<PAGE> 1
3/19/97 UNITED STATES DRAFT
3:05 P.M. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1996
[ ] 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
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Commission File Number 0-17137
D & N FINANCIAL CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
Delaware 38-2790646
------------------------------- ---------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
400 Quincy Street, Hancock, Michigan 49930
------------------------------------ -----
(Address of Principal Executive Offices (Zip Code)
Registrant's telephone number, including area code (906) 482-2700
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Securities Registered Pursuant to Section 12(b) of the Act:
None
----
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days.
YES X . NO .
--- ---
Indicate by checkmark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of March 11, 1997, there were issued and outstanding 8,314,654 shares of
the Registrant's Common Stock.
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, computed by reference to the closing price of such stock at
March 11, 1997, was $142,067,000. (The exclusion from such amount of the market
value of the shares owned by any person shall not be deemed an admission by the
Registrant that such person is an affiliate of the Registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
PARTS II and IV of Form 10-K - Annual Report to Stockholders for the Fiscal
Year Ended December 31, 1996.
PART III of Form 10-K - Portions of the Proxy Statement for the Annual
Meeting of Stockholders to be held in 1997.
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<PAGE> 2
PART I
ITEM 1. BUSINESS
D&N Financial Corporation ("D&N" or the "Company") is a financial services
holding company organized under the laws of the state of Delaware. The Company's
principal subsidiary is D&N Bank (the "Bank"), a federally chartered stock
savings bank headquartered in Hancock, Michigan.
The Bank was founded in 1889 and operated as a state-chartered mutual
savings and loan association until February 1984, when it converted to a federal
charter. In 1985, the Bank converted to a stock association, and in 1986,
converted to a federal savings bank. The Bank adopted a holding company
structure in July 1988. With total assets of $1.47 billion at December 31,
1996, D&N is the second largest savings institution headquartered in Michigan.
D&N's primary business consists of attracting deposits from the general
public and making real estate loans, business loans, and consumer loans and
other types of investments. The Company conducts its business through a network
of 37 full-service community banking offices, including its main office in
Hancock, Michigan, seven savings agency offices which provide depository
services and four mortgage banking offices. The Bank's deposits are insured up
to the maximum extent permitted by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is a member of the Federal Home Loan Bank ("FHLB") of
Indianapolis, which is one of the 12 regional banks comprising the FHLB System.
The Bank is subject to supervision by the Office of Thrift Supervision,
Department of the Treasury ("OTS") and by the FDIC.
In December 1993, the Company raised an additional $20.9 million of capital
in a shareholder rights offering and began to implement growth and expansion
strategies. At December 31, 1996, the Bank was in compliance with its
regulatory capital requirements.
The executive office of the Company is located at 400 Quincy Street,
Hancock, Michigan 49930, telephone (906) 482-2700.
Like many financial institutions, the operations of the Company's
subsidiary are materially affected by general economic conditions, the monetary
and fiscal policies of the federal government and the policies of the various
regulatory authorities, including the OTS, the FDIC and the Board of Governors
of the Federal Reserve System (the "Federal Reserve Board"). Its results of
operations are largely dependent upon its net interest income which is the
difference between the interest it receives on its loans and investment
securities, and the interest it pays on its liabilities. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Asset/Liability Management."
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<PAGE> 3
FORWARD LOOKING STATEMENTS
When used in this Form 10-K or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be",
"will allow", "intends to", "will likely result", "are expected to", "will
continue", "is anticipated", "estimate", "project", or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation,
to update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
LENDING ACTIVITIES
GENERAL. The Bank, has concentrated its lending activities on first
mortgage conventional loans secured by residential and commercial real estate
and both installment and revolving consumer and business loans. Approximately
$377.0 million or 54% of the Bank's total loans, excluding loans held for sale,
secured by real estate as of December 31, 1996, permit periodic interest rate
adjustments.
LOAN PORTFOLIO COMPOSITION. The following table sets forth information
concerning the composition of D&N's loan portfolio in dollar amounts and
percentages, by type of loan.
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------- ----------------- ----------------- ---------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
TYPE OF LOAN
REAL ESTATE
One to four family
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Permanent $ 600,923 56.91% $597,892 62.78% $526,572 64.07% $387,252 59.89% $457,196 62.93%
Construction 13,201 1.25 19,982 2.10 2,159 0.26 2,083 0.32 1,289 0.18
Income producing property
Permanent 85,619 8.11 89,176 9.36 115,162 14.01 131,372 20.31 173,122 23.83
Construction 26,472 2.51 21,074 2.21 17,741 2.16 10,475 1.62 933 0.13
--------- ------ ------- ----- -------- ------ -------- ----- -------- ------
Total real estate loans 726,215 68.78 728,124 76.45 661,634 80.50 531,182 82.14 632,540 87.07
CONSUMER LOANS
Automobile loans 141,056 13.36 81,885 8.60 46,711 5.68 34,220 5.29 32,494 4.47
Home equity 82,305 7.79 60,003 6.30 39,939 4.86 23,058 3.57 18,702 2.58
Home improvement 46,545 4.41 41,542 4.36 39,279 4.78 40,017 6.19 46,368 6.38
Mobile home loans 289 0.03 417 0.04 619 0.08 776 0.12 1,170 0.16
Unsecured 15,172 1.4 19,637 2.06 22,197 2.70 20,328 3.14 8,539 1.18
Other 53,901 5.10 35,975 3.78 22,194 2.70 16,245 2.51 12,188 1.68
-------- ------ ---------- ----- -------- ------ -------- ----- ------- ------
Total consumer loans 339,268 32.13 239,459 25.14 170,939 20.80 134,644 20.82 119,461 16.45
COMMERCIAL LOANS
Revolving business loans 2,363 0.22 1,119 0.12 -- -- -- -- -- --
Term business loans 9,982 0.95 6,650 0.70 4,748 0.58
--------- ------ ----- ------ ----- ------ -------- ----- -------- ------
Total commercial loans 12,345 1.17 7,769 0.82 4,748 0.58 -- -- -- --
--------- ------ ------- ------ ------- ------ -------- ----- -------- ------
Loans receivable, gross 1,077,828 102.08 975,352 102.41 837,321 101.88 665,826 102.96 752,001 103.52
Less:
Discounts (premiums)
on loans purchased (2,035) (0.19) (1,709) (0.18) 999 0.12 2,896 0.45 5,448 0.75
Allowance for losses 11,042 1.05 10,081 1.06 8,349 1.02 11,570 1.79 15,611 2.15
Undisbursed portion
of loan proceeds 12,085 1.14 13,198 1.38 4,213 0.51 2,750 0.43 404 0.06
Deferred income 860 0.08 1,423 0.15 1,885 0.23 1,901 0.29 4,037 0.56
---- ------ -------- ------ -------- ------ -------- ------- -------- -------
21,952 2.08 22,993 2.41 5,446 1.88 19,117 2.96 25,500 3.52
Loans receivable, net $1,055,876 100.00% $952,359 100.00% $821,875 100.00% $646,709 100.00% $726,501 100.00%
========== ======= ======== ======= ======== ====== ======== ======= ======== ======
</TABLE>
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<PAGE> 4
LOAN MATURITIES. The following schedule illustrates the maturity
structure of the Company's loan portfolio at December 31, 1996. Loans are shown
as maturing in the period in which payment is due. This schedule does not
reflect the effects of possible prepayments or enforcements of due-on-sale
clauses.
<TABLE>
<CAPTION>
Residential
Commercial and Real Estate
Business Income Producing Construction
Property Property Loans Consumer Loans Total
--------- ---------------- ------------ -------------- -----
Amounts
Due in
Years
Ending Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average Average
December 31, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- ------------- --------- -------- --------- -------- --------- ------- --------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1997 $ 4,046 9.50% $ 23,357 9.22% $ 23,494 9.10% $ 66,178 9.22% $ 117,075 9.21%
1998 2,001 9.39 9,500 9.05 8,686 9.67 66,872 9.14 87,059 9.19
1999 1,516 9.35 16,063 8.68 6,214 9.79 67,238 8.91 91,031 8.94
2000-2001 3,868 9.54 27,587 8.50 49 10.09 115,743 9.02 147,247 8.94
2002-2006 572 9.35 45,483 8.41 32 10.24 18,306 9.67 64,393 8.78
2007-2011 136 9.14 80,881 7.97 1,060 10.01 2,811 8.63 84,888 8.02
Thereafter 123 8.64 480,042 7.69 -- -- 30 9.75 480,195 7.69
-------- --------- ---- --------- ----- ---------- ---- ----------
Total $ 12,262 9.46% $ 682,913 7.90% $ 39,535 9.36% $ 337,178 9.09% $1,071,888 8.35%
======== ========= ========= ==========
Plus:
Accrued interest receivable,
net of reserve for uncollected
interest 5,940
Deferred income and premiums 1,175
Less: 12,085
Loans in process 11,042
Loss and valuation allowances ----------
$1,055,876
==========
</TABLE>
The total amount of loans, excluding loans held for sale, due after
December 31, 1997 which have fixed interest rates is $322.1 million, while the
amount of loans due after such date having floating or adjustable rates is
$627.4 million.
LOAN ORIGINATIONS, PURCHASES AND SALES. Federally chartered savings
institutions, like the Bank, have general authority to make real estate loans
throughout the United States. D&N has originated residential mortgage loans
secured by property both within and outside the State of Michigan. D&N has also
purchased residential mortgage loans secured by property located in various
states. In addition, the Company has originated income producing property loans
secured by real estate located in the State of Michigan and has purchased such
loans secured by property located in Michigan and elsewhere. Since 1990, the
Bank has chosen to focus the activities of its community banking offices on loan
originations in their market areas. At December 31, 1996, 75% of D&N's real
estate loans receivable (excluding government agency insured or guaranteed
mortgage-backed and derivative products) were secured by real estate located in
Michigan.
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<PAGE> 5
The following table presents information regarding the geographic location
of the properties securing D&N's residential mortgage and income producing
property loans at December 31, 1996. See "- Classified Assets, Loan
Delinquencies and Defaults" for a discussion of other real estate owned.
Outstanding Balance
at
December 31, 1996
-------------------
(In thousands)
MICHIGAN
One- to four-family residential . . . . . . . . . . . . . . . . $448,387
Apartments . . . . . . . . . . . . . . . . . . . . . . . . . . 15,554
Mini warehouse, storage . . . . . . . . . . . . . . . . . . . 848
Mobile home parks . . . . . . . . . . . . . . . . . . . . . . . 2,710
Motels/hotels . . . . . . . . . . . . . . . . . . . . . . . . 13,171
Shopping centers and retail . . . . . . . . . . . . . . . . . . 17,455
Office buildings . . . . . . . . . . . . . . . . . . . . . . . 8.317
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . 3,907
Condominiums and land development . . . . . . . . . . . . . . . 16,895
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,569
--------
538,813
CALIFORNIA
One- to four-family residential . . . . . . . . . . . . . . . . 22,222
Apartments . . . . . . . . . . . . . . . . . . . . . . . . . . 6,436
Mobile home parks . . . . . . . . . . . . . . . . . . . . . . . 133
Office buildings . . . . . . . . . . . . . . . . . . . . . . . 3,950
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . 726
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 390
103
--------
33,960
MASSACHUSETTS
One- to four-family residential . . . . . . . . . . . . . . . . 22,385
--------
22,385
NEW YORK
One- to four-family residential . . . . . . . . . . . . . . . . 5,836
Apartments . . . . . . . . . . . . . . . . . . . . . . . . . . 2,037
--------
7,873
NORTH CAROLINA
One- to four-family residential . . . . . . . . . . . . . . . . 4,778
--------
4,778
TEXAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
One- to four-family residential . . . . . . . . . . . . . . . . 8,762
--------
8,762
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<PAGE> 6
Outstanding Balance
at
December 31, 1996
-------------------
(In thousands)
PENNSYLVANIA
One- to four-family residential . . . . . . . . . . . . . . . . 5,508
Apartments . . . . . . . . . . . . . . . . . . . . . . . . . . 336
Office buildings . . . . . . . . . . . . . . . . . . . . . . . 22
Industrial. . . . . . . . . . . . . . . . . . . . . . . . . . . 130
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
-------
6,115
FLORIDA
One- to four-family residential . . . . . . . . . . . . . . . . 4,768
-------
4,768
OTHER (31 STATES)
One- to four-family residential. . . . . . . . . . . . . . . . 82,679
Apartments . . . . . . . . . . . . . . . . . . . . . . . . . . 2,316
Mobile home parks . . . . . . . . . . . . . . . . . . . . . . . 783
Motels/hotels . . . . . . . . . . . . . . . . . . . . . . . . . 368
Shopping centers and retail . . . . . . . . . . . . . . . . . . 2,428
Office buildings . . . . . . . . . . . . . . . . . . . . . . . 76
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . 138
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431
-------
89,219
Rated conventional residential
participation certificates. . . . . . . . . . . . . . . . . . . 5,775
-------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 722,448
Plus:
Accrued interest receivable, net of
reserve for uncollected interest . . . . . . . . . . . . . . 3,767
Deferred income, discounts and
premiums, net . . . . . . . . . . . . . . . . . . . . . . . . 489
Less:
Loans in process . . . . . . . . . . . . . . . . . . . . . . . (12,085)
Loss allowances . . . . . . . . . . . . . . . . . . . . . . . (7,173)
--------
Total $707,446
========
Residential loan originations are attributable to direct marketing efforts
of the Bank and of the Bank's subsidiary, D&N Mortgage Corporation, as well as
to referrals from real estate brokers and builders. Income producing property
loans are originated through the Bank's direct marketing efforts and through
referrals by existing customers. In 1996, total loan originations increased
$111.9 million, or 28% as a result of a significant increase in consumer
lending activity. Consumer loan originations alone increased $76.5 million, or
39%.
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<PAGE> 7
D&N Bank has sold loans and loan participations in the secondary market,
generally without recourse. Loans held for sale are recorded at the lower of
cost or market value. At December 31, 1996, the Bank had $5.3 million of net
loans held for sale consisting of 15 and 30 year fixed rate loans. These sales
have provided additional funds for loan originations and investments and also
generated income. The Bank generally continues, after the sale, to service the
loans and loan participations sold. Loan sales are made on a yield basis with a
portion of the difference between the yield to the purchaser and the amount paid
by the borrower constituting servicing income to D&N. On occasion, the Bank
also purchased mortgage loan servicing rights from others in order to maintain
its loan servicing portfolio economies of scale. During 1994, the Bank decided
to sell the majority of its portfolio of purchased mortgage loan servicing
rights in order to reduce the Bank's interest rate risk and balance sheet
volatility. The scale of loan servicing operations has been reduced as the Bank
concentrates its loan servicing activities on originated loans. The weighted
average servicing fee for loans serviced for others was .29% at December 31,
1996. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Noninterest Income." At December 31, 1996, D&N serviced
for others approximately $415 million in loans and loan participations. See
also Note A of Notes to Consolidated Financial Statements "Summary of
Significant Accounting Policies - Mortgage Servicing Rights".
The Bank's investment in mortgage servicing rights ("MSRs") totaled $1.4
million at December 31, 1996. The following table details the value of the
Bank's investment in MSRs.
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------
1996 1995 1994
------------ -------------- -----------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 1,113 $ 968 $ 9,870
Additions:
Capitalized servicing 630 621 --
Reductions:
Scheduled amortization 267 169 1,315
Additional amortization due to
changes in prepayment assumptions 33 71 421
Impairment -- 234 --
Sales -- -- 7,148
Transfers to loan portfolio under
recourse and other provisions -- 2 18
------- ------- -------
Total 300 476 8,902
------- ------- -------
Balance at end of year $ 1,443 $ 1,113 $ 968
======= ======= =======
Fair market value at end of year $ 1,770 $ 1,161 $ 912
======= ======= =======
</TABLE>
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<PAGE> 8
The following table shows origination, purchase, sale and
repayment activities of D&N Bank, including mortgage-backed securities, for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ----------- ----------- -----------
(In thousands)
<S> <C> <C> <C> <C> <C>
ORIGINATIONS
Real estate:
One- to four-family residential . . $194,357 $182,800 $ 81,279 $ 147,246 $ 121,468
Income producing property . . . . . 33,816 17,614 17,350 13,014 2,711
Non-real estate:
Consumer . . . . . . . . . . . . . 271,622 195,109 132,836 95,129 85,254
Commercial . . . . . . . . . . . . 11,437 3,739 4,748 -- --
-------- -------- -------- --------- ---------
Total originations . . . . . . . . 511,232 399,262 236,213 255,389 209,433
PURCHASES
Real estate:
One- to four-family residential . . . 148,405 103,524 188,481 72,125 5,662
Income producing property . . . . . -- -- 1,852 -- --
Mortgage-backed securities . . . . . 58,892 -- 68,391 108,749 91,453
-------- -------- -------- --------- ---------
Total purchases . . . . . . . . . . 207,297 103,524 258,724 180,874 97,115
-------- -------- -------- --------- ---------
Total additions . . . . . . . . . . 718,529 502,786 494,937 436,263 306,548
SALES
Real estate:
One- to four-family residential . . 68,024 107,080 45,311 106,167 40,610
Mortgage-backed securities(1) . . . -- 4,210 50,658 126,932 110,737
Non-real estate:
Consumer loans . . . . . . . . . . . 2,810 2,976 2,894 2,229 2,934
-------- -------- -------- --------- ---------
Total sales . . . . . . . . . . . 70,834 114,266 98,863 235,328 154,281
Principal repayments . . . . . . . . . 426,291 288,485 239,816 316,624 400,042
-------- -------- -------- --------- ---------
Total reductions . . . . . . . . . 497,125 402,751 338,679 551,952 554,323
Transfers to other real estate owned (3,373) (1,936) (2,861) (9,380) (6,259)
Increase (decrease) in other items,
net 9,033 8,801 1,079 (19,622) 4,477
-------- -------- -------- --------- ---------
Net increase (decrease) . . . . . $227,064 $106,900 $154,476 $(144,691) $(249,557)
======== ======== ======== ========= =========
</TABLE>
(1) Includes sales of CMO residuals which were carried at the lower of cost or
market.
Outstanding loan commitments of the Bank at December 31, 1996 amounted
to $36.7 million for one- to four-family residential real estate loans and
$32.7 million for commercial real estate loans. See "Regulation - Federal
Savings Association Regulation."
RESIDENTIAL MORTGAGE LOANS. At December 31, 1996, the Bank had $614.1
million in residential mortgage loans representing 58.2% of the Bank's total
loan portfolio. This amount represents a slight increase in the dollar value of
the residential loan portfolio. However, it also represents a decrease in the
percentage of the Bank's portfolio consisting of real estate loans as the Bank
shifted its focus to emphasize the origination of consumer loans. The original
contractual loan payment period for residential loans originated by D&N Bank
normally ranges from 15 to 30 years. Because borrowers may refinance or prepay
their loans, however, such loans often remain outstanding for a substantially
shorter period of time.
Prior to 1992, most of the Bank's residential mortgage loans were
originated by its mortgage banking subsidiary. The mortgage banking subsidiary
originated loans in southeastern Michigan, Illinois, Arizona, Texas and North
Carolina. The Bank now originates loans primarily in its Michigan
- 8 -
<PAGE> 9
market area through its community banking and mortgage banking offices.
Substantially all of the residential loans being originated by the Bank are in
a form which permits their sale in the secondary market.
