 assessable deposits. This charge was recorded upon enactment of
the Act on September 30, 1996, and paid on November 29, 1996. The annual
deposit insurance rate in effect prior to this recapitalization has been
reduced to 6.5 basis points of insured deposits.
22. SUBSEQUENT EVENTS
In April 1997, the boards of directors of Charter One Financial, Inc. and
Haverfield Corporation, the holding company of Home Bank, F.S.B. entered
into a definitive agreement to merge in a stock-for-stock exchange. Home
Bank, headquartered in Cleveland, Ohio, is a federally chartered savings
and loan with $342 million in assets ($273 million in deposits) and 10
branch offices throughout the Cleveland area.
Terms of the agreement call for the tax-free exchange of $27.00 in Charter
One common stock for each of Haverfield's common shares or a total
consideration of approximately $53.7 million. The price will stay fixed at
$27.00 per Haverfield share if Charter One's average stock price remains
between $41.09 and $55.60 per share during a 20-day pricing period ending
five business days before closing the transaction. The merger, which would
be accounted for as a purchase, is expected to close near the end of the
third quarter of 1997. Already approved by the boards of directors of both
companies, the transaction requires the approvals of the Office of Thrift
Supervision and Haverfield shareholders.
In May 1997, the boards of directors of Charter One Financial, Inc. and
RCSB Financial, Inc., the holding company of Rochester Community Savings
Bank, entered into a definitive agreement to enter into a strategic
alliance through a stock-for-stock exchange. Rochester Community Savings
Bank, headquartered in Rochester, New York, is a state-chartered savings
bank with $4 billion in assets ($2.4 billion in deposits) and 36 branch
offices in Rochester and Buffalo.
67
<PAGE> 71
Terms of the agreement call for a tax-free exchange of shares at a fixed
exchange ratio of .91 shares in Charter One common stock for each of RCSB's
common shares. Based on current RCSB shares, it is expected that
approximately 13.6 million new shares of Charter One stock will be issued
in conjunction with the merger, bringing the initial value of the
transaction to $635 million and the pro forma market capitalization of the
combined company to $2.9 billion. The merger, which would be accounted for
as a pooling of interests, is expected to close in the fourth quarter of
1997. Already approved by the boards of directors of both companies, the
transaction requires the approvals of the Office of Thrift Supervision and
each company's shareholders. In addition, RCSB has granted Charter One an
option to purchase shares equal to 19.9% of RCSB's outstanding common stock
under certain conditions.
23. RESTATEMENT
Subsequent to the issuance of the Company's 1996 consolidated financial
statements, the Company's management determined that (1) approximately $1.1
billion of the mortgage-backed security portfolio that was transferred
into held to maturity during 1996 should have remained in available for
sale, and (2) the offset to the fair value adjustment relating to such
security portfolio, which aggregated approximately $40.5 million, net of
tax, that was previously recorded as an increase to accrued liabilities
when such security portfolio was transferred from held to maturity to
available for sale during 1995, should have been recorded as a component
of shareholders' equity. As a result, the Company's 1996 and 1995
consolidated financial statements have been restated from the amounts
previously reported to reflect the proper recording of these
securities. The effects of the restatement did not affect net income.
A summary of the significant effects of the restatement is as follows:
<TABLE>
<CAPTION>
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -------------
<S> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1996:
Interest income:
Mortgage-backed securities available for sale ........................... $ 11,340 78,143
Mortgage-backed securities held to maturity ............................. 346,635 279,832
AT DECEMBER 31, 1996:
Mortgage-backed securities available for sale ............................. 21,800 1,070,705
Mortgage-backed securities held to maturity ............................... 4,692,996 3,633,369
Total assets .............................................................. 13,904,563 13,893,841
Accrued liabilities ....................................................... 104,738 100,985
Total liabilities ......................................................... 12,975,870 12,972,117
Unrealized gain on securities ............................................. 8,486 1,517
Shareholders' Equity ...................................................... 928,693 921,724
AT DECEMBER 31, 1995:
Other assets .............................................................. 115,964 95,466
Total assets .............................................................. 13,578,859 13,558,361
Accrued liabilities ....................................................... 155,593 94,620
Total liabilities ......................................................... 12,734,461 12,673,488
Unrealized gain (loss) on securities ...................................... (31,078) 9,397
Shareholders' Equity ...................................................... 844,398 884,873
</TABLE>
68
<PAGE> 72
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors
Charter One Financial, Inc.