The Bank's first mortgages customarily include "due-on-sale" clauses, which
are provisions giving the Bank the right to declare a loan immediately due and
payable in the event, among other things, that the borrower sells or otherwise
disposes of the real property subject to the mortgage and the loan is not
repaid. In general, the Bank enforces due-on-sale clauses in its first
mortgages.
In the case of conventional mortgage loans intended for sale, the Bank's
policy is to lend a maximum of 95% of the appraised value of single-family
residences. The Bank generally does not lend more than 90% of the appraised
value of the property on those loans it intends to hold. Private mortgage
insurance is required if the loan amount exceeds 80% of the appraised value, in
an amount sufficient to reduce the Bank's exposure to 75% or less of the
appraised value of the property. Property securing real estate loans made by
the Bank is appraised by independent appraisers selected by the Bank and whose
appraisals are reviewed by D&N personnel or other independent appraisers.
Loans up to the maximum limits for single family homes of the Federal Home
Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage
Association ("FNMA") (currently $214,600) may be approved by qualified loan
officers of the Bank. The Bank's Residential Loan Committee has single-family
lending authority up to $500,000, if two members approve. Loans in excess of
$500,000 must be approved by the Bank's Loan Committee (comprised of Messrs.
Butvilas, Donnelly, Janson, West and Sliwinski). Loans in excess of $2 million
must also be approved by the Bank's Board of Directors.
Title, fire and casualty insurance as well as surveys are generally
required on all mortgage loans.
D&N Bank also offers a variety of Adjustable Rate Mortgages, ("ARM") loans
which offer adjustable rates of interest, payments, loan balances or terms to
maturity which vary according to specified indices. The Bank's ARMs generally
have a loan term of 30 years with rate adjustments every year or every three
years during the term of the loan. ARMs currently originated by the Bank
contain a 2% limit as to the maximum amount of change in the interest rate at
any adjustment period and a 6% limit over the life of the loan. The Bank
generally originates ARMs to hold in its portfolio. At December 31, 1996,
residential ARMs totaled $290 million, or 49% of the Bank's total residential
one- to four-family mortgage loan portfolio. Of this total ARM portfolio, $153
million or 53% were purchased from others. Due to consumer demand, residential
loans originated during 1996 were predominately fixed rate loans.
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<PAGE> 10
Despite the benefits of ARMs to the Bank's asset/liability management
program, such loans also pose potential additional risks, primarily because as
interest rates rise, the underlying payment by the borrower rises, increasing
the potential for default. At the same time, marketability of the underlying
property may be adversely affected by higher interest rates.
MORTGAGE-BACKED SECURITIES. The Bank on occasion purchases
mortgage-backed securities to supplement residential loan production. The
types of securities purchased are based upon the Bank's asset/liability
management strategy and balance sheet objectives. In 1996, the Company
purchased $58.7 million of fixed rate Collateralized Mortgage Obligations
("CMO") with expected average lives of 2.1 to 3.3 years. CMOs are securities
derived by reallocating cash flows from mortgage pass-through securities or
pools of mortgage loans held by a trust. The CMO securities purchased by the
Bank in 1996 are backed by pass-through securities of either FHLMC, FNMA or
Government National Mortgage Association ("GNMA").
The Bank has in the past invested in interest only strip securities ("IOs")
and principal only strip securities ("POs") as part of its asset/liability
management strategy. At December 31, 1996, D&N had IOs with a book value and a
market value of $2.0 million, and had no POs at that date.
The following table sets forth information concerning the composition of
D&N's mortgage-backed securities portfolio in dollar amounts and percentages, by
type of security. See also Note E of Notes to Consolidated Financial
Statements.
<TABLE>
<CAPTION>
December 31
----------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED 1996 1995 1994 1993 1992
SECURITIES ---- ---- ---- ---- ----
--------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
---------------- --------------- --------------- --------------- ---------------
(Dollars In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
TYPE OF SECURITY
One- to four-family:
Mortgage-backed
securities. . . . . $249,186 99.18% $125,264 98.09% $147,988 97.81% $166,284 96.69% $212,652 88.23%
Interest only
certificates. . . . 2,070 0.82 2,456 1.92 3,886 2.57 4,321 2.51 27,075 11.23
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Mortgage-backed
securities, gross. . 251,256 100.00 127,720 100.01 151,874 100.38 170,605 99.20 239,727 99.46
Net (discounts)
premiums. . . . . . . -- -- (11) (0.01) (581) (0.38) 1,378 0.80 1,313 0.54
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Mortgage-backed
securities, net. . . . . $251,256 100.00% $127,709 100.00% $151,293 100.00% $171,983 100.00% $241,040 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
-10-
<PAGE> 11
INCOME PRODUCING PROPERTY LOANS. The Bank has historically originated and
purchased both permanent and, to a substantially lesser extent, construction
loans secured by income producing property and land development loans.
Essentially all permanent income producing property loans originated by the Bank
to date have been secured by real property located in Michigan.
To a substantially lesser extent, the Bank has also purchased income
producing property loans and participation interests in these loans outside of
Michigan. These loans may be in the form of mortgage-backed securities, may
have fixed or variable interest rates and most have been outstanding for three
to twelve years. At December 31, 1996, $24.0 million of D&N's portfolio of
income producing property loans were purchased loans.
During 1990, the Bank ceased all origination and purchase activity
involving income producing and land development loans. Although the Bank was
not originating new loans until 1993, it provided financing to facilitate the
sale of real estate it had acquired through foreclosure or in settlement of
loans. Some of this property has been in a distressed condition and has been
difficult to market. To facilitate a sale, the Bank has, from time to time,
provided financing at rates and terms which have not been reflective of true
market conditions. When this has occured, the Bank reduced the carrying value
of the below market loan by discounting the expected cash flows to a present
value using a market rate of interest. Since 1993, the Bank has resumed
originating income producing property loans secured by real estate.
The following table shows the composition of the Bank's income producing
property and land development loans at December 31, 1996. See "Non-Performing
Assets and Risk Elements."
<TABLE>
<CAPTION>
Amount Non-
Loans Percentage Performing or
Outstanding of Total of Concern
----------- ---------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Apartments and multi-family residences $ 25,574 25.91% $168
Other income producing property:
Motels/hotels 13,630 13.81 --
Offices 6,711 6.80 69
Mobile home parks 3,649 3.70 --
Shopping centers 23,740 24.05 2,487
Industrial 4,595 4.66 --
Other 7,651 7.75 --
------- ------ --------
Total 85,550 86.68 2,724
Land development loans and other 26,541 26.89 --
------- ------ --------
Total 112,091 113.57 $ 2,724
Allowance for losses (6,314) (6.40) ========
Loans in process, deferred income and
other miscellaneous credits (7,074) (7.17)
------- ------
Total $98,703 100.00%
======= ======
</TABLE>
- 11 -
<PAGE> 12
CONSUMER LENDING. Federal regulations permit federal savings institutions
to make secured and unsecured consumer loans, together with investments in
commercial paper and corporate debt securities, in an amount up to 35% of the
institution's assets. In addition, a federal savings institution has lending
authority above the 35% category for certain consumer loans, such as home equity
loans, property improvement loans, mobile home loans and deposit account secured
loans.
Consumer loans originated by the Bank are offered at fixed and adjustable
rates of interest. The underwriting standards employed by the Bank for consumer
loans include a determination of the applicant's payment history on other debts
and an assessment of ability to meet existing obligations and payments on the
proposed loan. The stability of the applicant's monthly income may be
determined by verification of gross monthly income from primary employment, and
additionally from any verifiable secondary income. Although creditworthiness of
the applicant is of primary consideration, the underwriting process also
includes a comparison of the value of the security, if any, in relation to the
proposed loan amount.
The Bank has established programs to originate consumer loans including
automobile loans, home improvement loans, home equity loans, student loans under
various guaranteed student loan programs, loans to depositors secured by pledges
of their deposit accounts and unsecured loans. Although consumer loans involve a
higher level of risk than one- to four-family residential mortgage loans, they
generally carry higher yields and have shorter terms to maturity. The Bank has
increased its origination of consumer loans during the past several years, and
is continuing to emphasize these types of loans. At December 31, 1996, consumer
loans totaled $339.3 million or 32% of the Bank's loan portfolio, an increase
of $99.8 million, or 42% from December 31, 1995.
During 1996, net consumer loan charge-offs were $926,000 compared to
$642,000 in 1995, $411,000 in 1994, $354,000 in 1993 and $744,000 in 1992.
Indirect loan originations totaled $115.5 million in 1996. Indirect
receivables amounted to $141.4 million at December 31, 1996 and make up 42% of
the consumer loan portfolio. Indirect loans are underwritten according to the
same guidelines as direct loans, and the maximum dollar exposure to any one
dealer is typically limited to $5 million.
Home equity loans and home equity credit lines are extended at fixed or
variable rates of interest and normally do not exceed 75% of the property's
appraised value less the amount owing, if any, on a first mortgage. Home equity
loans are repaid according to fixed monthly payments over a maximum term of ten
years. Home equity credit lines require a monthly interest and principal
payment based upon the outstanding balance. Home equity credit lines generally
have five-year terms at which time the Bank may require
- 12 -
<PAGE> 13
payment in full or renew the loan for another five-year term. Amounts repaid
are available for subsequent borrowing, subject to satisfactory loan
performance.
Home improvement loans are generally treated as home equity loans with a
first or second mortgage lien securing the loan. A small number of home
improvement loans are written as unsecured loans.
The Bank has increased its emphasis in recent years on unsecured loans.
These loans are underwritten according to strict guidelines, and loan officers
generally have lower approval limits for unsecured loans than for secured loans.
D&N Bank is subject to various state and federal limitations on the maximum
rates of interest it may charge on consumer and certain other loans. These
limitations have not had a significant effect on D&N's consumer loan activities.
LOANS TO ONE BORROWER
Under federal law, the aggregate amount of loans that the Bank is permitted
to make to any one borrower is generally limited to 15% of unimpaired capital
and surplus. At December 31, 1996, the Bank's loans to one borrower limit was
approximately $13.3 million. See "Regulation - Federal Savings Association
Regulation". At December 31, 1996, the Bank had no loans to one borrower in
excess of its lending limit.
CLASSIFIED ASSETS, LOAN DELINQUENCIES AND DEFAULTS
The Bank's collection procedures provide that when a residential mortgage
loan is 15 days past due, the borrower is contacted by mail and payment is
requested. For loans secured by income producing property, the borrower is
contacted by telephone when the loan is 15 days past due. If the delinquency
continues, subsequent efforts are made by telephone and mail to contact the
delinquent borrower. In certain instances, the Bank may modify the loan or
grant a limited moratorium on loan payments to enable the borrower to reorganize
his financial affairs. If the loan continues in a delinquent status for 90 days
or more, the Bank generally initiates foreclosure proceedings.
The process of non-judicial foreclosure in Michigan takes approximately six
weeks. A sheriff's sale is then held at which the Bank normally bids for the
purchase of the property. A conditional sheriff's deed is then awarded to the
highest bidder, usually the Bank, and the customer is given six months (or in
certain circumstances, one year) to redeem the conditional deed by repaying the
bid amount in full. During this redemption period, the borrower may occupy and
use the property as he sees fit. If he fails to redeem the sheriff's
- 13 -
<PAGE> 14
deed, then the Bank acquires clear title to the real estate and subsequently
sells it to recover its investment. In most cases, it is not economical to
obtain a deficiency judgment against the borrower if residential property is
sold for less than the unpaid balance of the loan.
The following table sets forth information concerning delinquent mortgage
and other loans at December 31, 1996. The amounts presented represent the total
remaining principal balances of the related loans (before reserves for losses),
rather than the actual payment amounts which are overdue. Real Estate
<TABLE>
<CAPTION>
Income Producing
Commercial Residential Property Consumer
--------------- --------------- ------------------ -----------------
Number Amount Number Amount Number Amount Number Amount
------ ------ ------ ------ ------ -------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans delinquent for:
30 - 59 days -- $ -- 128 $4,289 2 $ 1,116 517 $ 2,896
60 - 89 days 1 96 34 1,410 1 109 195 864
90 days and over -- -- 58 3,047 5 2,724 145 658
------ ------- --- ------ --- ------- --- -------
Total delinquent loans 1 $ 96 220 $8,746 8 $ 3,949 857 $ 4,418
====== ======= === ====== === ======= === =======
</TABLE>
Federal regulations provide for the classification of loans and other
assets such as debt and equity securities considered to be of lesser credit
quality as "substandard," "doubtful" or "loss" assets. The regulation requires
insured institutions to classify their own assets and to establish prudent
general allowances for loan losses for assets classified "substandard" or
"doubtful." For the portion of assets classified as "loss", an institution is
required to either establish specific allowances for loan losses for assets of
100% of the amount classified or charge off such amount. In addition, the
OTS may require the establishment of a general allowance for losses based on
assets classified as "substandard" and "doubtful" or based on the general credit
quality of the asset portfolio of an institution. At December 31, 1996, $10.4
million of the Bank's assets were classified as "substandard", $37,000 of such
assets were classified as "doubtful" and $385,000 were classified as "loss".
The Bank's classification of assets is consistent with OTS examination
classifications.
Hotels and motels account for $3.3 million of classified assets and
apartments account for $4.3 million. The balance of classified assets consists
of loans and real estate owned of various income producing properties, land,
residential real estate and consumer loans. Classified assets amounting to $3.7
million, or 16% of total classified assets, are secured by real estate located
in the state of California.
- 14 -
<PAGE> 15
NONPERFORMING ASSETS AND RISK ELEMENTS
Nonperforming assets, including other real estate owned, decreased to
$8.1 million at December 31, 1996 compared to $9.7 million at December 31,
1995. The ratio of nonperforming assets to total assets was 0.55% at December
31, 1996 compared to 0.79% at December 31, 1995. Allowances for losses
represented 136% of nonperforming assets at December 31, 1996.
Loans are placed on nonaccrual status when the collection of principal
and/or interest becomes doubtful. In addition, residential mortgage loans and
income producing property loans are placed on nonaccrual status when the loan
becomes 90 days or more contractually delinquent. All consumer loans more than
90 days delinquent are charged against the consumer loan allowance for loan
losses. For 1996, the Bank would have recorded interest income of $558,000 if
nonaccrual and restructured loans had performed in accordance with their
original terms. The Bank recognized $6,000 of interest income on these loans
in 1996. During 1996 and 1995, the amount of interest income on impaired loans
was insignificant.
The following table sets forth the
amounts and categories of risk elements in Bank's loan portfolio:
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonaccruing loans $ 6,621 $ 8,225 $ 17,995 $ 30,102 $ 44,703
Accruing loans delinquent
more than 90 days -- 24 5 13 --
Restructured loans -- -- -- 166 167
-------- -------- -------- -------- --------
Total nonperforming loans 6,621 8,249 18,000 30,281 44,870
Other real estate owned (OREO) 1,470 1,452 6,520 13,312 11,186
-------- -------- -------- -------- --------
Total nonperforming assets $ 8,091 $ 9,701 $ 24,520 $ 43,593 $ 56,056
======== ======== ======== ======== ========
Nonperforming loans as a
percentage of total loans 0.62% 0.86% 2.17% 4.60% 6.05%
======== ======== ======== ======== ========
Nonperforming assets as a
percentage of total assets 0.55% 0.79% 2.17% 4.04% 4.47%
======== ======== ======== ======== ========
Allowance for loan losses as a
percentage of nonperforming loans 166.77% 122.21% 46.38% 38.21% 34.79%
======== ======== ======== ======== ========
Allowances for loan and OREO losses
as a percentage of
nonperforming assets 136.47% 105.29% 35.40% 28.03% 30.08%
======== ======== ======== ======== ========
</TABLE>
- 15 -
<PAGE> 16
OTHER REAL ESTATE OWNED
Other real estate owned, net of reserves, totaled $1.5 million at
December 31, 1996, compared with $1.3 million at December 31, 1995. Other real
estate owned consisted of single family homes, multi-family dwelling units and
commercial real estate. At foreclosure, real estate is recorded at estimated
fair value less disposal costs. Any difference between estimated fair value
and the loan balance is charged to the allowance for loan losses.
The largest asset in other real estate owned is a auto retail center
located in Michigan. This asset has a carrying value of $743,000 at December
31, 1996.
OTHER LOANS OF CONCERN
In addition to nonperforming assets, the Bank has other loans of
concern aggregating $15.9 million. These are loans which are currently
performing but which demonstrate a specific weakness or weaknesses which, if
not corrected, could cause failure of the borrower and default. These loans
are closely monitored by management, and as the weaknesses are corrected, may
be reclassified as acceptable loans.
Included in other loans of concern at December 31, 1996, are three
income producing property loans totaling $4.7 million that have all paid as
agreed but, for various reasons, indicate potential payment concerns.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established at levels considered
appropriate based on management's judgment of potential losses in residential,
income producing and consumer loan portfolios. The loan portfolios are
reviewed at least quarterly for changes in performance, collateral value and
overall quality. Allocated allowances are established for problem loans with
expected losses, and in addition, allowances are established for unidentified
potential losses. Regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses. Such
agencies may require the Bank to recognize additions to the allowance based
upon their judgment of the information available to them at the time of their
examination. A $1.1 million provision for potential loan losses was made in
1996, compared to $2.4 million in 1995 and $100,000 in 1994. Management's
judgment in determining the level of the allowance for loan losses is
influenced by several factors during the quarterly reviews. These factors
include, but are not limited to, past loan performance and loss experience,
current economic and market conditions, collateral location and market values,
industry and geographic
- 16 -
<PAGE> 17
concentrations and delinquency statistics and ratios. Management also
considers the different levels of risk between income producing property loans,
installment loans and one- to four-family residential loans. In addition,
management considers the level of nonperforming assets and classified assets,
the level of lending activity and the overall size of the loan portfolio.
Income-producing property charge-offs were primarily due to writedowns of
loans to estimated fair value. Consumer loan charge-offs increased somewhat,
but charge-off ratios decreased as the consumer loan portfolio grew at a
faster rate. See "Lending Activities" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
The following table sets forth an analysis of the Bank's allowance for
loan losses:
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year . . . . . . . . . . . . . $10,081 $ 8,349 $ 11,570 $ 15,611 $ 18,744
Charge-offs:
Residential mortgages . . . . . . . . . . . . . . . . 314 169 110 1,136 329
Mortgages on income producing property . . . . . . . -- 1,019 3,109 2 ,584 2,180
Consumer loans . . . . . . . . . . . . . . . . . . . 1,216 999 773 681 1,000
-----------------------------------------------------------------------
1,530 2,187 3,992 4,401 3,509
Recoveries:
Residential mortgages. . . . . . . . . . . . . . . . 3 917 9 25 --
Mortgages on income producing property . . . . . . . 1,098 245 300 8 3
Consumer loans . . . . . . . . . . . . . . . . . . . 290 357 362 327 256
-----------------------------------------------------------------------
1,391 1,519 671 360 259
Net charge-offs . . . . . . . . . . . . . . . . . . . 139 668 3,321 4,041 3,250
Provision charged to operations . . . . . . . . . . . 1,100 2,400 100 -- 117
Balance at end of year . . . . . . . . . . . . . . . . $11,042 $ 10,081 $ 8,349 $ 11,570 $ 15,611
=======================================================================
Net charge-offs as a percentage
of average loans . . . . . . . . . . . . . . . . . . 0.01% 0.07% 0.43% 0.59% 0.42%
=======================================================================
Allowance for loan losses as a
percentage of total loans . . . . . . . . . . . . . 1.03% 1.05% 1.01% 1.76% 2.10%
=======================================================================
</TABLE>
- 17 -
<PAGE> 18
The following table summarizes the allocation of the allowance for
loan losses by major categories at the dates indicated:
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
Amount to Total Amount to Total Amount to Total Amount to Total Amount to Total
---------- ----------- --------- ------------- -------- ---------- ------- --------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential mortgages $ 859 57% $ 1,170 63% $ 813 63% $ 429 60% $ 380 63%
Mortgages on income
producing property 6,314 10 6,115 11 6,423 17 9,617 19 13,353 21
Commercial loans 400 1 400 1 -- -- -- -- -- --
Consumer loans 3,469 32 2,396 25 1,113 20 1,524 21 1,878 16
---------------------------------------------------------------------------------------------------------
Total $11,042 100% $10,081 100% $8,349 100% $11,570 100% $15,611 100%
=========================================================================================================
</TABLE>
INVESTMENT ACTIVITIES
Federal savings institutions have authority to invest in various types
of liquid assets, including U.S. Treasury obligations and securities of various
federal agencies, certificates of deposit at insured banks, bankers'
acceptances and federal funds. Federal savings institutions are also permitted
to invest in any account at a federally insured institution.
Federal savings institutions may also invest a portion of their assets
in certain commercial paper and corporate debt securities. They are also
authorized to invest in mutual funds whose assets conform to the type of
investment that a federal savings institution is authorized to make directly.
There are various restrictions on the foregoing investments. For example, the
commercial paper must be appropriately rated by at least two national
investment rating services and the corporate debt securities must be
appropriately rated in one of the two highest rating categories by at least one
such service. In addition, the commercial paper must mature within nine months
of issuance. Moreover, a federal savings institution's total investment in the
commercial paper and corporate debt securities of any one issuer may not exceed
the loans to one borrower limitation applicable to the savings institution,
except that a federal savings institution may invest up to 5% of its assets in
the shares of any appropriate mutual fund. At December 31, 1996, the Bank was
in compliance with all such requirements.
The Bank has invested in various securities which are acquired in the
capital markets. These investments consist of loans, mortgage-backed
securities, corporate debt securities and derivative mortgage instruments.
Investments were funded with advances from the FHLB and short-term borrowings,
primarily in the form of reverse repurchase agreements, and retail deposits.
Various combinations of techniques and instruments, including interest rate
exchange agreements, interest rate caps, interest rate floors, collateralized
mortgage obligation residuals, interest only stripped mortgage-
- 18 -
<PAGE> 19
backed securities and principal only stripped mortgage-backed securities, have
been used in an attempt to provide adequate and relatively stable returns over
a variety of interest rate environments. The investments and financings are
structured based upon forecasts of mortgage loan repayments for loans and
mortgage-backed securities. If mortgage loan repayments differ significantly
from the level upon which the investment was made, the interest rate spread and
market value may be reduced.
As a member of the FHLB System, the Bank must maintain minimum levels of
liquid assets specified by federal regulations which vary from time to time. See
"Regulation -- Federal Home Loan Bank System." Liquidity may increase or
decrease depending upon the availability of funds and comparative yields on
investments in relation to return on loans.
Historically, the Bank has maintained liquid assets above the minimum
requirements imposed by federal regulations and at a level believed adequate to
meet requirements of normal daily activities, repayment of maturing debt and
potential deposit outflows. Cash flow is regularly reviewed and updated to
maintain adequate liquidity. For the month of December 1996, the Bank's average
liquidity ratio (liquid assets as a percentage of net withdrawable deposits and
current borrowings) was 6.6%, which was in excess of regulatory requirements.
The following table sets forth information concerning the Bank's investment
securities at the dates indicated. See also Note D of Notes to Consolidated
Financial Statements for additional information regarding the contractual
maturities and weighted average yields of the Bank's investment securities.
<TABLE>
<CAPTION>
December 31
------------------------------------------------------------------
1996 1995 1994
------------------------------------------------------------------
Book Market Book Market Book Market
Value Value Value Value Value Value
------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and government
agencies and corporations . . . . . . . . . $ 40,757 $ 40,801 $35,100 $35,229 $ 7,819 $ 7,819
U.S. Treasury available for sale . . . . . . . 57,996 58,000 40,656 40,899 61,979 61,536
Valuation allowance . . . . . . . . . . . . 4 -- 244 -- (443) --
-----------------------------------------------------------------
98,757 98,801 76,000 76,128 69,355 69,355
Investment in Federal Home Loan
Bank stock . . . . . . . . . . . . . . . . . . 19,959 19,959 19,953 19,953 19,937 19,937
Other equity securities . . . . . . . . . . . . 23 23 186 186 85 85
Other equity securities available
for sale . . . . . . . . . . . . . . . . . . . . 1,032 1,038 110 298 14 14
Valuation allowance . . . . . . . . . . . . 6 -- 187 -- -- --
-----------------------------------------------------------------
$119,777 $119,821 $ 96,436 $96,565 $89,391 $89,391
=================================================================
</TABLE>
- 19 -
<PAGE> 20
The book value and market value of investment securities at December 31,
1996, by maturity ranges, were as follows:
<TABLE>
<CAPTION>
Weighted
Market Average
Book Value Value Yield
----------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
U. S. Treasury and government agencies
and corporate securities maturing:
In one year or less . . . . . . . . . . . . . . . . . . . . . . . $ 74,121 $ 74,124 5.71%
After one year through five years . . . . . . . . . . . . . . . . 24,632 24,677 6.07
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . 4 -- --
----------------------------------------
98,757 98,801 5.80
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . 21,014 21,020 7.72
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . 6 -- --
-----------------------------------------
$ 119,777 $ 119,821 6.14%
========================================
</TABLE>
SOURCE OF FUNDS
GENERAL. Deposits are an important source of the Bank's funds for use
in lending and for other general business purposes. In addition to deposits,
the Bank derives funds from loan repayments, advances from the FHLB of
Indianapolis and other borrowings, and at times has derived funds from reverse
repurchase agreements and loan and securities sales. Scheduled loan repayments
are a relatively stable source of funds, while loan prepayments and deposit
inflows and outflows are significantly influenced by general interest rates and
money market conditions. Borrowings may be used to compensate for reductions
in normal sources of funds, such as deposit inflows at less than projected
levels or deposit outflows, or to support expanded activities. Historically,
the Bank has borrowed primarily from the FHLB of Indianapolis, through
institutional reverse repurchase agreements and, to a lesser extent, from other
sources.
DEPOSIT ACTIVITIES. The Bank attracts both short-term and long- term
deposits from the general public by offering a wide assortment of accounts and
rates. In recent years, market conditions have required the Company to rely
increasingly on short-term accounts that are more responsive to market interest
rates. The Bank offers regular savings accounts, checking accounts, various
money market accounts, fixed interest rate certificates with varying
maturities, negotiated rate certificates of deposit of $100,000 or above
("Jumbo CDS") and individual retirement accounts.
The composition of the Bank's deposits at the end of recent periods is
set forth in Note I of Notes to Consolidated Financial Statements. At December
31, 1996, the Company had no brokered deposits. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." In addition,
the Bank believes that, based on its experience over the past five years, its
savings accounts are stable sources of deposits.
- 20 -
<PAGE> 21
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------------------
1996 1995 1994
-----------------------------------------------------------------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
----------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Regular Accounts:
Savings accounts,
1.75% - 5.07% . . . . . . . . . . . $149,226 15.48% $149,728 16.22% $130,297 15.93%
Checking and NOW accounts,
0.00% - 1.50% . . . . . . . . . . . 107,550 11.16 91,621 9.93 91,484 11.19
Money market accounts,
variable . . . . . . . . . . . . . . 89,321 9.26 86,080 9.33 95,573 11.69
-------------------------------------------------------------------------
Total regular accounts . . . . 346,097 35.90 327,429 35.48 317,354 38.81
Certificates:
0.00 - 2.99% . . . . . . . . . . . . 9,864 1.02 6,218 0.67 15,697 1.92
3.00 - 4.99% . . . . . . . . . . . . 74,620 7.74 67,887 7.36 264,075 32.30
5.00 - 6.99% . . . . . . . . . . . . 476,651 49.44 443,782 48.08 150,810 18.44
7.00 - 8.99% . . . . . . . . . . . . 52,073 5.40 59,847 6.48 51,327 6.28
9.00 - 10.99% . . . . . . . . . . . 3,894 0.40 16,310 1.77 16,671 2.04
11.00 - 12.99% . . . . . . . . . . . -- -- -- -- 450 0.05
-------------------------------------------------------------------------
Total certificates . . . . . . . . 617,102 64.00 594,044 64.36 499,030 61.03
Accrued interest . . . . . . . . . . . . 934 0.10 1,459 0.16 1,290 0.16
-------------------------------------------------------------------------
Total deposits . . . . . . . . . $964,133 100.00% $922,932 100.00% $817,674 100.00%
=========================================================================
</TABLE>
The variety of deposit accounts offered by the Bank has allowed it to
be competitive in obtaining funds and has allowed it to respond with
flexibility (by paying rates of interest more closely approximating market
rates of interest) to, although not eliminate the threat of, disintermediation
(the flow of funds away from depository institutions such as savings
institutions into direct investment vehicles such as government and corporate
securities). In addition, the Bank has become much more subject to short-term
fluctuations in deposit flows. The ability of the Bank to attract and maintain
deposits, and its cost of funds, have been, and will continue to be,
significantly affected by money market conditions.
The following table sets forth the deposit flows at D&N Bank during
the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------
1996 1995 1994
-------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Opening balance . . . . . . . . . . . $ 922,932 $ 817,674 $ 844,012
Deposits. . . . . . . . . . . . . . . 2,425,493 1,992,613 1,741,646
Withdrawals . . . . . . . . . . . . . (2,422,882) (1,922,325) (1,794,778)
Interest credited . . . . . . . . . . 39,115 34,801 27,579
Accrued interest . . . . . . . . . . (525) 169 (785)
----------- ----------- -----------
Ending balance . . . . . . . . . . . $ 964,133 $ 22,932 $ 817,674
=========== =========== ===========
</TABLE>
- 21 -
<PAGE> 22
The following table sets forth the change in dollar amount of deposits in
the various types of deposit programs offered by the Bank for the periods
indicated.
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------
1996 1995 1994
------------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Savings accounts . . . . . . . . . . . . . . . . . . . . $ (502) $ 19,431 $ (10,022)
Checking and NOW accounts . . . . . . . . . . . . . . . 15,929 137 (640)
Money market accounts . . . . . . . . . . . . . . . . . 3,241 (9,493) (20,754)
Certificates with maturities:
7 to 91 days . . . . . . . . . . . . . . . . . . . . . 8,319 (2,162) (2,120)
92 days to 6 months . . . . . . . . . . . . . . . . . 1,133 12,448 (32,418)
6 months to 1 year . . . . . . . . . . . . . . . . . . 33,200 21,925 (10,708)
1 year to 1 1/2 years . . . . . . . . . . . . . . . . 16,156 15,004 6,858
1 1/2 years to 3 years . . . . . . . . . . . . . . . . (15,179) 34,840 44,249
3 years to 10 years . . . . . . . . . . . . . . . . . (26,232) 7,655 (2,432)
Negotiable rate certificates . . . . . . . . . . . . . . 5,661 5,304 2,434
---------- --------- ---------
Increase (decrease) . . . . . . . . . . . . . . . . . . 41,726 105,089 (25,553)
Change in accrued interest . . . . . . . . . . . . . . . (525) 169 (785)
---------- --------- ---------
Total increase (decrease) . . . . . . . . . . . . . . . $ 41,201 $ 105,258 $ (26,338)
========== ========= =========
</TABLE>
The following table shows rate and maturity information for the Bank's deposits
as of December 31, 1996.
<TABLE>
<CAPTION>
Interest Rate Range -- Certificates
0.00 3.00 5.00 7.00 9.00
Percent to to to to to
Amount of Total 2.99% 4.99% 6.99% 8.99% 10.99%
--------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Savings accounts . . . . . . . . . $149,226 15.48% $ -- $ -- $ -- $ -- $ --
Checking and NOW accounts . . . . . 107,550 11.16 -- -- -- -- --
Money market accounts . . . . . . . 89,321 9.26 -- -- -- -- --
-------------------------------------------------------------------------
346,097 35.90 -- -- -- -- --
Certificate accounts
maturing in quarter ending:
03/31/97 . . . . . . . . . . . . . 136,674 14.17 3,324 37,974 84,136 11,234 6
06/30/97 . . . . . . . . . . . . . 117,589 12.19 2,358 16,141 93,583 5,420 87
09/30/97 . . . . . . . . . . . . . 61,958 6.42 1,536 8,369 51,149 904 --
12/31/97 . . . . . . . . . . . . . 76,529 7.93 984 3,370 70,858 1,246 71
03/31/98 . . . . . . . . . . . . . 43,264 4.49 623 1,910 35,039 5,596 96
06/30/98 . . . . . . . . . . . . . 50,587 5.25 553 1,722 41,753 6,444 115
09/30/98 . . . . . . . . . . . . . 43,338 4.50 153 1,447 38,513 3,115 110
12/31/98 . . . . . . . . . . . . . 21,935 2.28 31 999 17,019 3,684 202
03/31/99 . . . . . . . . . . . . . 11,524 1.20 66 1,016 5,077 3,700 1,665
06/30/99 . . . . . . . . . . . . . 8,658 0.90 101 520 3,652 2,933 1,452
09/30/99 . . . . . . . . . . . . . 2,693 0.28 -- 346 1,857 400 90
12/31/99 . . . . . . . . . . . . . 3,020 0.31 60 150 2 ,537 273 --
Maturity over 3 years . . . . . . 39,333 4.08 75 656 31,478 7,124 --
--------------- -----------------------------------------------------
Total . . . . . . . . . . . . . . $617,102 64.00 $ 9,864 $74,620 $476,651 $52,073 $3,894
=====================================================
Interest accrued . . . . . . . . . 934 0.10
---------------
Total deposits . . . . . . . . . $964,133 100.00%
===============
</TABLE>
- 22 -
<PAGE> 23
The following table shows the scheduled maturities of certificates of
deposit of $100,000 or greater as of December 31, 1996.
<TABLE>
<CAPTION>
December 31, 1996
-----------------
(In thousands)
<S> <C>
Certificates with maturities:
Three months or less . . . . . . . . $ 30,059
Over three through six months . . . 13,868
Over six through twelve months . . . 17,291
Over twelve months . . . . . . . . . 17,892
--------
Total . . . . . . . . . . . . . $ 79,110
========
</TABLE>
BORROWINGS. The FHLB of Indianapolis functions as a central reserve bank,
providing credit for savings institutions within its assigned region. As a
member of the FHLB of Indianapolis, D&N Bank is required to own capital stock in
the FHLB of Indianapolis and is authorized to apply for advances on the security
of such stock and certain of its residential mortgage loans and other assets
(principally, securities which are obligations of, or guaranteed by, the United
States) provided certain standards related to creditworthiness have been met.
See "Regulation -- Federal Home Loan Bank System." FHLB advances are made
pursuant to several different credit programs. Each credit program has its own
interest rate and range of maturities. The FHLB of Indianapolis prescribes the
acceptable uses to which the advances pursuant to each program may be made as
well as limitations on the size of advances. Depending on the program
limitations, the amount of advances are generally based on the FHLB of
Indianapolis' assessment of the institution's creditworthiness. The FHLB of
Indianapolis is required to review its credit limitations and standards at least
once every six months. The Bank utilizes borrowings, in part, to fund
increases in loan demand.
The Bank has entered into reverse repurchase agreements with major
investment bankers utilizing government securities or various mortgage
instruments as collateral. These reverse repurchase agreements are generally
utilized in connection with the Bank's investments. See "Investment Activities"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations".
- 23 -
<PAGE> 24
The following table sets forth the maximum month-end and average
balance of FHLB advances, securities sold under agreements to repurchase and
other borrowings as of the dates indicated.
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------
1996 1995 1994
------------------------------------
(In thousands)
<S> <C> <C> <C>
Maximum Balance:
Advances from FHLB . . . . . . . . . . . . . . . . . . . . $338,003 $226,003 $186,003
Securities sold under agreements
to repurchase . . . . . . . . . . . . . . . . . . . . . . 74,621 52,579 54,911
Other borrowings . . . . . . . . . . . . . . . . . . . . . 13,385 12,368 17,213
Average Balance: . . . . . . . . . . . . . . . . . . . . .
Advances from FHLB . . . . . . . . . . . . . . . . . . . 259,694 200,770 123,710
Securities sold under
agreements to repurchase . . . . . . . . . . . . . . . . . 40,095 24,020 17,284
Other borrowings . . . . . . . . . . . . . . . . . . . . . 9,720 11,504 14,423
</TABLE>
The following table sets forth certain information as to the Bank's
FHLB advances, securities sold under agreements to repurchase and other
borrowings at the dates indicated. See also Note K of Notes to Consolidated
Financial Statements.
<TABLE>
<CAPTION>
At December 31
----------------------------------------
1996 1995 1994
---------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Advances from FHLB . . . . . . . . . . . . . . . . . $338,003 $206,003 $186,003
Securities sold under agreements to repurchase . . . 58,040 -- 28,627
Other borrowings . . . . . . . . . . . . . . . . . . 7,994 10,292 12,326
-------- -------- --------
Total borrowings . . . . . . . . . . . . . . . . . $404,037 $216,295 $226,956
======== ======== ========
Weighted average interest
rate of advances from FHLB . . . . . . . . . . . . 5.59% 5.82% 6.03%
Weighted average interest rate
of securities sold under agreements
to repurchase . . . . . . . . . . . . . . . . . . . 5.66 -- 6.29
Weighted average interest
rate of other borrowings . . . . . . . . . . . . . 9.76 9.59 10.00
Weighted average interest
rate of total borrowings . . . . . . . . . . . . . 5.68 6.00 6.28
</TABLE>
- 24 -
<PAGE> 25
The following table sets forth the Bank's maturity and rate structure
of FHLB advances as of December 31, 1996.
<TABLE>
<CAPTION>
Weighted
Average
Rate Amount
-----------------------------
(Dollars in thousands)
<S> <C> <C>
Matures within:
One year . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.52% $251,000(1)
Two years . . . . . . . . . . . . . . . . . . . . . . . . . . 5.77 43,000
Three years . . . . . . . . . . . . . . . . . . . . . . . . . 5.84 43,000
Four years . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . 4.00 1,003
-------------------------
Total FHLB advances . . . . . . . . . . . . . . . . . . . . . . . 5.59% $338,003
=========================
</TABLE>
(1) Includes variable rate advances which adjust quarterly.
SERVICE CORPORATION ACTIVITIES
The Bank is permitted to invest an amount equal to 2% of its
assets (excluding those of its subsidiaries) in its service corporations. Up
to an additional 1% of assets may be invested in service corporations provided
that such amount is used for certain types of community development projects.