We have audited the accompanying consolidated statements of financial
condition of Charter One Financial, Inc. and subsidiaries as of December
31, 1996 and 1995, and the related consolidated statements of income,
shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. The
consolidated financial statements give retroactive effect to the merger of
Charter One Financial, Inc. and FirstFed Michigan Corporation which has
been accounted for as a pooling of interests as described in Note 2 to the
consolidated financial statements. We did not audit the statements of
income, shareholders' equity, and cash flows of FirstFed Michigan
Corporation for the year ended December 31, 1994, which statements reflect
a net loss of $96.3 million. Those financial statements were audited by
other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the amounts included for FirstFed Michigan
Corporation for such period, is based solely on the report of such other
auditors. As described in Note 2 to the consolidated financial statements,
subsequent to the issuance of the report of the other auditors, the
financial statements of FirstFed Michigan Corporation were restated to
conform to the accounting practices of Charter One Financial, Inc. for the
year ended December 31, 1994.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits and
the report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of Charter One Financial,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1996 in conformity with generally accepted
accounting principles.
We also audited the adjustments described in Note 2 that were applied to
restate the 1994 financial statements of both FirstFed Michigan Corporation
and Charter One Financial, Inc. In our opinion, such adjustments are
appropriate and have been properly applied.
As discussed in Note 23, the accompanying consolidated financial statements
have been restated.
/s/Deloitte & Touche LLP
Cleveland, Ohio
January 22, 1997 (August 6, 1997 as to Notes 22 and 23)
69
<PAGE> 73
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
FirstFed Michigan Corporation
We have audited the consolidated statements of financial
condition of FirstFed Michigan Corporation and subsidiaries as of December 31,
1994 and 1993, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31 , 1994. These consolidated financial statements are
the responsibility of the 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 financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of
FirstFed Michigan Corporation and subsidiaries at December 31, 1994 and 1993,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1994, in conformity with generally
accepted accounting principles.
As discussed in notes 1, 2, and 3 to the consolidated
financial statements, the Corporation changed its method of accounting for
investments to adopt the provisions of the Financial Accounting Standards
Board's Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" at January 1,
1994. As discussed in notes 1 and 19 to the consolidated financial statements,
the Corporation changed its method of accounting for the amortization of
goodwill in 1994 to adopt the provisions of the Financial Accounting Standards
Board's SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift
Institutions." As discussed in note 15 to the consolidated financial
statements, the Corporation changed its method of accounting for postretirement
benefits other than pensions in 1993 to adopt the provisions of the Financial
Accounting Standards Board's SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other than Pensions." As discussed in notes 1 and 13 to
the consolidated financial statements, the Corporation changed its method of
accounting for income taxes in 1992 to adopt the provisions of the Financial
Accounting Standards Board's SFAS No. 109, "Accounting for Income Taxes."
/s/ KPMG Peat Marwick LLP
KPMG PEAT MARWICK LLP
Detroit, Michigan
January 18, 1995
70
<PAGE> 74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the section captioned "Proposal 1 - Election of
Directors" in the Company's definitive proxy statement for the Company's 1997
Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by
reference. Reference is also made to the information appearing in Part I -
"Executive Officers," which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the
sections of the Proxy Statement captioned "Compensation of Directors",
"Directors' Stock Option Plan", "Executive Compensation and Other Information",
"1996 Compensation Committee Report on Executive Compensation", "Compensation
Committee Interlocks and Insider Participation" and "Comparison of Cumulative
Total Return Among Charter One Financial, Inc., S & P 500 Index and Peer Group
Index."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the
section of the Proxy Statement captioned "Outstanding Voting Securities."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
section of the Proxy Statement captioned "Compensation Committee Interlocks and
Insider Participation" and "Transactions with Related Parties."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
1. REPORTS OF INDEPENDENT ACCOUNTANTS
2. CONSOLIDATED FINANCIAL STATEMENTS
(a) Consolidated Statements of Financial Condition as of December
31, 1996 and 1995
(b) Consolidated Statements of Income for the Years Ended December
31, 1996, 1995 and 1994
(c) Consolidated Statements of Shareholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994
(d) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994
(e) Notes to Consolidated Financial Statements
71
<PAGE> 75
All financial statement schedules are omitted because the
required information is not applicable or is included in the
Consolidated Financial Statements or related notes.
3. EXHIBITS*
(2) Agreement and Plan of Merger, dated as of May 30, 1995,
by and among Charter One Financial, Inc. and FirstFed
Michigan Corporation, which contains a list briefly
identifying the contents of all omitted schedules and
similar attachments, which Charter One agrees to furnish
supplementally to the Commission upon request (filed
with Charter One's Current Report on Form 8-K for the
event on May 31, 1996 (as amended).
(3.1) Second Restated Certificate of Incorporation (filed with
Charter One's Current Report on Form 8-K for the event
on October 31, 1995.)
(3.2) Bylaws (filed with Charter One's Current Report on Form
8-K for the event on October 31, 1995.)
(4.1) Form of Certificate of Common Stock (Exhibit 4.2 to the
Form S-1 dated January 22, 1988.) (Commission File No.
33-16207.)
(4.2) Shareholder Rights Agreement between Charter One
Financial, Inc. and First National Bank of Boston, dated
May 26, 1995 (agreement with Charter One's Annual Report
on Form 10-K for the fiscal year ended December 31,
1994; amendment included in Exhibit 2 to this report.)
(10.1) Charter One Financial, Inc. Long-Term Stock Incentive
Plan. (Exhibit 10.1 to the Form S-1 dated January 22,
1988.) (Commission File No. 33-16207.)
(10.2) Charter One Financial, Inc. Directors' Stock Option
Plan. (Exhibit 10.2 to the Form S-1 dated January 22,
1988.) (Commission File No. 33-16207.)
(10.3) Employment Agreements between Charter One Bank, F.S.B.
and Charles John Koch and John David Koch; the
Agreements were terminated on October 31, 1995. (Exhibit
10.3 to the Form S-1 dated January 22, 1988.)
(Commission File No. 33-16207.)
(10.4) Forms of Salary Continuation Agreement between Charter
One Bank, F.S.B. and Charles John Koch, John David Koch,
and Robert J. Vana; the Agreements were terminated on
October 31, 1995. (Exhibit 10.7 to the Form S-1 dated
January 22, 1988.) (Commission File No. 33-16207.)
(10.5) Charter One Bank, F.S.B. Executive Incentive Goal
Achievement Plan. (Exhibit 10.8 to the Form 10-K for the
fiscal year ended December 31, 1994.) (Commission File
No. 0-16311.)
(10.6) Charter One Bank Pension Plan as Amended and Restated
Effective January 1, 1990 and Amendment No. 1 Thereto.
(Exhibit 10.9 to the Form 10-K for the fiscal year ended
December 31, 1994.) (Commission File No. 0-16311.)
(10.7) Charter One Bank, F.S.B. Employee Savings Plan and Trust
and Amendments Thereto. (Exhibit 10.10 to the Form 10-K
for the fiscal year ended December 31, 1993.)
(Commission File No. 0-16311.)