In addition, federal regulations permit institutions to make specified types of
loans to such subsidiaries (other than special-purpose finance subsidiaries) in
which the institution owns more than 10% of the stock, in an aggregate amount
not exceeding 50% of the institution's total capital as defined below. As of
December 31, 1996, the Bank's investment in stock of and loans to its
subsidiaries (other than its special-purpose finance subsidiary) was in
compliance with the regulations and totaled $4.3 million. A federal
institution may also invest up to 30% of its assets in special-purpose finance
subsidiaries established and operated in accordance with federal regulations.
The Bank's investment in its special purpose finance subsidiary, D&N Funding I
Corp., was in compliance with these regulations at December 31, 1996. Federal
law imposes special capitalization requirements on savings institutions such as
the Bank which are engaged in activities through a subsidiary that are not
permissible for national banks. See "Regulation -- Regulatory Capital
Requirements." The following is a description of the Bank's service
corporations.
D&N Enterprises, Inc. ("Enterprises") was formed in 1972 for
the purpose of developing real estate through joint venture arrangements. At
December 31, 1996, the Company had a $300,000 investment in Enterprises and
loans totaling approximately $1.4 million to the subsidiary.
- 25 -
<PAGE> 26
Enterprises entered into the Cumberland Joint Venture in February 1989 to
acquire land (73 acres) and to develop the land into 168 residential building
sites in Rochester Hills, Michigan. Enterprises sold this property in two
separate transactions in 1993 and 1994 and provided financing to the new
borrowers at market rates and terms. The sales resulted in a total gain of
$662,000 recognized in 1994.
Enterprises entered into the Northside Joint Venture in March 1989 to
acquire and develop commercial sites in Shelby Township, Michigan. Enterprises
is in the process of marketing this property in its entirety.
D&N Holdings, Inc. ("Holdings") was formed in 1985 and is involved in the
sale of mortgage life insurance through its investment in Minnesota Mutual Life
Insurance Company ("MIMLIC") and also offers insurance products and annuity
contracts through Quincy Insurance Agency, Inc., a subsidiary of Holdings formed
in 1995. In Michigan, MIMLIC's mortgage life insurance policies are marketed and
sold primarily through Michigan savings institutions. At December 31, 1996, D&N
Bank's investment in Holdings totaled approximately $200,000.
MORTGAGE BANKING. On May 1, 1984, D&N Bank established a mortgage banking
operation through a subsidiary, D&N Mortgage Corporation ("DNMC"). This
subsidiary was relatively dormant from 1992 until 1995. Since restarting
operations, D&N Mortgage Corporation has originated loans mainly for the Bank's
portfolio. D&N Mortgage Corporation currently has four origination offices
located in Michigan's lower peninsula in the cities of Grand Rapids, Hastings,
West Bloomfield and St. Joseph. At December 31, 1996, the Bank had $2.4 million
invested in this subsidiary.
FINANCE SUBSIDIARY. In 1986, D&N Bank incorporated a special- purpose
finance subsidiary, D&N Funding I Corp. ("Funding"). Funding was established
solely for the purpose of issuing collateralized mortgage obligations ("CMOs").
In August 1986, Funding pledged $61.5 million in principal amount of FHLMC
participation certificates to collateralize the issuance and sale of the CMOs
from which the Bank received $56.4 million in net proceeds. The CMOs were sold
through a third party conduit and were secured by the pledge of the
participation certificates. D&N Bank reinvested the proceeds from the sale of
the CMOs in residential and commercial mortgage loans.
COMPETITION
At December 31, 1996, the Bank ranked second among all savings institutions
headquartered in the State of Michigan with respect to total assets. D&N is the
largest financial institution based in the Upper Peninsula of Michigan.
- 26 -
<PAGE> 27
D&N Bank experiences substantial competition in attracting and retaining
deposits and in lending funds. The primary factors in competing for deposits
are the ability to offer attractive rates, the availability of convenient office
locations and the range and quality of services offered.
Direct competition for deposits comes from other savings institutions,
credit unions and commercial banks. Additional significant competition for
deposits comes from money market mutual funds and corporate and government
securities. The primary factors in competing for loans are interest rates, loan
origination fees and the range of services offered. Competition for origination
of real estate loans and consumer loans normally comes from other savings
institutions, credit unions, commercial banks, mortgage bankers, mortgage
brokers and insurance companies.
The deposit programs of savings institutions such as the Bank compete with
government securities, money market mutual funds and other investment
alternatives. Legislative and regulatory action has increased competition
between savings institutions and other financial institutions, such as
commercial banks, by expanding the ranges of financial services that may be
offered by savings institutions such as interest bearing checking accounts,
trust services and consumer loan products, while reducing or eliminating the
difference between savings institutions and commercial banks with respect to
long-term lending authority, taxation and maximum rates of interest that may be
paid on savings deposits.
EMPLOYEES
At December 31, 1996, the Bank had 526 employees, including 87 part-time
employees. Management considers its relations with its employees to be
satisfactory. The Bank's employees are not represented by any collective
bargaining group.
The Bank currently maintains a comprehensive employee benefit program
providing, among other benefits, a 401(k) plan with an Employee Stock Ownership
Program, hospitalization and major medical insurance, paid sick leave, long-term
disability insurance and life insurance. The Bank terminated the pension plan
and disbursed all of the assets in 1996. In connection with acquisitions of
five savings and loan institutions in 1980, 1982, 1986, 1988, and 1996 employees
of these institutions were made eligible to participate in the Bank's benefit
programs and were given full credit for all years of service under prior plans
of the acquired institutions.
EXECUTIVE OFFICERS
The following information as to the business experience during the past
five years is supplied with respect to executive officers of the Company or its
wholly owned subsidiary, other than the Chief Executive Officer, who do not
- 27 -
<PAGE> 28
serve on the Company's Board of Directors. Executive officers are elected
annually to serve until their successors are elected or until they resign or are
removed by the Board of Directors. There are no arrangements or understandings
between the persons named and any other person pursuant to which such officers
were elected.
George J. Butvilas, age 51. Joining D&N as President in May 1990, Mr.
Butvilas was named Chief Executive Officer of the Bank in 1991 and Chief
Executive Officer of the Company in 1992. He brought with him over 16 years
experience as a commercial and community banker. Mr. Butvilas was formerly
Executive Vice President and Director of Boulevard Bancorp, Inc. of Chicago,
Illinois.
Kenneth R. Janson, age 45, is Executive Vice President/Chief Financial
Officer and Treasurer of the Company and the Bank. Prior to joining the Bank in
May 1988 as Vice President/Financial Analysis, he was affiliated with various
universities, the last six years as Associate Professor of Accounting at
Michigan Technological University. Mr. Janson is responsible for directing the
Bank's accounting, investment and investor relations functions.
Peter L. Lemmer, age 39, is Senior Vice President/General Counsel of the
Company and the Bank. Prior to joining D&N Bank in October 1990, he held
various positions involving legal services, the last five years as Senior Vice
President/Compliance and Vice President, Associate General Counsel/Compliance
Officer with Cal America Savings, later known as Columbus Savings, and American
Federal Bank, respectively. Mr. Lemmer is responsible for the legal and
regulatory functions of the Bank.
Alfred J. Sliwinski, age 50, is Executive Vice President/Community Banking.
He has been employed by D&N Bank in various community banking capacities since
May 1977 and is presently responsible for the community banking, bank operations
and information systems functions of the Bank.
Richard E. West, age 50, is Senior Vice President/Wholesale Lending. Prior
to joining D&N Bank in January 1990, he was Servicing Manager for 20 years with
Rothschild Financial Corporation and Valley National Bank of Arizona. Mr. West
is responsible for directing the loan servicing, residential lending and
consumer lending functions of the Bank.
Linda K. Korpela, age 46, is Vice President/Corporate Secretary of the
Company and the Bank. She has been employed by the Bank since 1969 and served
as Assistant Secretary of the Bank from 1978 to 1990.
Donald W. Schulze, age 46, is Senior Vice President/Human Resources of the
Bank. He has been with D&N Bank in various capacities since 1986 and is
presently responsible for the training and development, facilities management
and human resources functions of the Bank.
- 28 -
<PAGE> 29
Frank R. Donnelly, age 56, is Senior Vice President/Commercial Lending
of the bank. He has been employed by the Bank in various capacities since 1995
and is presently responsible for the business lending and commercial real
estate lending functions of the Bank.
Leonard M. Bolduc, age 58, is Senior Vice President/Retail Loan Operations
of the Bank, responsible for planning and directing the consumer lending and
consumer and residential loan servicing functions. Prior to joining D&N Bank in
May 1988, he was employed by Citicorp Acceptance Company for three years, most
recently as Regional Credit Center Manager. Mr. Bolduc was also employed for 19
years in various capacities at ITT Consumer Financial Corporation, his last
position being Vice President/Division Director.
Daniel D. Greenlee, age 44, is Senior Vice President/Controller of the
Bank. He has been with D&N Bank in various capacities since 1984 and is
presently responsible for the accounting, financial and regulatory reporting,
financial analysis, tax and risk management functions of the Bank.
- 29 -
<PAGE> 30
REGULATION
GENERAL
The Bank is a federally chartered savings bank, the deposits of which
are federally insured and backed by the full faith and credit of the United
States Government. Accordingly, the Bank is subject to broad federal
regulation and oversight extending to all operations. The Bank is a member of
FHLB of Indianapolis and is subject to certain limited regulation by the
Federal Reserve Board. As the savings and loan holding company of the Bank,
the Company also is subject to federal regulation and oversight. The purpose
of the regulation of the Company and other holding companies is to protect
subsidiary savings institutions. The Bank is a member of the Savings
Association Insurance Fund ("SAIF"), and the deposits of the Bank are insured
by the FDIC. As a result, the FDIC has certain regulatory and examination
authority over the Bank. Certain of these regulatory requirements and
restrictions are discussed below or elsewhere in this document.
FEDERAL REGULATION
The OTS has extensive authority over the operations of savings
institutions. As part of this authority, the Bank is required to file periodic
reports with the OTS and is subject to periodic examinations by the OTS and the
FDIC. The last regular OTS and FDIC examinations of the Bank were as of June
30, 1996. Under agency scheduling guidelines, it is likely that another
examination will be initiated in the near future. When these examinations are
conducted by the OTS and the FDIC, the examiners may require the Bank to
provide for higher general or specific loan loss reserves.
The OTS has established a schedule for the assessment of fees upon all
savings institutions to fund the operations of the OTS. The general
assessment, to be paid on a semi-annual basis, is based upon the savings
institution's total assets as reported in the institution's latest quarterly
thrift financial report. The Bank's OTS assessment for the fiscal year ended
December 31, 1996, was $239,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and the Company.
This enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
- 30 -
<PAGE> 31
In addition, the investment, lending and branching authority of the
Bank is prescribed by federal laws and regulations, and it is prohibited from
engaging in any activities not permitted by such laws and regulations. For
instance, no savings institution may invest in non-investment grade corporate
debt securities. In addition, the permissible level of investment by federal
institutions in loans secured by non-residential real property may not exceed
400% of total capital, except with approval of the OTS. Federal savings
institutions are also generally authorized to branch nationwide. The Bank is
in compliance with the noted restrictions.
The Bank's general permissible lending limit for loans-to-one-borrower
is equal to the greater of $500,000 or 15% of unimpaired capital and surplus
(except for loans fully secured by certain readily marketable collateral, in
which case this limit is increased to 25% of unimpaired capital and surplus).
At December 31, 1996, the Bank's lending limit under this restriction was $13.3
million. The Bank is in compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
safety and soundness standards on matters such as loan underwriting and
documentation, internal controls and audit systems, interest rate risk exposure
and compensation and other employee benefits. Any institution which fails to
comply with these standards must submit a compliance plan. A failure to submit
a plan or to comply with an approved plan will subject the institution to
further enforcement action. The OTS and the other federal banking agencies
have also proposed additional guidelines on asset quality and earnings
standards. No assurance can be given as to the final form of the proposed
regulations.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the SAIF, which is administered by the FDIC.
Savings deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging
in any activity the FDIC determines by regulation or order to pose a serious
risk to the FDIC. The FDIC also has the authority to initiate enforcement
actions against savings institutions, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged or is engaging in unsafe or unsound practices, or
is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a
risk-based system under which all insured institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified
as well
- 31 -
<PAGE> 32
capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or
core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least
6% and a risk-based capital ratio of at least 10%) and considered healthy pay
the lowest premium while institutions that are less than adequately capitalized
(i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based
capital ratio of less than 8%) and considered of substantial supervisory
concern pay the highest premium. Risk classification of all insured
institutions will be made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio to
that designated reserve level, or such higher reserve ratio as established by
the FDIC. In addition, the FDIC may impose special assessments
on SAIF members to repay amounts borrowed from the United States Treasury or
for any other reason deemed necessary by the FDIC.
As is the case with the SAIF, the FDIC is authorized to adjust the
insurance premium rates for banks that are insured by the BIF of the FDIC in
order to maintain the reserve ratio of the BIF at 1.25% of BIF insured
deposits. As a result of the BIF reaching its statutory reserve ratio, the
FDIC revised the premium schedule for BIF insured institutions to provide a
range of .04% to 0.31% of deposits. The revisions became effective in the
third quarter of 1995. In addition, the BIF rates were further revised,
effective January 1996, to provide a range of 0% to .27% with a minimum annual
assessment of $2,000. The SAIF rates, however, were not adjusted.
Due to the shrinking deposit base for SAIF assessments and the
requirement that SAIF premiums be used to make the interest payments on bonds
issued by the Financing Corporation ("FICO") in order to finance the costs of
resolving thrift failures in the 1980s, the SAIF would not attain the
designated reserve ratio until the year 2002. As a result, SAIF insured
members would generally be subject to higher deposit insurance premiums than BIF
members until, all things being equal, the SAIF attains the required reserve
ratio.
In order to help eliminate this disparity and any competitive
disadvantage due to disparate deposit insurance premium schedules, legislation
to recapitalize the SAIF was enacted on September 30, 1996.
The legislation required a special one-time assessment of approximately
65.7 cents per $100 of SAIF deposits held by the Bank at March 31, 1995. D&N
Bank recognized the one-time special assessment in a tax affected charge
- 32 -
<PAGE> 33
to earnings of approximately $3.6 million during the quarter ended September
30, 1996. The legislation is intended to fully recapitalize the SAIF fund so
that commercial bank and thrift deposits will be charged FDIC premiums at the
same rate beginning October 1, 1996.
D&N Bank, however, will continue to be subject to an assessment to
fund repayment of the FICO bond obligation of 6.5 cents per $100 of deposits
while BIF insured institutions will pay 1.3 cents per $100 of deposits until
the year 2000 when the assessment will be imposed at the same rate on all FDIC
insured institutions.
REGULATORY CAPITAL REQUIREMENTS
Federally insured savings institutions, such as the Bank, are required
to maintain a minimum level of regulatory capital. The OTS has established
capital standards, including a tangible capital requirement, a leverage ratio
(or core capital) requirement and a risk-based capital requirement applicable
to such savings institutions. These capital requirements must be generally as
stringent as the comparable capital requirements for national banks. The OTS
is also authorized to impose capital requirements in excess of these standards
on individual institutions on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of mortgage servicing rights
(MSRs) must be deducted from tangible capital. At December 31, 1996, the Bank
had $1,443,000 of unamortized MSRs, none of which was required to be deducted
from tangible capital.
The OTS regulations establish special capitalization requirements for
savings institutions that own subsidiaries. Under these regulations certain
subsidiaries are consolidated for capital purposes and others are excluded from
assets and capital. In determining compliance with the capital requirements,
all subsidiaries engaged solely in activities permissible for national banks or
engaged in certain other activities solely as agent for its customers are
"includable" subsidiaries that are consolidated for capital purposes in
proportion to the institution's level of ownership, including the assets of
includable subsidiaries in which the institution has a minority interest that
is not consolidated for GAAP purposes. For excludable subsidiaries the debt
and equity investments in such subsidiaries are deducted from assets and
capital, with a transition period ending on July 1, 1996, for investments made
before April 12, 1989. At December 31, 1996, the Bank had approximately $1.7
million net investment in subsidiaries that will be excluded from capital
pursuant to this transition rule.
- 33 -
<PAGE> 34
At December 31, 1996, the Bank had tangible capital of $76.0 million, or
5.11% of adjusted total assets, which is approximately $53.7 million above the
minimum requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets (as defined by regulation). Core capital generally
consists of tangible capital plus certain intangible assets, including a
limited amount of purchased credit card relationships. As a result of the
prompt corrective action provisions discussed below, however, a savings
institution must maintain a core capital ratio of at least 4% to be considered
adequately capitalized unless its supervisory condition is such to allow it to
maintain a 3% ratio.
At December 31, 1996, the Bank had core capital equal to $76.0 million, or
5.11% of adjusted total assets, which is $31.4 million above the minimum
leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings institutions to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be
used to satisfy the risk-based requirement only to the extent of core capital.
The OTS is also authorized to require a savings institution to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At December 31, 1996, the Bank had
$10.7 million of general loss reserves which could be counted as supplementary
capital.
Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. The Bank had no such
exclusions from capital and assets at December 31, 1996.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For example,
the OTS has assigned a risk weight of 50% for prudently underwritten permanent
one-to four-family first lien mortgage loans not more than 90 days delinquent
and having a loan to value ratio of not more than 80% at origination unless
insured to such ratio by an insurer approved by FNMA or FHLMC.
- 34 -
<PAGE> 35
OTS regulations also require that every savings institution
with more than normal interest rate risk to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings institution, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The rule provides for a two quarter lag between
calculating interest rate risk and recognizing any deduction from capital. The
rule will not become effective until the OTS evaluates the process by which
savings institutions may appeal an interest rate risk deduction determination.
The OTS is uncertain as to when this evaluation may be completed. Any savings
institution with less than $300 million in assets and a total capital ratio in
excess of 12% is exempt from this requirement unless the OTS determines
otherwise. The Bank does not expect the rule to have a significant effect
on its calculation of total capital.
On December 31, 1996, the Bank had total capital of $86.7 million
(including $76.0 million in core capital and $10.7 million in qualifying
supplementary capital) and risk-weighted assets of $871.7 million (including
$45.7 million in converted off-balance sheet assets); or total capital of 9.94%
of risk-weighted assets. This amount was $16.9 million above the 8% requirement
in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against institutions that fail to meet their
capital requirements. The OTS is generally required to take action to restrict
the activities of an "undercapitalized institution" (generally defined to be one
with less than either a 4% core ratio, a 4% Tier 1 risk-based capital ratio or
an 8% risk-based capital ratio). Any such institution must submit a capital
restoration plan and until such plan is approved by the OTS may not increase its
assets, acquire another institution, establish a branch or engage in any new
activities, and generally may not make capital distributions. The OTS is
authorized to impose the additional restrictions, discussed below, that are
applicable to significantly undercapitalized institutions.
As a condition to the approval of the capital restoration plan, any company
controlling an undercapitalized institution must agree that it will enter into a
limited capital maintenance guarantee with respect to the institution's
achievement of its capital requirements.
Any savings institution that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions
- 35 -
<PAGE> 36
which may cover all aspects of its operations and include a forced merger or
acquisition of the institution. An institution that becomes "critically
undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to
further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized institutions. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings institution, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized institution is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of conservator or a receiver.