(10.8) Form of Employment Agreement between Charter One Bank,
F.S.B. and Mark D. Grossi; the Agreement was terminated
on October 31, 1995. (Exhibit 10.11 to the Form 10-K for
the fiscal year ended December 31, 1993.) (Commission
File No. 0-16311.)
(10.9) Charter One Bank, F.S.B. Profit Sharing Plan and
Amendments Thereto. (Exhibit 10.12 to the Form 10-K for
the fiscal year ended December 31, 1993.) (Commission
File No. 0-16311.)
72
<PAGE> 76
(10.10) First American Savings Bank, F.S.B. Nonqualified
Retirement Plan and First Amendment Thereto. (Exhibit
10.17 to the Form 10-K for the fiscal year ended
December 31, 1993.) (Commission File No. 0-16311.)
(10.11) FirstFed Michigan Corporation 1983 Stock Option Plan.
(Filed with the Form S-8 dated November 1, 1995.)
(Commission No. 33-61273.)
(10.12) FirstFed Michigan Corporation 1991 Stock Option Plan.
(Filed with the Form S-8 dated November 1, 1995.)
(Commission File No. 33-61273.)
(10.13) First Federal of Michigan Management Incentive Award
Plan, as amended and restated effective January 1, 1995;
the Plan was terminated on October 31, 1995. (Exhibit
10.13 to the Form 10-K for the fiscal year ended
December 31, 1995.) (Commission File No. 0-16311.)
(10.14) First Federal of Michigan Supplemental Executive
Retirement Plan, as amended and restated effective
January 1, 1995; the Plan was terminated on October 31,
1995. (Exhibit 10.14 to the Form 10-K for the fiscal
year ended December 31, 1995.) (Commission File No.
0-16311.)
(10.15) First Federal of Michigan Equity Performance
Appreciation Plan, as amended and restated effective
January 1, 1995; the Plan was terminated on October 31,
1995. (Exhibit 10.15 to the Form 10-K for the fiscal
year ended December 31, 1995.) (Commission File No.
0-16311.)
(10.16) Employment Agreement, dated March 10, 1994, between
FirstFed Michigan Corporation, First Federal of Michigan
and Richard W. Neu; the Agreement was terminated on
October 31, 1995. (Exhibit 10.7 to the FirstFed Michigan
Corporation Form 10-K for the fiscal year ended December
31, 1993.) (Commission File No. 0-17829.)
(10.17) Retirement Plan for Salaried Employees of First Federal
of Michigan, as amended and restated effective January
1, 1995. (Exhibit 10.17 to the Form 10-K for the fiscal
year ended December 31, 1995.) (Commission File No.
0-16311.)
(10.18) First Federal of Michigan Salaried Employees' Profit
Sharing Plan, as amended and restated effective January
1, 1995. (Exhibit 10.18 to the Form 10-K for the fiscal
year ended December 31, 1995.) (Commission File No.
0-16311.)
(10.19) Forms of Supplemental Retirement Agreements, dated
October 31, 1995, between Charter One Financial, Inc.
and Charles John Koch, Richard W. Neu, John David Koch,
Mark D. Grossi, and Robert J. Vana. (Exhibits 10.4 and
10.5 to the Form S-4 dated July 25, 1995.) (Commission
File No. 33-61273.)
(10.20) Forms of Employment Agreements, dated October 31, 1995,
between Charter One Financial, Inc. and Charles John
Koch, Richard W. Neu, John David Koch, Mark D. Grossi,
and Robert J. Vana. (Exhibits 10.1, 10.2 and 10.3 to the
Form S-4 dated July 25, 1995.) (Commission File No.
33-61273.)
(11) Statement regarding Computation of Per Share Earnings
(21) Subsidiaries of the Registrant
(23.1) Consent of Deloitte & Touche LLP
(23.2) Consent of KPMG Peat Marwick LLP
(27) Financial Data Schedule
- -------------------------------
73
<PAGE> 77
* Exhibits followed by a parenthetical reference are incorporated by
reference herein from the document described therein. All reference
filings, unless otherwise indicated, were made by Charter One Financial,
Inc.
4. REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the three months
ended December 31, 1996.
74
<PAGE> 78
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.
CHARTER ONE FINANCIAL, INC.
By: RICHARD W. NEU
-------------------------------
Richard W. Neu
Director, Executive Vice President and
Chief Financial Officer
Date: August 12, 1997
75
<PAGE> 79
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
EXHIBITS
TO
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(For the Fiscal Year Ended December 31, 1996)
----------------------
CHARTER ONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
================================================================================
<PAGE> 80
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
(11) Statement regarding Computation of Per Share Earnings
(21) Subsidiaries of the Registrant
(23.1) Consent of Deloitte & Touche LLP
(23.2) Consent of KPMG Peat Marwick LLP
(27) Financial Data Schedule
<PAGE> 1
EXHIBIT 11
CHARTER ONE FINANCIAL, INC.
COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
FOR THE 3 For the 12 For the 3 For the 12
MOS. ENDED Mos. Ended Mos. Ended Mos. Ended
DECEMBER 31, December 31, December 31, December 31,
1996 1996 1995 1995
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Computation of earnings
per share:
Weighted average number of
common shares outstanding........ 46,602,411 46,831,011 47,144,900 47,163,378
Add common stock equivalents
for shares issuable under:
Stock Appreciation Rights
Plan(1)...................... 48,866 48,603 - 55,439
Stock Option Plan(1)........... 1,229,868 1,036,578 - 933,005
------------- ------------- ------------- -------------
Weighted average number of
shares outstanding adjusted
for common stock equivalents 47,881,145 47,916,192 47,144,900 48,151,822
============= ============= ============= =============
Earnings applicable to
common stock..................... $ 42,871 $ 127,722 $ (58,430) $ 34,032
============= ============= ============= =============
Earnings per share(2).............. $ .90 $ 2.67 $ (1.24) $ 0.71
============= ============= ============= =============
- -------------------
<FN>
(1) Additional shares issuable were derived under the "treasury stock method"
using average market price during the period.
(2) Earnings per share have been restated for the 5% stock dividend issued
September 30, 1996. Due to a net loss in the fourth quarter of 1995, the
assumed exercise of stock options is antidilutive.
</TABLE>
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<PAGE> 2
EXHIBIT 21
CHARTER ONE FINANCIAL, INC.
SUBSIDIARIES OF THE REGISTRANT
AT DECEMBER 31, 1996
<TABLE>
<CAPTION>
JURISDICTION OF PERCENT OF
INCORPORATION OWNERSHIP
---------------- ---------------
<S> <C> <C>
CHARTER MICHIGAN BANCORP, INC........................................ Michigan 100%
SUBSIDIARY OF CHARTER MICHIGAN BANCORP, INC.
Charter One Bank, F.S.B............................................ United States 100%
SUBSIDIARIES OF CHARTER ONE BANK, F.S.B.
1215 Financial Center Associates Ltd............................... Ohio 99%
First Financial Services and Development Corporation............... Ohio 100%
Thriftco, Inc...................................................... Ohio 100%
ICX Corporation.................................................... Ohio 100%
1001 Services, Inc................................................. Michigan 100%
1001 Holding, Inc.................................................. Michigan 100%
FirstFed of Michigan International N.V............................. Michigan 100%
SUBSIDIARIES OF FIRST FINANCIAL SERVICES AND
DEVELOPMENT CORPORATION
First Family Financial Services, Inc. dba First Data Tech.......... Ohio 100%
First Northern Insurance Agency, Inc............................... Ohio 100%
Real Estate Appraisal Services, Inc................................ Ohio 100%
Servco, Inc........................................................ Ohio 100%
Charter One Investments, Inc....................................... Ohio 100%
GCCC, Inc. dba ACS................................................. Ohio 100%
Renaissance Insurance Agency, Inc.................................. Michigan 100%
SUBSIDIARY OF 1001 SERVICES, INC.