If the OTS determines that an institution is in an unsafe or unsound
condition or is engaged in an unsafe or unsound practice, it is authorized to
reclassify a well-capitalized institution as an adequately capitalized
institution and if the institution is adequately capitalized, to impose the
restrictions applicable to an undercapitalized institution. If the institution
is undercapitalized, the OTS is authorized to impose the restrictions applicable
to a significantly undercapitalized institution.
The imposition by the OTS or the FDIC of any of these measures on the Bank
may have a substantial adverse effect on the Bank's operations and
profitability. The Company's stockholders do not have preemptive rights, and
therefore, if the Company is directed by the OTS or the FDIC to issue additional
shares of Common Stock, such issuance may result in the dilution in the
percentage of ownership of the Company.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions on institutions with respect to
their ability to pay dividends or make other distributions of capital. OTS
regulations prohibit an institution from declaring or paying any dividends or
from repurchasing any of its stock if, as a result, the regulatory capital of
the institution would be reduced below the amount required to be maintained for
the liquidation account established in connection with its mutual to stock
conversion.
Generally, institutions such as the Bank, that before and after the
proposed distribution meet their capital requirements, may make capital
distributions during any calendar year equal to the greater of 100% of net
income for the year-to-date plus 50% of the amount by which the lesser of the
institution's tangible, core or risk-based capital exceeds its fully phased-in
capital requirement for such capital component, as measured at the beginning of
the calendar year, or 75% of its net income for the most recent four quarter
period. However, an institution deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
The Bank may pay dividends in accordance with this general authority.
- 36 -
<PAGE> 37
Savings institutions that will meet their current minimum capital
requirement following a proposed capital distribution need only submit written
notice to the OTS 30 days prior to such distribution. The OTS may object to the
distribution during the 30-day period based on safety and soundness concerns.
See " -- Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal, a savings institution may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMEL 1 or 2 rating, is not of
supervisory concern and would remain adequately capitalized (as defined in the
OTS prompt corrective action regulation) following the proposed distribution.
Savings institutions that would remain adequately capitalized following the
proposed distribution but do not meet the other noted requirements must notify
the OTS 30 days prior to declaring a capital distribution. The OTS stated it
will generally regard as permissible that amount of capital distributions that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings institution may not make a capital
distribution without prior approval of the OTS and the FDIC if it is
undercapitalized before, or as a result of, such a distribution. As under the
current rule, the OTS may object to a capital distribution if it would
constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
LIQUIDITY
All savings institutions, including the Bank, are required to maintain an
average daily balance of liquid assets equal to a certain percentage of the sum
of its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. The liquidity asset ratio requirement may vary
from time to time (between 4% and 10%) depending upon economic conditions and
savings flows of all savings institutions. At the present time, the minimum
liquid asset ratio is 5%.
In addition, short-term liquid assets (e.g., cash, certain time deposits,
certain bankers acceptances and short-term United States Treasury obligations)
currently must constitute at least 1% of the institution's average daily balance
of net withdrawable deposit accounts and current borrowings. Penalties may be
imposed upon institutions for violations of either liquid asset ratio
requirement. At December 31, 1996, the Bank was in compliance with both
requirements, with an overall liquid asset ratio of 6.6% and a short-term liquid
asset ratio of 3.7%.
- 37 -
<PAGE> 38
ACCOUNTING
An OTS policy statement applicable to all savings institutions clarifies
and reemphasizes that the investment activities of a savings institution must be
in compliance with approved and documented investment policies and strategies,
and must be accounted for in accordance with GAAP. Under the policy statement,
management must support its classification of and accounting for loans and
securities (i.e., whether held for investment, available for sale or trading)
with appropriate documentation. The Bank is in compliance with these rules.
The OTS has adopted an amendment to its accounting regulations, which may
be made more stringent than GAAP, to require that transactions be reported in a
manner that best reflects their underlying economic substance and inherent risk
and that financial reports must incorporate any other accounting regulations or
orders prescribed by the OTS.
QUALIFIED THRIFT LENDER TEST
All savings institutions, including the Bank, are required to meet a
qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings institution to have at least 65% of
its portfolio assets as defined by regulation in qualified thrift investments on
a monthly average for nine out of every 12 months on a rolling basis. Such
assets primarily consist of residential housing related loans and investments.
At December 31, 1996, the Bank met the test and has always met the test since
its inception.
Any savings institution that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If the institution does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the Bank Insurance Fund. If an institution that fails the test has not yet
requalified and has not converted to a national bank, its new investments and
activities are limited to those permissible for both a savings institution and a
national bank, and it is limited to national bank branching rights in its home
state. In addition, the institution is immediately ineligible to receive any
new FHLB borrowings and is subject to national bank limits for payment of
dividends. If such institution has not requalified or converted to a national
bank within three years after the failure, it must divest of all investments and
cease all activities not permissible for a national bank. In addition, it must
repay promptly any outstanding FHLB borrowings, which may result in prepayment
penalties. If any institution that fails the QTL test is controlled by a
holding company, then within one year after the failure, the holding company
must register as a bank holding company and become subject to all restrictions
on bank holding companies. See " -- Holding Company Regulation."
- 38 -
<PAGE> 39
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of the
Bank, to assess the institution's record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
applications, such as a merger or the establishment of a branch, by the Bank.
An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
The federal banking agencies, including the OTS, have recently revised the
CRA regulations and the methodology for determining an institution's compliance
with the CRA. Due to the heightened attention being given to the CRA in the
past few years, the Bank may be required to devote additional funds for
investment and lending in its local community. The Bank was examined for CRA
compliance in 1995 and received a rating of "Satisfactory".
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings institution or its subsidiaries
and its affiliates are required to be on terms as favorable to the institution
as transactions with non-affiliates. In addition, certain of these transactions
are restricted to a percentage of the institution's capital. Affiliates of the
Bank include the Company and any company which is under common control with the
Bank. In addition, a savings institution may not lend to any affiliate engaged
in activities not permissible for a bank holding company or acquire the
securities of most affiliates. The Bank's subsidiaries are not deemed
affiliates; however, the OTS has the discretion to treat subsidiaries of savings
institutions as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
- 39 -
<PAGE> 40
HOLDING COMPANY REGULATION
The Company is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, the Company is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. In addition, the OTS has enforcement authority over the Company and
its non-savings institution subsidiaries which also permits the OTS to restrict
or prohibit activities that are determined to be a serious risk to the
subsidiary savings institution.
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings institution as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than the Bank or any other SAIF-insured savings institution)
would become subject to such restrictions unless such other institutions each
qualify as a QTL and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, the Company must obtain the approval of the
OTS prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition, within
one year of such failure the Company must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the activities
authorized for a unitary or multiple savings and loan holding company. See " --
Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control of
any other SAIF-insured institution. Such acquisitions are generally prohibited
if they result in a multiple savings and loan holding company controlling
savings institutions in more than one state. However, such interstate
acquisitions are permitted based on specific state authorization or in a
supervisory acquisition of a failing savings institution.
FEDERAL SECURITIES LAW
The stock of the Company is registered with the SEC under the Securities
and Exchange Act of 1934, as amended (the "Exchange Act"). The Company is
subject to the information, proxy solicitation, insider trading restrictions and
other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information
- 40 -
<PAGE> 41
requirements, each affiliate of the Company is able to sell in the public
market, without registration, a limited number of shares in any three-month
period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW and Super NOW checking accounts). At December
31, 1996, the Bank was in compliance with these reserve requirements. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements that may be imposed
by the OTS. See "--Liquidity."
Savings institutions are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require institutions to
exhaust other reasonable alternative sources of funds, including FHLB
borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of Indianapolis, which is one of 12
regional FHLBs, that administer the home financing credit function of savings
institutions. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures established
by the board of directors of the FHLB. These policies and procedures are
subject to the regulation and oversight of the Federal Housing Finance Board.
All advances from the FHLB are required to be fully secured by sufficient
collateral as determined by the FHLB. In addition, all long-term advances are
required to provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Indianapolis. At December 31, 1996, the Bank had $20.0 million in FHLB
stock, which was in compliance with this requirement. In past years, the Bank
has received substantial dividends on its FHLB stock. Over the past five
calendar years such dividends have averaged 8.22% and were 7.84% for calendar
year 1996.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings institutions and to contribute to low- and
moderate priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of the Bank's FHLB stock may result in a corresponding
reduction in the Bank's capital.
- 41 -
<PAGE> 42
For the year ended December 31, 1996, the dividends paid by the FHLB of
Indianapolis to the Bank totaled $1.6 million. The $394,000 dividend received
for the quarter ended December 31, 1996 reflects an annualized rate of 7.89%.
FEDERAL AND STATE TAXATION
D&N and its subsidiaries file a consolidated federal income tax return on a
calendar year basis using the accrual method of accounting.
Savings institutions, such as the Bank, were permitted to establish
reserves for bad debts and make annual additions thereto which could be taken as
a deduction in computing taxable income for federal income tax purposes. This
tax bad debt reserve method available to thrifts institutions was repealed for
tax years beginning after 1995. As a result, the Bank was required to change
from the reserve method to the specific charge-off method to compute its bad
debt deduction. Basically, repeal of the thrift bad debt reserve method puts
large thrifts, such as the Bank, on the tax method used by large commercial
banks.
Upon repeal, the Bank is required to recapture into income the portion of
its bad debt reserves (other than the supplemental reserve) that exceeds its
base year reserves (i.e. its tax reserves for the last tax year beginning before
1988). The recapture amount resulting from the change in the Bank's method of
accounting for its bad debt reserves is taken into taxable income ratably (on a
straight-line basis) over a six-year period.
The base year reserve is frozen, not forgiven. Certain events can still
trigger a recapture of the base year reserve. For example, while the base year
reserve will not be recaptured if the thrift converts to a bank charter or is
merged into a bank, it will be recaptured if the thrift ceases to qualify as a
bank for federal income tax purposes. The base year reserves also remain
subject to income tax penalty provisions which, in general, require recapture
upon certain stock redemptions of, and excess distributions to, shareholders.
In addition to the regular income tax, corporations, such as the Company,
generally are subject to a minimum tax. An alternative minimum tax is imposed
at a minimum tax rate of 20% on alternative minimum income, which is the sum of
a corporation's regular taxable income (with certain adjustments) and tax
preference items, less any available exemption. The alternative minimum tax is
imposed to the extent it exceeds the corporation's regular income tax and net
operating losses can offset no more than 90% of alternative minimum taxable
income.
D&N and its consolidated subsidiaries have been audited or their books
closed without audit by the IRS with respect to consolidated federal income tax
- 42 -
<PAGE> 43
returns through December 31, 1993. With respect to years examined by the IRS,
either all deficiencies have been satisfied or sufficient reserves have been
established to satisfy asserted deficiencies. In the opinion of management, any
examination of open returns (including returns of subsidiaries and predecessors
of, or entities merged into, D&N) would not result in a deficiency which could
have a material adverse effect on the financial condition of D&N and its
consolidated subsidiaries. See Note L of Notes to Consolidated Financial
Statements.
During the third quarter of 1996, the Bank recognized an adjustment to its
balance of deferred tax assets following the enactment in August of federal
legislation which resolved the recapture status of previously allowed
accelerated deductions for bad debts. Thrift institutions such as the Bank had
been permitted to deduct a portion of their income as bad debt allowances. This
practice was more advantageous than the specific-loss method of deduction which
was mandated for other classes of financial institutions. The opportunity to
use the percentage-of-income method expired in 1995, but the status of
previously accelerated deductions remained in question until the 1996
legislation was enacted. The presence of unresolved prior deductions was felt
to be hindrance to evolution and consolidation of the financial services
industry because thrift institutions that had recorded such accelerated
deductions were required to repay them before charter conversions or
acquisitions by non-thrift institutions could be approved. The new legislation
required that accelerated deductions recorded after 1987 would have to be
repaid, but forgave that portion of institutions' accelerated loan loss
deductions that were recorded before 1988.
MICHIGAN TAXATION. The State of Michigan imposes a tax on intangible
personal property in the amount of $.20 per $1,000 of deposits of a savings bank
or a savings and loan institution less deposits owed to the federal or Michigan
state governments, their agencies or certain other financial institutions. The
Michigan intangibles tax is being phased out over four years until the tax is
fully repealed effective January 1, 1998. The State of Michigan also imposes a
"Single Business Tax." The Single Business Tax is a value-added type of tax for
the privilege of doing business in the State of Michigan. The major components
of the Single Business Tax are federal taxable income, compensation and
depreciation as increased by net operating loss carryforwards, if any, utilized
in arriving at federal taxable income, and decreased by the cost of acquisition
of tangible assets during the year. The tax rate is 2.30% of the Michigan
adjusted tax base.
DELAWARE TAXATION. As a Delaware business corporation, the Company is
required to file annual returns with and pay annual fees to the State of
Delaware. The Company is also subject to an annual franchise tax imposed by the
State of Delaware based on the number of authorized shares of the Company stock.
- 43 -
<PAGE> 44
ITEM 2. PROPERTIES
Offices
The following table sets forth information with respect to D&N offices
as of December 31, 1996.
<TABLE>
<CAPTION>
Owned Lease Date Net
or Expiration Acquired or Book
Office Locations Leased Date Constructed Value
- ---------------------------------------- ------------ ----------- ----------------- --------
<S> <C> <C> <C> <C>
MAIN OFFICE:
400 Quincy Street
Hancock, Michigan . . . . . . . . . . . . . Owned -- 1972 $2,989,880
BRANCH OFFICES:
1000 S. Carpenter Street
Iron Mountain, Michigan . . . . . . . . . . Owned -- 1968 289,797
1930 U.S. 41, West
Marquette, Michigan . . . . . . . . . . . . Owned -- 1976 1,474,559
2325 Ludington Street
Escanaba, Michigan . . . . . . . . . . . . Owned -- 1975 323,553
501 Court Street
Sault Ste. Marie, Michigan . . . . . . . . Owned -- 1980 336,286
U.S. 41
Ishpeming, Michigan . . . . . . . . . . Owned -- 1978 194,272
1015 Tenth Street
Menominee, Michigan . . . . . . . . . . . . Owned -- 1976 258,730
100 S. Suffolk Street
Ironwood, Michigan . . . . . . . . . . . . Owned -- 1982 261,358
330 Fifth Street
Calumet, Michigan . . . . . . . . . . . . . Owned -- 1980 83,022
Festival Foods, Highway M-26
Houghton, Michigan . . . . . . . . . . . . Leased Monthly 1986 3,873
Pat's Foods, 111 U.S. 41
L'Anse, Michigan . . . . . . . . . . . . . Leased December 31, 1997 1992 7,406
No Options
901 W. Sharon Avenue, Suite 100
Houghton, Michigan . . . . . . . . . . . . Leased May 25, 2000 1995 178,169
Two 5 Yr. Options
</TABLE>
- 44 -
<PAGE> 45
<TABLE>
<CAPTION>
Owned Lease Date Net
or Expiration Acquired or Book
Office Locations Leased Date Constructed Value
- ---------------------------------------- ------------ ----------- ----------------- --------
<S> <C> <C> <C> <C>
23505 Greater Mack
St. Clair Shores, Michigan . . . . . . . . Owned -- 1956 115,997
141 S. Main Street
Romeo, Michigan. . . . . . . . . . . . . Owned -- 1974 326,341
460 S. Saginaw Street
Flint, Michigan . . . . . . . . . . . . . Owned -- 1924 798,527
300 Fenton Square
Fenton, Michigan . . . . . . . . . . . . . Owned -- 1984 189,517
2629 W. Pierson Road
Flint, Michigan. . . . . . . . . . . . . . Leased October 4, 2010 1995 57,471
No Options
3410 S. Dort Highway
Flint, Michigan. . . . . . . . . . . . . . Leased September 30,1998 1961 55,389
One 5 Yr. Option
G-4409 Miller Road
Flint, Michigan. . . . . . . . . . . . . .. Owned -- 1975 404,582
1151 N. Ballenger Highway
Flint, Michigan. . . . . . . . . . . . . . Leased August 31, 1997 1975 --
Yearly Option
4400 South Saginaw, Suite 1310 . .
Flint, Michigan. . . . . . . . . . . . . Leased February 28, 1999 1994 56,682
One 5 Yr. Option
4495 Corunna Road
Flint, Michigan . . . . . . . . . . . . . . Leased March 10, 2006 1996 88,585
Two 5 Yr. Options
12770 S. Saginaw Street
Grand Blanc, Michigan . . . . . . . . . . . Owned -- 1981 338,523
727 S. State Road
Davison, Michigan. . . . . . . . . . . . . Owned -- 1972 177,659
1559 E. Pierson Road
Flushing, Michigan . . . . . . . . . . . Owned -- 1974 223,302
G-6120 Fenton Road
Flint, Michigan . . . . . . . . . . . . . . Owned -- 1979 150,052
3213 Genesee Road
Flint, Michigan. . . . . . . . . . . . . Owned -- 1979 201,811
</TABLE>
- 45 -
<PAGE> 46
<TABLE>
<CAPTION>
Owned Lease Date Net
or Expiration Acquired or Book
Office Locations Leased Date Constructed Value
- ---------------------------------------- ------------ --------------------- ------------- --------
<S> <C> <C> <C> <C>
1305 W. 14 Mile Road
Clawson, Michigan. . . . . . . . . . . . . Leased March 31, 1998 1995 --
One 3 Yr. Option
363 West Big Beaver, Suite 150
Troy, Michigan . . . . . . . . . . . . . . Leased June 30, 2002 1995 323,510
Two 3 Yr. Options
3005 University Drive
Auburn Hills, Michigan . . . . . . . . . . Leased December 14, 2006 1996 79,388
Two 5 Yr. Options
611 East Grand River
Howell, Michigan . . . . . . . . . . . . . Leased January 1, 2002 1967 33,245
Two 5 Yr. Options
9880 East Grand River
Brighton, Michigan . . . . . . . . . . . . Leased February 28, 1999 1988 252
Two 5 Yr. Options
419 South Lafayette
South Lyon, Michigan . . . . . . . . . . . Leased October 31, 2000 1990 322,036
One 10 Yr. Option
1075 East Main Street
Pinckney, Michigan . . . . . . . . . . . . Owned -- 1971 340,519
10590 Highland Road
Hartland, Michigan . . . . . . . . . . . . Leased August 1, 2000 1995 93,421
Two 5 Yr. Options
524 West Grand River
Fowlerville, Michigan. . . . . . . . . . . Owned -- 1974 63,194
5844 N. Sheldon Road
Canton, Michigan . . . . . . . . . . . . . Leased July 31, 1997 1995 --
Two 3 Yr. Options
OTHER OFFICE PROPERTIES:
435 Building
435 Mesnard Street
Hancock, Michigan. . . . . . . . . . . . . Owned -- 1974 280,885
424 Building
424 Hancock Street
Hancock, Michigan. . . . . . . . . . . . . Owned -- 1986 458,114
Troy Commercial Lending
363 W Big Beaver Road, Suite 201
Troy, Michigan . . . . . . . . . . . . . . Leased June 30, 2002 1995 69,307
</TABLE>
- 46 -
<PAGE> 47
<TABLE>
<CAPTION>
Owned Lease Date Net
or Expiration Acquired or Book
Office Locations Leased Date Constructed Value
- ---------------------------------------- ------------ ----------- ----------------- --------
<S> <C> <C> <C> <C>
Troy Corporate Center
363 W. Big Beaver Road, Ste 100
Troy, Michigan . . . . . . . . . . . . . . Leased June 30, 2002 1995 86,637
Two 3 Yr. Options
Marquette Residential Lending
309 S. Front Street
Marquette, Michigan . . . . . . . . . . . . Leased October 31, 1997 1992 2,741
Yearly Option
Mortgage Corp. Lending Office
3900 Sparks Drive SE, Suite 105
Grand Rapids, Michigan. . . . . . . . . . . Leased February 28, 1998 1994 --
No Options
Mortgage Corp. Lending Office
2620 S. Cleveland Avenue, Suite 201
St. Joseph, Michigan . . . . . . . . . . . Leased April 30, 1997 1994 --
One 2 Yr. Option
Mortgage Corp. Lending Office
7071 Orchard Lake Road, Suite 100
West Bloomfield, Michigan . . . . . . . . . Leased November 1, 1998 1995 --
No Options
Mortgage Corp Lending Office
145 W. State St.
Hastings, Michigan . . . . . . . . . . . . Leased December 31, 1997 1996 7,867
Yearly Option
</TABLE>
At December 31, 1996, the net book value of the land, buildings and
leasehold improvements owned by D&N Bank was $11,747,000, and the net book value
of its office furniture, fixtures and equipment was $4,017,000.
COMPUTER EQUIPMENT. D&N Bank processes all depositor and borrower customer
files and transactions through a third party data services provider including
general ledger accounting and information reporting. The book value of all
computer equipment and software owned by the Bank was $738,000 at December 31,
1996. The Bank also leases an insignificant amount of data processing hardware
and software.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in a number of matters of litigation,
substantially all of which have arisen in the ordinary course of business. It
is the opinion of management that the resulting liabilities, if any, from these
actions will not materially affect the Consolidated Financial Statements.
- 47 -
<PAGE> 48
D&N Bank is a plaintiff, like approximately 120 other institutions, in a
currently pending claim in the United States Court of Federal Claims seeking
substantial damages as a result of the 1989 Financial Institutions Reform,
Recovery and Enforcement Act's mandatory phase-out of the regulatory capital
treatment of supervisory goodwill. Arguments concerning the extent of damages
in the cases of three initial plaintiffs are scheduled to begin March 17, 1997.
The other cases, including D&N's, are scheduled to be considered after the
initial cases are resolved. The ultimate outcome of these matters cannot be
ascertained at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
1996.
- 48 -
<PAGE> 49
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Page 48 of the attached 1996 Annual Report to Stockholders is
herein incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
Page 4 of the attached 1996 Annual Report to Stockholders is
herein incorporated by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Pages 12 through 21 of the attached 1996 Annual Report to
Stockholders are herein incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS SUPPLEMENTARY DATA
Pages 22 through 45 of the attached 1996 Annual Report to
Stockholders are herein incorporated by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no Current Report on Form 8-K filed within 24
months prior to the date of the most recent financial statements
reporting a change of accountants and/or reporting disagreements
on any matter of accounting principle or financial statement
disclosure.
- 49 -
<PAGE> 50
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Executive Officers of the Company is contained on
page 27 herein. Information concerning Directors of the Company, is
incorporated herein by reference from the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held in 1997, except for
information contained under the heading "Compensation Committee Report" and
"Stockholder Return Performance Presentation." A copy of this Proxy Statement
will be filed not later than 120 days after the close of the fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the Company's definitive Proxy Statement or the Annual Meeting of
Stockholders to be held in 1997, except for information contained under the
heading "Compensation Committee Report" and "Stockholder Return Performance
Presentation." A copy of this Proxy Statement will be filed not later than 120
days after the close of the fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the Company's definitive
Proxy Statement for the Annual Meeting of Stockholders to be held in 1997,
except for information contained under the heading "Compensation Committee
Report" and "Stockholder Return Performance Presentation." A copy of this Proxy
Statement will be filed not later than 120 days after the close of the fiscal
year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions
incorporated herein by reference from the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders to be held in 1997, except for the
information contained under the heading Compensation Committee Report" and
"Stockholder Return Performance Presentation." A copy of this Proxy Statement
will be filed not later than 120 days after the close of the fiscal year.
- 50 -
<PAGE> 51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The following information appearing in the Registrant's Annual Report to
Stockholders for the year ended December 31, 1996, is incorporated by reference
in this Annual Report on Form 10-K as Exhibit 13.
Annual Report Section Pages in Annual Report
- --------------------- ----------------------
Selected Financial Data 4
Management's Discussion and Analysis 12 - 21
of Financial Condition and Results
of Operations
Report of Independent Auditors 22
Consolidated Statements of Condition 23
Consolidated Statements of Income 24
Consolidated Statements of 25
Stockholders' Equity
Consolidated Statements of Cash Flows 26
Notes to Consolidated Financial Statements 27 - 45
(a) (2) Financial Statement Schedules
All financial statement schedules have been omitted as the required
information is inapplicable or has been included in the Notes to Consolidated
Financial Statements.
- 51 -
<PAGE> 52
(a) (3) Exhibits
<TABLE>
<CAPTION>
Reference to Sequential
Prior Filing Page Number
or Exhibit Where Attached/
Regulation Number Located in
S-K Exhibit Attached ThisForm 10-K
Number Document Hereto Report
- ----------- ----------------------------- ------------- --------------------
<S> <C> <C> <C>
3(I) Articles of Incorporation * Not applicable
3(ii) By-Laws * Not applicable
4 Instruments defining the * Not applicable
rights of security holders,
including debentures
9 Voting Trust Agreement None Not applicable
10 Material Contracts
1993 401(k) Plan & Trust * Not applicable
(1994 Amendment)
1984 Stock Option Plan * Not applicable
(1995 Amendment)
1994 Management
Stock Incentive * Not applicable
Plan (1995 Amendment)
Employment Agreement of
G. Butvilas * Not applicable
11 Statement re: computation 11 Filed Herewith
of per share earnings
12 Statement re: computation Not required Not applicable
of ratios
13 Annual Report to Security 13 Filed Herewith
Holders
16 Letter re: change in None Not applicable
Certifying Accountant
18 Letter re: change in None Not applicable
accounting principles
21 Subsidiaries of Registrant 21 Filed Herewith
22 Published report regarding None Not applicable
matters submitted to vote
of security holders
23 Consent of Experts and 23 Filed Herewith
Counsel
24 Power of Attorney Not required Not applicable
27 Financial Data Schedule 27 Filed Herewith
</TABLE>
<PAGE> 53
<TABLE>
<S> <C> <C> <C>
28 Information from reports None Not applicable
furnished to state
insurance regulatory
authorities
99 Additional exhibits None Not applicable
</TABLE>
- -------------------
*Filed as exhibits to the Registrant's registration statement on Form
S-2 (File No. 33-69300) filed with the Commission on September 23, 1993 or as
part of reports filed for the purpose of updating such description. All of
such previously filed documents are hereby incorporated herein by reference in
accordance with Item 601 of Regulation S-K.
(b) Reports on Form 8-K
None.
<PAGE> 54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
D&N FINANCIAL CORPORATION
Date By: /s/ GEORGE J. BUTVILAS
-------------------------------- -------------------------
GEORGE J. BUTVILAS
(Duly Authorized
Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ GEORGE J. BUTVILAS By: /s/ KENNETH D. SEATON
-------------------------------- -------------------------
GEORGE J. BUTVILAS KENNETH D. SEATON
Director, President and Director, Chairman of
Chief Executive Officer the Board
(Principal Executive Officer)
Date Date
-------------------------------- -------------------------
By: /s/ JOSEPH C. BROMLEY By: /s/ B. THOMAS M. SMITH,JR
-------------------------------- -------------------------
JOSEPH C. BROMLEY B. THOMAS M. SMITH, JR
Director Director
Date Date
-------------------------------- -------------------------
By: /s/ STANLEY A. JACOBSON By: /s/ PETER VAN PELT
-------------------------------- -------------------------
STANLEY A. JACOBSON PETER VAN PELT
Director Director
Date Date
-------------------------------- -------------------------
<PAGE> 55
By: /s/ RANDOLPH P. PIPER By: /s/ STEVEN E. ZACK
----------------------------- -------------------------
RANDOLPH P. PIPER STEVEN E. ZACK
Director Director
Date Date
----------------------------- -------------------------
By: /s/ SHARON A. REESE DALENBERG
-----------------------------
SHARON A. REESE DALENBERG
Director
Date
-----------------------------
By: /s/ KENNETH R. JANSON
-----------------------------
KENNETH R. JANSON
Executive Vice President/
Chief Financial Officer
Date
-----------------------------
<PAGE> 56
EXHIBIT INDEX
<TABLE>
<CAPTION>
Reference to Sequential
Prior Filing Page Number
or Exhibit Where Attached/
Regulation Number Located in
S-K Exhibit Attached ThisForm 10-K
Number Document Hereto Report
- ----------- ----------------------------- ------------- --------------------
<S> <C> <C> <C>
3(I) Articles of Incorporation * Not applicable
3(ii) By-Laws * Not applicable
4 Instruments defining the * Not applicable
rights of security holders,
including debentures
9 Voting Trust Agreement None Not applicable
10 Material Contracts
1993 401(k) Plan & Trust * Not applicable
(1994 Amendment)
1984 Stock Option Plan * Not applicable
(1995 Amendment)
1994 Management
Stock Incentive * Not applicable
Plan (1995 Amendment)
Employment Agreement of
G. Butvilas * Not applicable
11 Statement re: computation 11 Filed Herewith
of per share earnings
12 Statement re: computation Not required Not applicable
of ratios
13 Annual Report to Security 13 Filed Herewith
Holders
16 Letter re: change in None Not applicable
Certifying Accountant
18 Letter re: change in None Not applicable
accounting principles
21 Subsidiaries of Registrant 21 Filed Herewith
22 Published report regarding None Not applicable
matters submitted to vote
of security holders
23 Consent of Experts and 23 Filed Herewith
Counsel
24 Power of Attorney Not required Not applicable
27 Financial Data Schedule 27 Filed Herewith
</TABLE>
<PAGE> 57
<TABLE>
<S> <C> <C> <C>
28 Information from reports None Not applicable
furnished to state
insurance regulatory
authorities
99 Additional exhibits None Not applicable
</TABLE>
- -------------------
*Filed as exhibits to the Registrant's registration statement on Form
S-2 (File No. 33-69300) filed with the Commission on September 23, 1993 or as
part of reports filed for the purpose of updating such description. All of
such previously filed documents are hereby incorporated herein by reference in
accordance with Item 601 of Regulation S-K.
<PAGE> 1
EXHIBIT 11
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------------------------------------
1996 1995 1994
-------------------- -------------------- ---------------------
Fully Fully Fully
Primary Diluted Primary Diluted Primary Diluted
------- ------- ------- ------- ------- -------
(In thousands, except per share)
<S> <C> <C> <C> <C> <C> <C>
Net Income 8,995 8,995 10,417 10,417 3,383 3,383
======= ======= ========= ======= ======= =======
Average Shares
Common 7,579 7,579 7,430 7,430 7,420 7,420
Common equivalents 501 651 289 502 26 14
------- ------- --------- ------- ------- -------
Total 8,080 8,230 7,719 7,932 7,446 7,434
======= ======= ========= ======= ======= =======
Earnings per common
and common
equivalent share $ 1.11 $ 1.09 $ 1.35 $ 1.31 $ 0.45 $ 0.46
======= ======= ========= ======= ======= =======
</TABLE>
Common share equivalents assume exercise of stock options and warrants, if
dilutive.
<PAGE> 1
SELECTED FINANCIAL HIGHLIGHTS
D&N FINANCIAL CORPORATION
Exhibit 13
<TABLE>
<CAPTION>
--------------------------------------------------------------------------
1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
FOR THE YEAR:
Net interest income. . . . . . . . . . . . . $ 42,763 $ 34,750 $ 23,786 $ 21,212 $ 29,894
Provision for loan losses. . . . . . . . . . 1,100 2,400 100 -- 117
Noninterest income(loss) . . . . . . . . . . 7,224 6,912 7,488 (21,536) 13,397
Net income (loss). . . . . . . . . . . . . . 8,995 10,417 3,383 (66,642)(1) 4,008
Earnings (loss) per share
Primary . . . . . . . . . . . . . . . . . 1.11 1.35 0.46 (15.06) 0.91
Fully diluted . . . . . . . . . . . . . . 1.09 1.31 0.46 (15.06) 0.91
Weighted average shares:
Primary . . . . . . . . . . . . . . . . . 8,080,333 7,718,700 7,419,636 4,423,889 4,408,043
Fully diluted . . . . . . . . . . . . . . 8,229,812 7,932,142 7,419,636 4,423,889 4,408 043
Stock price range . . . . . . . . . . . . . 12 - 17 3/4 7 1/4 - 13 1/2 6 5/8 - 10 6 1/2 - 12 1/2 4 3/4 - 8 1/2
AT YEAR END:
Total assets . . . . . . . . . . . . . . . . 1,473,054 1,228,497 1,128,732 1,080,131 1,252,843
Net loans receivable . . . . . . . . . . . . 1,055,876 952,359 821,875 646,709 726,501
Nonperforming assets . . . . . . . . . . . . 8,091 9,701 24,520 43,593 56,056
Mortgage-backed securities . . . . . . . . . 251,256 127,709 151,293 171,983 241,040
Excess of cost over net assets of
association acquired. . . . . . . . . . . -- -- 384 845 36,380
Mortgage servicing rights . . . . . . . . . 1,443 1,113 968 9,870 29,198
Deposits . . . . . . . . . . . . . . . . . . 964,133 922,932 817,674 844,012 916,644
Borrowings . . . . . . . . . . . . . . . . . 404,037 216,295 226,956 101,648 174,232
Stockholders' equity . . . . . . . . . . . . 86,121 71,979 58,325 56,887 101,789
Per share. . . . . . . . . . . . . . . . 10.32 9.63 7.86 7.67 23.09
Tangible stockholders' equity. . . . . . . . 85,110 70,855 58,264 57,049 67,323
Per share. . . . . . . . . . . . . . . . 10.20 9.48 7.85 7.69 15.27
Number of offices . . . . . . . . . . . . . 48 46 41 38 40
SELECTED RATIOS:
Return on average assets . . . . . . . . . . 0.67% 0.89% 0.31% (5.47)% 0.28%
Return on average equity . . . . . . . . . . 11.58 16.01 5.97 (74.99) 4.05
Average equity to average assets . . . . . . 5.77 5.53 5.26 7.29 6.89
Net interest margin. . . . . . . . . . . . . 3.26 3.04 2.31 1.95 2.28
General and administrative expenses
to average assets . . . . . . . . . . . . 2.34 2.44 2.48 2.30 1.83
Nonperforming assets to total assets . . . . 0.55 0.79 2.17 4.04 4.47
Allowance for loan losses to
nonperforming loans . . . . . . . . . . . 166.77 122.21 46.38 38.21 34.79
Allowance for loan losses to total loans . . 1.03 1.05 1.01 1.76 2.10
Net loan charge-offs to average loans. . . . 0.01 0.07 0.43 0.59 0.42
Tangible capital ratio . . . . . . . . . . . 5.11 5.41 5.05 4.89 4.32
Core capital ratio . . . . . . . . . . . . . 5.11 5.41 5.09 4.97 5.32
Risk-based capital ratio . . . . . . . . . . 9.94 10.45 10.08 10.21 10.57
</TABLE>
(1) Includes cumulative effect of change in accounting for goodwill of
($34,754,000).
4
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations
GENERAL
D&N Financial Corporation (D&N or the Company) is a savings bank holding
company whose sole subsidiary is D&N Bank (the Bank). D&N's primary focus is
the delivery of financial services through its community banking offices in
Michigan and consumer loan origination network in the Great Lakes states. This
discussion highlights important trends and events that have shaped the
Company's financial performance in 1996.
In 1996, D&N reported income, before one-time regulatory charges, of $13.1
million, or $1.58 per fully diluted share. Net income in 1995 was $10.4 million
or $1.31 per share and in 1994 the Company earned $3.4 million or $0.46 per
share.
D&N Bank incurred a one-time charge in 1996 as its mandated contribution to
replenish the Federal Deposit Insurance Corporation's (FDIC) depleted Savings
Association Insurance Fund (SAIF). The third quarter assessment was $5.5
million before consideration of its impact on federal taxes, and is expected to
reduce the Bank's annual deposit insurance premiums by approximately $1.6
million.
Also during the third quarter of 1996, the Bank recognized a $500,000
adjustment to its balance of deferred tax assets following the enactment in
August of federal legislation which resolved the recapture status of previously
allowed accelerated deductions for bad debts. Historically, thrift institutions
such as the Bank had been permitted to deduct a portion of their income as bad
debt allowances. This practice was more advantageous than the specific-loss
method of deduction which was mandated for other classes of financial
institutions. The opportunity to use the percentage-of-income method expired in
1995, but the status of previously accelerated deductions remained in question
until the 1996 legislation was enacted. Notably, the presence of unresolved
prior deductions was felt to be a hindrance to evolution and consolidation of
the financial services industry because thrift institutions that had recorded
such accelerated deductions were required to repay them before charter
conversions or acquisitions by non-thrift institutions could be approved. The
new legislation required that accelerated deductions recorded after 1987 would
have to be repaid, but forgave that portion of institutions' accelerated loan
loss deductions that were recorded before 1988.
Including the non-recurring charges associated with the recapitalization of the
SAIF and the recapture of previously recorded post-1987 bad debt deductions,
the Company's net income for 1996 was $9.0 million or $1.09 per fully-diluted
share.
On December 31, 1996, the Company's balance sheet included total assets of
$1.47 billion, compared to $1.23 billion at the end of 1995. This 20% growth
reflected primarily the Bank's loan origination success, with $518 million of
new loans funded in 1996. Outstanding loan balances totaled $1.07 billion at
December 31, 1996, an increase of 11% during the year. Mortgage backed
securities also increased by 97% to $251 million as the Bank securitized $120
million of its residential mortgage loan production with the Federal National
Mortgage Association (FNMA or Fannie Mae).
Equity and capital support for D&N's robust growth in 1996 came from the
retention of earnings and as a consequence of the Bank's merger, in April, with
Macomb Federal Savings Bank (Macomb). The acquisition, accounted for as a
pooling of interests, added retail deposits, a quality loan portfolio, and a
prime community banking location in St. Clair Shores, Michigan to the D&N
franchise. In addition, the strong capital base of Macomb helped to support the
robust loan production that D&N experienced throughout its networks.
In 1996 the Company made provisions for loan losses of $1.1 million, after
making provisions of $2.4 million and $100,000 in 1995 and 1994, respectively.
At December 31, 1996, the allowance for loan losses was $11.0
12
<PAGE> 3
million, or 1.03% of outstanding loans. D&N's portfolio of nonperforming assets
declined during 1996 by $1.6 million or 17% to $8.1 million. At December 31,
1996, the allowance for loan losses was 167% of the loans deemed to be
nonperforming. This ratio was 122% in 1995 and 46.4% in 1994.
Noninterest income from operations increased by 14.7% in 1996 after
experiencing a decline in 1995. In 1994 the Company sold a substantial portion
of its portfolio of purchased mortgage loan servicing rights, and focused its
servicing efforts on its own customers' loans. The increases in both loan
related and deposit related fee income experienced in 1996 reflects the
successful implementation of servicing strategies designed to complement the
Company's community banking focus.