1001 Realty, Inc................................................... Michigan 100%
SUBSIDIARIES OF 1001 HOLDING, INC.
1001 Insurance Agency, Inc......................................... Michigan 100%
Bay Life Insurance Company, Inc.................................... Arizona 100%
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF DELOITTE & TOUCHE LLP
<PAGE> 2
INDEPENDENT AUDITORS' CONSENT
Charter One Financial, Inc.
We consent to the incorporation by reference in Registration Statements No.
33-24070, No. 33-23805, No. 33-54508, and No. 33-61273 of Charter One Financial,
Inc. on forms S-8 of our report dated January 22, 1997 (August 6, 1997 as to
Notes 22 and 23, which expresses an unqualified opinion, refers to the report
of other auditors on the consolidated financial statements of a company that
was merged with Charter One Financial, Inc., includes an explanatory paragraph
relating to an adjustment which was applied to restate the 1994 consolidated
financial statements to conform the adoption date of a change in accounting
principle as a result of a merger accounted for as a pooling of interests and
includes an explanatory paragraph relating to the restatement of the
consolidated financial statements described in footnote 23, appearing in this
Annual Report on Form 10-K/A of Charter One Financial, Inc. for the year ended
December 31, 1996.
/s/Deloitte & Touche LLP
Cleveland, OH
August 6, 1997
<PAGE> 1
EXHIBIT 23.2
CONSENT OF KPMG PEAT MARWICK LLP
<PAGE> 2
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Charter One Financial, Inc.
We consent to the incorporation by reference in Registration Statements No.
33-24070, N. 33-23805, No. 33-54508, and No. 33-61273 of Charter One Financial,
Inc. on Forms S-8 of our report dated January 18, 1995, relating to the
consolidated statements of operations, stockholders' equity, and cash flows of
FirstFed Michigan Corporation and subsidiaries for the year ended December 31,
1994, which expresses an unqualified opinion and includes an explanatory
paragraph relating to the change in method of accounting for debt and equity
securities and goodwill in 1994, which report appears in the December 31, 1996,
Annual Report on Form 10-K of Charter One Financial, Inc.
/s/KPMG Peat Marwick LLP
Detroit, MI
March 19, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 152,301
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 118,003
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,314,337
<INVESTMENTS-CARRYING> 3,633,369
<INVESTMENTS-MARKET> 3,652,547
<LOANS> 8,166,264
<ALLOWANCE> 65,922
<TOTAL-ASSETS> 13,893,841
<DEPOSITS> 7,841,197
<SHORT-TERM> 0
<LIABILITIES-OTHER> 175,629
<LONG-TERM> 4,955,291
0
0
<COMMON> 475
<OTHER-SE> 921,249
<TOTAL-LIABILITIES-AND-EQUITY> 13,893,841
<INTEREST-LOAN> 602,432
<INTEREST-INVEST> 379,180
<INTEREST-OTHER> 22,866
<INTEREST-TOTAL> 1,004,478
<INTEREST-DEPOSIT> 326,948
<INTEREST-EXPENSE> 621,086
<INTEREST-INCOME-NET> 383,392
<LOAN-LOSSES> 4,001
<SECURITIES-GAINS> (1,044)
<EXPENSE-OTHER> 244,024
<INCOME-PRETAX> 192,505
<INCOME-PRE-EXTRAORDINARY> 192,505
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 127,722
<EPS-PRIMARY> 2.67
<EPS-DILUTED> 2.67
<YIELD-ACTUAL> 2.92
<LOANS-NON> 13,558
<LOANS-PAST> 6,563
<LOANS-TROUBLED> 15,294
<LOANS-PROBLEM> 25,000
<ALLOWANCE-OPEN> 64,436
<CHARGE-OFFS> 2,887
<RECOVERIES> 2,515
<ALLOWANCE-CLOSE> 65,922
<ALLOWANCE-DOMESTIC> 65,922
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