Results of Operations
Net Interest Income
The Company's primary source of earnings is its net interest income, defined as
the difference between the interest earned on its loans and investments and the
interest paid on its deposits and other liabilities. Interest income and
interest expense each increased in 1996 as the average size of the Company's
earning assets grew substantially. Interest income increased by $13.5 million,
or 14.9%, in 1996. The average yield on earning assets increased by 2 basis
points to 7.95% in 1996, from 7.93% in 1995. In 1994, earning assets yielded
6.95%. Driving the interest income gains in 1996 was D&N's 14.7% increase in
average earning balances, while 1995's gains were more evenly attributable to
larger balances and higher average earning rates.
Interest expense increased by $5.5 million, or 9.9%, in 1996 as the average
balance of interest-bearing liabilities increased by 14.6%, more than
off-setting the 22 basis point decrease in the average rate paid on those
liabilities. In 1996, interest-bearing liabilities had an average cost of
4.93%, compared to 5.15% in 1995 and 4.89% in 1994. Because the average yield
on interest-earning assets increased and the average cost of interest-bearing
liabilities decreased in 1996, the Company's interest rate spread increased
from 2.79% in 1995 to 3.02% in 1996. In 1994 the spread was 2.06%. Similarly,
the Bank's net interest margin, or ratio of net interest income to average
interest-earning assets, increased from 3.04% in 1995 to 3.26% in 1996. In 1994
the net interest margin was 2.31%. Average interest-earning assets exceeded
average interest-bearing liabilities by $64.5 million in 1996 compared to $55.3
million in 1995 and $52.1 million in 1994.
Spread and margin improvements in 1996 reflect the expiration, in late 1995, of
the last of the Company's portfolio of interest rate exchange agreements. In
1995 those contracts added 23 basis points to the average cost of interest
bearing liabilities, while the burden was 100 basis points in 1994.
Average balances of loans outstanding were higher in 1996 than 1995, as the
Company's loan originations increased significantly. Average balances of
mortgage-backed securities were slightly higher, while the investment
securities category declined. Loans increased by $169.7 million, or 19.0%;
mortgage-backed securities increased by $6.5 million, or 4.6%; and investment
securities declined by $7.6 million, or 6.8%. Average earning rates on loans
and mortgage-backed securities were lower in 1996 than 1995, while the average
earning rate on the investment portfolios increased modestly. In 1996, loans
earned an average yield of 8.11% compared to 8.13% in 1995. Mortgage-backed
securities earned an average of 7.46% in 1996, versus an average rate of 7.55%
in 1995. Investment securities earned 6.96% in 1996, up from 6.85% in 1995.
Even though average loan yields fell from the previous year, overall
earning-asset performance increased as a greater proportion of the
earning-asset portfolio was comprised of more profitable loan assets in 1996
than in 1995.
13
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations (continued)
The average balances of loan assets and mortgage-backed securities also
increased from 1994 to 1995. As in 1996, average investment balances fell in
1995, reflecting the Company's application of surplus liquidity assets to fund
loan growth.
Average deposit balances increased 10.1% to $938 million in 1996, from $852
million in 1995. The average cost of deposits increased 14 basis points, to
4.67%, in 1996, from 4.53% in 1995. From 1994 to 1995, average deposit balances
increased by $30 million, or 3.7%. In 1994, the average cost of deposits was
3.63%.
The average balance of borrowed funds increased by 31.0%, to $310 million in
1996, from $236 million in 1995. In 1994, the average balance of borrowed funds
was $155 million.
The following tables set forth the extent to which the Company's net interest
income has been affected by changes in average interest rates and average
balances of interest-earning assets and interest-bearing liabilities:
<TABLE>
<CAPTION>
Years Ended December 31, 1996 and 1995
----------------------------------------------------------------------------------
Average balance (1) Average rate Interest Variance due to: (2)
----------------------------------------------------------------------------------
Increase
1996 1995 1996 1995 1996 1995 (Decrease) Volume Rate
- ---------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (3) . . . . . . . . . . . . $1,062,108 $ 892,364 8.11% 8.13% $ 86,151 $72,550 $13,601 $13,767 ($166)
Mortgage-backed securities (4) 146,560 140,093 7.46 7.55 10,930 10,577 353 484 (131)
Investments and deposits (4) 103,848 111,476 6.96 6.85 7,228 7,638 (410) (525) 115
----------------------------------------------------------------------------------
1,312,516 1,143,933 7.95 7.93 104,309 90,765 13,544 13,726 (182)
----------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits . . . . . . . . . . . . 938,484 852,382 4.67 4.53 43,859 38,639 5,220 4,020 1,200
Borrowings . . . . . . . . . . . 309,516 236,242 5.71 6.29 17,687 14,855 2,832 4,283 (1,451)
Interest rate instruments . . . . -- -- -- 0.23 -- 2,521 (2,521) -- (2,521)
----------------------------------------------------------------------------------
1,248,000 1,088,624 4.93 5.15 61,546 56,015 5,531 8,303 (2,772)
----------------------------------------------------------------------------------
Interest rate spread . . . . . . . . 3.02 2.79
Excess average earning assets. . . . $ 64,516 $ 55,309 7.95% 7.93%
==================================
Net interest margin . . . . . . . . 3.26% 3.04% $ 42,763 $34,750 $ 8,013 $ 5,423 $2,590
===========================================================
<CAPTION>
Years Ended December 31, 1995 and 1994
----------------------------------------------------------------------------------
Average balance (1) Average rate Interest Variance due to:(2)
----------------------------------------------------------------------------------
Increase
1995 1994 1995 1994 1995 1994 (Decrease) Volume Rate
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Interest-earning assets:
Loans (3) . . . . . . . . . . . . $ 892,364 $ 769,733 8.13% 7.57% $72,550 $58,274 $14,276 $9,744 $4,532
Mortgage-backed securities (4) 140,093 135,669 7.55 5.80 10,577 7,875 2,702 264 2,438
Investments and deposits (4) 111,476 124,271 6.85 4.40 7,638 5,462 2,176 (611) 2,787
----------------------------------------------------------------------------------
1,143,933 1,029,673 7.93 6.95 90,765 71,611 19,154 9,397 9,757
----------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits . . . . . . . . . . . . 852,382 822,112 4.53 3.63 38,639 29,806 8,833 1,134 7,699
Borrowings . . . . . . . . . . . 236,242 155,420 6.29 5.28 14,855 8,207 6,648 4,854 1,794
Interest rate instruments . . . . -- -- 0.23 1.00 2,521 9,812 (7,291) -- (7,291)
----------------------------------------------------------------------------------
1,088,624 977,532 5.15 4.89 56,015 47,825 8,190 5,988 2,202
----------------------------------------------------------------------------------
Interest rate spread . . . . . . . . 2.79 2.06
Excess average earning assets. . . . $ 55,309 $ 52,141 7.93% 6.95%
==================================
Net interest margin 3.04% 2.31% $34,750 $23,786 $10,964 $3,409 $7,555
===========================================================
</TABLE>
(1) Based on average daily balances.
(2) Changes in interest income and interest expense attributable to changes in
both rate and volume have been attributed proportionately to the change
due to rate and the change due to volume.
(3) Loans on nonaccrual are included in the average balances shown above. The
variance due to rate includes the effect of such loans because no interest
is earned on such loans.
(4) Average rates on mortgage-backed and investment securities available for
sale are based on historical amortized cost balances.
14
<PAGE> 5
In 1995 and 1994, D&N's interest expense included the net costs of interest
rate hedging instruments. During 1995, contracts written in the 1980s to
exchange fixed interest payments for variable receipts ("interest rate swaps")
resulted in net charges to interest expense of $2.5 million. During 1994, these
costs totaled $9.8 million. The swap contracts, originally executed as hedges
against rising interest rates, have expired, with the final contract maturing
in November of 1995.
NONINTEREST INCOME
D&N's noninterest income includes recurring fees from loan and deposit-related
activities, recurring income from the marketing of assets that are originated
for sale, and non-recurring gains and losses from events such as securities
sales and sales of non-earning and depreciated assets.
D&N's loan and deposit-related fee income totaled $5.5 million in 1996, up
$506,000 or 10.1% from 1995, reflecting primarily the Bank's successful
introduction of a new line of retail checking account products.
In 1996, net loan servicing and administrative fees were unchanged from 1995 at
$1.9 million. Deposit-related fees, on the other hand, increased by 15.1% in
1996.
Gains on sales of loans totaled $1.0 million in 1996, up from $882,000 in 1995.
In 1996, $66.1 million of D&N's residential mortgages were sold to secondary
market investors, compared to $67.4 million in 1995. In each year, D&N Bank
retained the rights to service all of these loans.
Other income increased from $222,000 in 1995 to $470,000 in 1996 as D&N Bank's
subsidiary, Quincy Insurance Agency, successfully initiated sales of annuities
and other investment products.
NONINTEREST EXPENSE
General and administrative expenses in 1996 included $1.4 million of
non-recurring costs associated with the Bank's merger with Macomb Federal
Savings Bank. Excluding these costs, general and administrative expenses were
up by $1.5 million, or 5.1%, in 1996, following an increase of $2.0 million, or
7.6% in 1995. These increases reflect the costs of D&N's expanding retail
delivery network, as the number of Bank and D&N Mortgage Company offices
increased from 41 at the end of 1994 to 48 at the end of 1996.
In 1996, noninterest expense included $71,000 of net operating costs related to
other real estate owned (OREO). In 1995 and 1994, net recoveries on sales of
OREO properties exceeded operating costs resulting in credits in this category
of $1.0 million and $2.1 million, respectively.
In 1995 and 1994, D&N's noninterest expense included amortization costs for
goodwill associated with the Company's 1982 merger with First Federal Savings
and Loan Association of Flint, Michigan.
Excluding the FDIC's SAIF recapitalization assessment of $5.5 million, deposit
insurance premiums in 1996 were $2.4 million, unchanged from the 1995 level,
and down from $2.6 million in 1994.
INCOME TAXES
The Company's effective income tax rates were 3.74% in 1996, (19.16%) in 1995,
and 4.25% in 1994, primarily as a result of reductions in each year of a
portion of the valuation allowance for deferred tax assets provided in prior
years, when the Company incurred substantial net operating losses. The
valuation allowance has been eliminated as of December 31, 1996.
15
<PAGE> 6
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations (continued)
FINANCIAL CONDITION
BALANCE SHEET TRENDS
At December 31, 1996, D&N's assets totaled $1.47 billion, an increase of $245
million, or 20%, from the previous year end. The Company's balance sheet growth
has been fueled by substantial loan production and increased capitalization.
In 1996, net loans receivable increased by $104 million, or 10.9%, reflecting
continued strong demand for the Company's consumer loan products. Balances of
mortgage-backed securities increased $124 million, or 97%, primarily as a
consequence of securitization of $120 million of the Bank's residential
mortgage loans. All of the servicing rights for sold and securitized mortgages
were retained, resulting in an increase in the balances of loans serviced for
others from $278 million to $415 million during the year.
The Company's liabilities increased by 20%, or $230 million, to $1.39 billion
at December 31, 1996, compared to $1.16 billion at the end of 1995. Overall
deposit balances increased by 4.5%, or $41.2 million, while core deposits
experienced a 5.7% increase from $327.4 million at December 31, 1995, to $346.1
million at year end 1996. Borrowed funds increased by 87%, or $188 million, in
1996, while advance payments by borrowers and investors held in escrow
increased from $11.3 million to $11.8 million.
In 1996, D&N's stockholders' equity rose from $72.0 million to $86.1 million.
Profitable operations contributed $9.0 million to the Company's retained
earnings while the exercise of warrants and options resulted in $5.5 million of
net capital contributions in 1996. An additional source of equity in 1996 was
$1.2 million of excess market value attributable to investment and
mortgage-backed securities held for sale. In accordance with the provisions of
SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities,"
unrealized gains such as these are recorded in the stockholders' equity section
of the Company's Statement of Financial Condition, but are not recognized
through the Statement of Income.
Under its federal charter, the Bank must maintain adequate levels of capital to
assure the safety and soundness of its operations. At December 31, 1996, the
Bank had a tangible capital ratio of 5.11%, a core capital ratio of 5.11%, and
a risk-based capital ratio of 9.94%. D&N Bank's ratios continue to exceed the
levels specified in the Financial Institutions Reform, Recovery and Enforcement
Act (FIRREA) as minimally acceptable standards. At the close of 1996, those
minimum standards were tangible capital of 1.50%, core capital of 3.0% (with a
proposed regulation which would raise the core capital requirement to between
4.00% and 5.00%), and risk-based capital of 8.00%.
The Bank's primary regulator, the Office of Thrift Supervision (OTS), has
issued its final rules adding an interest rate risk component to the total
capital that certain rate-sensitive institutions must maintain. The rule
requires the OTS to measure an institution's interest rate risk as the
percentage change in market value of its portfolio resulting from a
hypothetical 200 basis point shift in interest rates. At December 31, 1996,
D&N's level of interest rate risk was such that no additional capital was
required.
LIQUIDITY AND CAPITAL RESOURCES
The OTS also requires that institutions maintain liquid assets in the form of
cash, short-term U.S. Government securities and other qualifying assets, in
amounts equal to at least 5% of net withdrawable accounts and borrowed funds
payable in one year or less. For the month of December 1996, the Bank's average
liquidity ratio was 6.61%, down from the December 1995 ratio of 8.3%.
16
<PAGE> 7
Borrowing capacity can be viewed as a supplemental source of liquidity for the
Bank. D&N's government bond and mortgage-backed securities portfolios include
high quality investment securities which are readily acceptable as collateral
for additional borrowed funds, obtainable from either the FHLB system or from
other financial institutions. Also, much of the Bank's residential mortgage
loan portfolio would be acceptable as collateral to support new advances from
the FHLB. In the aggregate, by virtue of its inventory of unpledged security
and mortgage loan collateral, D&N had approximately $180 million of unused
borrowing capacity at December 31, 1996.
LOAN PORTFOLIO
The following table categorizes the Bank's loans receivable for the past five
years:
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Residential mortgages . . . . . . . . . $ 600,923 $597,892 $526,572 $387,252 $457,196
Mortgages on income-producing property 85,619 89,176 115,162 131,372 173,122
Construction loans . . . . . . . . . . 39,673 41,056 19,900 12,558 2,222
Consumer loans . . . . . . . . . . . . 339,268 239,459 170,939 134,644 119,461
Commercial loans . . . . . . . . . . . 12,345 7,769 4,748 -- --
Allowance for losses. . . . . . . . . . (11,042) (10,081) (8,349) (11,570) (15,611)
Discounts, deferrals and other. . . . . (10,910) (12,912) (7,097) (7,547) (9,889)
-----------------------------------------------------
$1,055,876 $952,359 $821,875 $646,709 $726,501
=====================================================
</TABLE>
D&N's investment in loans increased by $104 million, or 10.9%, in 1996.
Consumer loans and commercial loans experienced the most significant percentage
increases, while residential mortgages grew at a more modest rate. The Bank's
investment in mortgages on income-producing properties decreased for the sixth
consecutive year and the year-end balance of construction loans was down
slightly from the previous year. Consumer loans increased by $99.8 million, or
41.7% in 1996. Commercial loans increased by $4.6 million, or 58.9%, while
residential mortgage loans increased during the year by $3.0 million, or 0.5%.
Mortgages on income-producing properties decreased by $3.6 million, or 4.0%, as
construction loan balances declined by $1.4 million, or 3.4%. At the end of
1996, 44% of the Company's loan balances were in consumer or commercial-related
loans, compared to a 38% weighting at the end of 1995.
D&N originated $518 million of loans in 1996, up $113 million, or 28.0% from
$405 million originated in 1995. Aggregate mortgage loan production was $228
million, an increase of $24 million, or 11.9%, from 1995. Construction lending
accounted for $42.9 million of this total, up 8.6% from $39.5 million in 1995.
Consumer loan production totaled $272 million in 1996, up by $76.5 million, or
39.2%, from 1995. Within the consumer category, home equity credit line (HECL)
production was again strong, increasing by $12.8 million, or 23.4%, over 1995.
CREDIT RISK MANAGEMENT AND PROVISION FOR
LOSSES ON LOANS AND OTHER ASSETS
At December 31, 1996, the Company's nonperforming assets totaled $8.1 million,
down from $9.7 million at the end of the previous year and $24.5 million at the
end of 1994. The 1996 balance was comprised of $6.6 million of nonperforming
loans and $1.5 million of other real estate owned (OREO). At the end of 1996,
nonperforming loans comprised just 0.62% of the loan portfolio, and the
allowance for loan losses stood at 167% of the total balances of nonperforming
loans.
17
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations (continued)
The following table traces the Company's nonperforming asset experience for the
last five years:
<TABLE>
<CAPTION>
December 31
----------------------------------------------------------------------------
1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonaccruing loans............................... $6,621 $8,225 $17,995 $30,102 $44,703
Accruing loans delinquent more than 90 days..... -- 24 5 13 --
Restructured loans.............................. -- -- -- 166 167
----------------------------------------------------------------------------
Total nonperforming loans....................... 6,621 8,249 18,000 30,281 44,870
Other real estate owned (OREO).................. 1,470 1,452 6,520 13,312 11,186
----------------------------------------------------------------------------
Total nonperforming assets................... $8,091 $9,701 $24,520 $43,593 $56,056
============================================================================
Nonperforming loans as a percentage
of total loans............................... 0.62% 0.86% 2.17% 4.60% 6.05%
============================================================================
Nonperforming assets as a percentage of
total assets................................. 0.55% 0.79% 2.17% 4.04% 4.47%
============================================================================
Allowance for loan losses as a percentage of
nonperforming loans.......................... 166.77% 122.21% 46.38% 38.21% 34.79%
============================================================================
Allowances for loan and OREO losses as a
percentage of nonperforming assets........... 136.47% 105.29% 35.40% 28.03% 30.08%
============================================================================
</TABLE>
Allowances for losses on the loan portfolio increased by $1.0 million in 1996.
Losses of $1.5 million were charged off and $1.4 million were recovered, as new
provisions for loan losses of $1.1 million were recorded during the year. At
December 31, 1996, the allowance for loan losses was $11.0 million, 1.03% of
the total outstanding loan portfolio balance.
The following table details the changes in the Company's allowance for loan
losses for the last five years:
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------------------------
1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period............................ $10,081 $ 8,349 $11,570 $15,611 $18,744
Charge-offs:
Residential mortgages.................................. 314 169 110 1,136 329
Mortgages on income-producing property................. -- 1,019 3,109 2,584 2,180
Commercial loans....................................... -- -- -- -- --
Consumer loans......................................... 1,216 999 773 681 1,000
-------------------------------------------------------------------
1,530 2,187 3,992 4,401 3,509
Recoveries:
Residential mortgages.................................. 3 917 9 25 --
Mortgages on income-producing property................. 1,098 245 300 8 3
Commercial loans....................................... -- -- -- -- --
Consumer loans......................................... 290 357 362 327 256
-------------------------------------------------------------------
1,391 1,519 671 360 259
Net charge-offs........................................... 139 668 3,321 4,041 3,250
Provision charged to operations........................... 1,100 2,400 100 -- 117
-------------------------------------------------------------------
Balance at end of period.................................. $11,042 $10,081 $ 8,349 $11,570 $15,611
===================================================================
Net charge-offs as a percentage of average loans.......... 0.01% 0.07% 0.43% 0.59% 0.42%
===================================================================
Allowance for loan losses as a percentage
of total loans......................................... 1.03% 1.05% 1.01% 1.76% 2.10%
===================================================================
</TABLE>
18
<PAGE> 9
At the end of 1996, $6.3 million of the allowance for loan losses was allocated
to the commercial real estate mortgage portfolio while $3.5 million of the
allowance was allocated to the consumer loan portfolio. The following table
summarizes the allocation of the allowance for loan losses among the Company's
assets in each of the past five years:
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------------------
1996 1995 1994
---------------------------------------------------------------------------
PERCENTAGE Percentage Percentage
OF LOANS of loans of loans
AMOUNT TO TOTAL Amount to total Amount to total
- --------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential mortgages................... $ 859 57% $ 1,170 63% $ 813 63%
Mortgages on income-producing property.. 6,314 10 6,115 11 6,423 17
Commercial loans........................ 400 1 400 1 -- --
Consumer loans.......................... 3,469 32 2,396 25 1,113 20
-----------------------------------------------------------------------
$11,042 100% $10,081 100% $8,349 100%
=======================================================================
<CAPTION>
--------------------------------------------------
1993 1992
--------------------------------------------------
Percentage Percentage
of loans of loans
Amount to total Amount to total
- -------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Residential mortgages................... $ 429 60% $ 380 63%
Mortgages on income-producing property.. 9,617 19 13,353 21
Commercial loans........................ -- -- -- --
Consumer loans.......................... 1,524 21 1,878 16
----------------------------------------------
$11,570 100% $15,611 100%
==============================================
</TABLE>
ANALYSIS OF CASH FLOWS
The Company's balances of cash and cash equivalents declined from $22.4 million
to $12.8 million in 1996. During the year, $235 million of cash was provided
from financing activities, primarily from expanded borrowings and increases in
customers' deposit balances. Investing activities utilized $272 million of
available cash and cash equivalents as loan purchases, mortgage-backed security
purchases, and purchases of investment securities exceeded repayments in these
categories. Operating activities provided $27.0 million of net cash in 1996.
ASSET/LIABILITY MANAGEMENT
The Company's objectives for the management of assets and liabilities include
achieving and maintaining adequate and stable levels of both net interest
income and market value for the Company's net assets. The level of net interest
income that can be attained is enhanced by assuming credit, liquidity and
interest rate risks and by striving to keep nonearning asset balances to a
minimum. Net interest income and market value of portfolio equity (MVPE)
stability is enhanced across various interest rate scenarios by properly
matching maturity structures of assets and liabilities.
19
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations (continued)
The Company employs various tools, including gap analysis, duration analysis
and simulation analysis, to assess the sensitivity of its net interest income
and MVPE to changes in interest rates. D&N's cumulative gap analysis for
December 31, 1996 is presented in the following table:
<TABLE>
<CAPTION>
Maturity
------------------------------------------------------------------------
0 to 3 4 to 12 1 to 5 Over 5
Months Months Years Years Total
- -------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Assets:
Cash and due from banks/others............... $ 12,789 $ -- $ -- $ -- $ 12,789
Investment securities........................ 23,003 50,255 24,178 22,341 119,777
Mortgage-backed certificates................. 16,455 51,140 94,574 89,087 251,256
Net loans receivable......................... 232,114 327,417 476,162 20,183 1,055,876
Other assets................................. 5,547 6,967 3,608 17,234 33,356
----------------------------------------------------------------------
Total assets............................ $ 289,908 $ 435,779 $598,522 $148,845 $1,473,054
======================================================================
Liabilities:
Deposits..................................... $ 181,095 $ 335,659 $312,376 $135,003 $ 964,133
FHLB advances and other borrowed money....... 299,280 60,719 43,035 1,003 404,037
Escrow funds................................. -- -- -- 11,808 11,808
Other liabilities............................ -- -- -- 6,955 6,955
----------------------------------------------------------------------
Total liabilities....................... 480,375 396,378 355,411 154,769 1,386,933
----------------------------------------------------------------------
Stockholders' Equity:
Common stock................................. -- -- -- 84 84
Additional paid-in capital................... -- -- -- 55,452 55,452
Retained earnings and other.................. -- -- -- 30,811 30,811
Treasury stock............................... -- -- -- (226) (226)
----------------------------------------------------------------------
Total liabilities and equit............. $ 480,375 $ 396,378 $355,411 $240,890 $1,473,054
======================================================================
Reprice difference.............................. $(190,467) $ 39,401 $243,111 $(92,045)
Cumulative gap.................................. $(190,467) $(151,066) $ 92,045 --
Percent of total assets......................... (12.93)% (10.26)% 6.25% --
======================================================================
</TABLE>
For each maturity category in the table above, the difference between
interest-earning assets and interest-bearing liabilities reflects an imbalance
between repricing opportunities for the two sides of the balance sheet. The
consequence of a negative cumulative gap at the end of one year suggests that,
if interest rates were to fall, the Company's earnings stream would be enhanced
as more liability balances would reprice to lower rates than would asset
balances. Similarly, the negative cumulative gap suggests that if interest
rates were to rise, liability costs would increase more quickly than asset
yields, placing negative pressure on earnings.
With a cumulative one-year gap of -10.3%, D&N's balance sheet is somewhat
liability sensitive. At year-end, however, 46.0% of the Bank's loan portfolio
carried variable or adjustable interest rates, and a growing proportion of the
fixed-rate loan portfolio was comprised of relatively shorter-term installment
consumer loans.
The balances presented reflect contractual repricings for certificates of
deposit. Certain demand deposit accounts and regular savings accounts, however,
have been classified as repricing beyond one year. While these accounts are
subject to immediate withdrawal, experience has shown them to be relatively
rate insensitive. If these accounts were included in the 0-3 month category,
the gap in that time frame would be negative $379 million and the cumulative
gap at twelve months would be negative $317 million.
20
<PAGE> 11
SIGNIFICANT LITIGATION
In 1989, the Financial Institutions Reform, Recovery and Enforcement Act
(FIRREA) was passed, significantly altering the regulatory environment in which
depository institutions in general, and the Company in particular, would
subsequently operate. A provision of the Act provided for the elimination, over
time, of one form of regulatory capital that many institutions, including D&N
Bank, had utilized in their capital structures. The phased elimination of
supervisory goodwill, an intangible asset previously created when Companies
such as D&N acquired weaker institutions at the request of Government-sponsored
deposit insurance funds, resulted in many of the affected companies
experiencing capital shortfalls. In D&N's case, $42 million of unamortized
supervisory goodwill was permitted to be counted as regulatory capital in 1989
at the time of the Act's passage, while $37 million remained in 1993 when its
phase-out as qualifying capital was complete. The loss of this significant
portion of D&N's regulatory capital base precipitated drastic changes in the
Company's strategic plans, including the 56% shrinkage of the balance sheet
from $2.3 billion in 1988 to $1.0 billion in 1993, the closure of the Company's
national network of mortgage origination offices, the elimination of many jobs,
and the cessation of stockholder dividends.
A number of institutions, including D&N, that were adversely affected by the
FIRREA legislation subsequently initiated legal actions against the United
States. The institutions have claimed that the inducements offered by federal
regulatory agencies to acquire weakened or insolvent thrifts constituted
contractual guarantees that the goodwill created through the acquisition
transactions would qualify as regulatory capital. FIRREA's mandated phase-out
of regulatory capital treatment for supervisory goodwill, then, has been
alleged to be a breach of a contract right. The United States Court of Federal
Claims has registered approximately 120 similar cases, including D&N's, which
seek damages for such breach.
Early cases were bifurcated into questions of liability and damages, with the
trial courts reasoning that, until the question of the government's liability
was unequivocally established, efforts to determine damages or to develop
damage theories were potentially irrelevant. Three early cases have proceeded
through the Court of Claims, and after consolidation, through the Federal
Circuit of the United States Court of Appeals, and the United States Supreme
Court. In July of 1996, the Supreme Court found generally that the United
States was liable for damages under a theory of contractual breach, and that
claims of governmental immunity were not applicable in these cases. The cases
were remanded to the Court of Claims where arguments concerning the extent of
damages are scheduled to begin on March 17, 1997.
In consideration of the complexities of the pending litigation, the similarity
of issues in the various cases, and the potential magnitude of the damage
amounts that might ultimately be awarded, the Court of Claims has issued a case
management order on the remaining cases, in essence creating an orderly
procedure for these lawsuits to proceed. At this time estimation of potential
damages from this action is speculative.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS 125 provides accounting and reporting
standards for the subject matter based on consistent application of a financial
component's approach that focuses on control. The standard will be adopted
effective January 1, 1997 and is not expected to have any material effect on
the financial statements.
In March 1997, the FASB issued SFAS 128, "Earnings Per Share". SFAS 128
supersedes APB 15, "Earnings Per Share", and simplifies the computation of
earnings per share ("EPS") by replacing the "primary" EPS requirements of APB
15 with a "basic" EPS computation based upon weighted shares outstanding. The
new standard requires a dual presentation of basic and diluted EPS. Diluted EPS
is similar to "fully diluted" EPS required under APB 15. The Company will adopt
the provisions of this statement, as required, in 1997.
21
<PAGE> 12
REPORT OF INDEPENDENT AUDITORS
[COOPERS & LYBRAND LETTERHEAD]
BOARD OF DIRECTORS AND STOCKHOLDERS
D&N FINANCIAL CORPORATION
We have audited the Consolidated Statements of Condition of D&N Financial
Corporation and Subsidiary as of December 31, 1996 and 1995, and the related
Consolidated Statements of Income, Stockholders' Equity and Cash Flows for each
of the three years in the period ending 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.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of D&N Financial
Corporation and Subsidiary at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the period
ending December 31, 1996, in conformity with generally accepted accounting
principles.
Coopers & Lybrand LLP
Detroit, Michigan
January 22, 1997
22
<PAGE> 13
CONSOLIDATED STATEMENTS OF CONDITION
D&N FINANCIAL CORPORATION
<TABLE>
<CAPTION>
December 31
----------------------
1996 1995
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and due from banks........................................................ $ 2,847 $ 9,264
Federal funds sold............................................................. 8,600 --
Interest-bearing deposits in other banks....................................... 1,342 13,176
---------------------------
Total cash and cash equivalents............................................ 12,789 22,440
Investment securities
(market value of $60,783,000 in 1996 and $55,368,000 in 1995).............. 60,739 55,239
Investment securities available for sale (at market value)..................... 59,038 41,197
Mortgage-backed securities
(market value of $213,304,000 in 1996 and $73,647,000 in 1995)............. 214,690 72,668
Mortgage-backed securities available for sale (at market value)................ 36,566 55,041
Loans receivable (including loans held for sale of $5,218,000 in 1996
and $21,713,000 in 1995).................................................. 1,066,918 962,440
Allowance for loan losses...................................................... (11,042) (10,081)
---------------------------
Net loans receivable....................................................... 1,055,876 952,359
Other real estate owned, net................................................... 1,470 1,319
Federal income taxes........................................................... 6,002 5,374
Office properties and equipment, net........................................... 15,764 14,850
Other assets................................................................... 10,120 8,010
---------------------------
$ 1,473,054 $ 1,228,497
===========================
LIABILITIES
Checking and NOW accounts...................................................... $ 107,550 $ 91,621
Money market accounts.......................................................... 89,321 86,080
Savings deposits............................................................... 149,226 149,728
Time deposits.................................................................. 617,102 594,044
Accrued interest............................................................... 934 1,459
---------------------------
Total deposits............................................................. 964,133 922,932
Securities sold under agreements to repurchase................................. 58,040 --
FHLB advances and other borrowed money......................................... 345,997 216,295
Advance payments by borrowers and investors held in escrow..................... 11,808 11,329
Other liabilities.............................................................. 6,955 5,962
---------------------------
Total liabilities.......................................................... 1,386,933 1,156,518
STOCKHOLDERS'EQUITY
Preferred stock (1,000,000 shares authorized; none issued)..................... -- --
Common stock, $.01 par value per share (shares authorized - 25,000,000;
shares outstanding - 8,370,494 in 1996 and 7,497,305 in 1995).............. 84 75
Additional paid-in capital..................................................... 55,452 49,936
---------------------------
Total paid-in capital...................................................... 55,536 50,011
Retained earnings - substantially restricted................................... 29,568 20,573
Less: Cost of Treasury stock (22,339 shares in 1996 and 21,456 in 1995)....... (226) (257)
Less: Leveraged ESOP debt...................................................... -- (63)
Unrealized holding gains on debt securities available for sale, net of tax..... 1,243 1,715
---------------------------
Total stockholders' equity................................................. 86,121 71,979
---------------------------
$ 1,473,054 $ 1,228,497
===========================
</TABLE>
See Notes to Consolidated Financial Statements.
23
<PAGE> 14
CONSOLIDATED STATEMENTS OF INCOME
D&N FINANCIAL CORPORATION
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share )
<S> <C> <C> <C>
INTEREST INCOME
Loans.......................................................... $ 86,151 $ 72,550 $ 58,274
Mortgage-backed securities..................................... 10,930 10,577 7,875
Investments and deposits....................................... 7,228 7,638 5,462
-----------------------------------------
TOTAL INTEREST INCOME...................................... 104,309 90,765 71,611
INTEREST EXPENSE
Deposits....................................................... 43,859 38,639 29,806
Securities sold under agreements to repurchase................. 2,193 1,450 808
FHLB advances and other borrowed money......................... 15,494 13,405 7,399
Interest rate instruments...................................... -- 2,521 9,812
-----------------------------------------
TOTAL INTEREST EXPENSE..................................... 61,546 56,015 47,825
-----------------------------------------
NET INTEREST INCOME........................................ 42,763 34,750 23,786
Provision for loan losses...................................... 1,100 2,400 100
-----------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSS.......... 41,663 32,350 23,686
NONINTEREST INCOME
Loan servicing and administrative fees, net.................... 1,914 1,882 2,228
Deposit related................................................ 3,621 3,147 3,098
Gain on sale of loans held for sale............................ 1,031 882 227
Other.......................................................... 470 222 1,173
-----------------------------------------
TOTAL OPERATING NONINTEREST INCOME......................... 7,036 6,133 6,726
Gain (loss) on investment securities available for sale........ 188 (120) (221)
Gain on sale of loans and mortgage-backed securities
available for sale......................................... -- 899 843
Gain on sale of loan servicing rights.......................... -- -- 140
-----------------------------------------
TOTAL NONINTEREST INCOME................................... 7,224 6,912 7,488
NONINTEREST EXPENSE
Compensation and benefits...................................... 16,881 15,732 14,581
Occupancy...................................................... 2,834 2,273 1,987
Other expense.................................................. 11,863 10,713 10,122
-----------------------------------------
GENERAL AND ADMINISTRATIVE EXPENSE......................... 31,578 28,718 26,690
Other real estate owned, net................................... 71 (999) (2,136)
Amortization of intangibles.................................... -- 370 448
FDIC insurance................................................. 7,894 2,431 2,639
-----------------------------------------
TOTAL NONINTEREST EXPENSE.................................. 39,543 30,520 27,641
-----------------------------------------
INCOME BEFORE INCOME TAX EXPENSE........................... 9,344 8,742 3,533
Federal income tax expense (credit)............................ 349 (1,675) 150
-----------------------------------------
NET INCOME................................................. $ 8,995 $ 10,417 $ 3,383
=========================================
Earnings per common and common equivalent share:
Primary.................................................... $ 1.11 $ 1.35 $ 0.46
=========================================
Fully Diluted.............................................. $ 1.09 $ 1.31 $ 0.46
=========================================
</TABLE>
See Notes to Consolidated Financial Statements.
24
<PAGE> 15
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
D&N FINANCIAL CORPORATION
<TABLE>
<CAPTION>
Unrealized
Holding
Gains
Treasury (Losses) on
Additional Stock & Leveraged Securities Total
Common Paid-In Retained Treasury ESOP Available Stockholders'
Stock Capital Earnings Warrants Debt for Sale Equity
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance December 31, 1993................... $ 74 $ 49,580 $ 6,773 $ (213) $ (135) $ 808 $ 56,887
Net income.................................. -- -- 3,383 -- -- -- 3,383
Issuance of common stock
upon exercise of stock options
and warrants - 1,390 shares........... -- 11 -- -- -- -- 11
Reduction of leveraged ESOP debt............ -- -- -- -- 36 -- 36
Change in value of securities
available for sale.................... -- -- -- -- -- (1,992) (1,992)
--------------------------------------------------------------------------------
Balance December 31, 1994................... $ 74 $ 49,591 $ 10,156 $ (213) $ (99) $(1,184) $ 58,325
Net income.................................. -- -- 10,417 -- -- -- 10,417
Issuance of common stock upon
exercise of stock options and
warrants - 55,351 shares.............. 1 345 -- -- -- -- 346
Purchase of 10,000 warrants................. -- -- -- (44) -- -- (44)
Reduction of leveraged ESOP debt............ -- -- -- -- 36 -- 36
Change in value of securities
available for sale.................... -- -- -- -- -- 2,899 2,899
--------------------------------------------------------------------------------
Balance December 31, 1995................... $ 75 $ 49,936 $ 20,573 $ (257) $ (63) $ 1,715 $ 71,979
Net income.................................. -- -- 8,995 -- -- -- 8,995
Issuance of common stock upon
exercise of stock options
and warrants - 873,189 shares......... 9 9,046 -- -- -- -- 9,055
Net purchase of Treasury stock
and warrants.......................... -- -- -- (3,499) -- -- (3,499)
Reissuance of 232,955
Treasury shares....................... -- (3,530) -- 3,530 -- -- --
Reduction of leveraged ESOP debt............ -- -- -- -- 63 -- 63
Change in value of securities
available for sale.................... -- -- -- -- -- (472) (472)
--------------------------------------------------------------------------------
Balance December 31, 1996................... $ 84 $ 55,452 $ 29,568 $ (226) $ -- $ 1,243 $ 86,121
================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
25
<PAGE> 16
CONSOLIDATED STATEMENTS OF CASH FLOWS
D&N FINANCIAL CORPORATION
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income............................................................ $ 8,995 $ 10,417 $ 3,383
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses............................................ 1,100 2,400 100
Depreciation and amortization of office properties and equipment..... 1,954 1,843 1,841
Amortization of net premiums (discounts) on purchased
loans and securities................................................ (73) (2,395) 1,132
Originations and purchases of loans held for sale.................... (56,132) (91,203) (15,432)
Proceeds from sales of loans held for sale........................... 73,658 75,928 48,181
(Gain) loss on investment securities available for sale.............. (188) 120 221
Gain on loans and mortgage-backed securities available for sale...... -- (899) (843)
Gain on sale of loan servicing rights................................ -- -- (140)
Amortization and writedowns of mortgage servicing rights............. 300 476 1,754
Other................................................................ (2,635) (7,888) 2,657
------------------------------------------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES................... 26,979 (11,201) 42,854
INVESTING ACTIVITIES
Proceeds from sales of investment securities available for sale...... 298 10,070 20,779
Proceeds from maturities of investment securities.................... 83,970 44,025 138,879
Purchases of investment securities to be held to maturity............ (107,012) (60,309) (135,304)
Proceeds from sales of mortgage-backed securities available for sale. -- 4,145 52,348
Proceeds from sales of loans......................................... -- 33,535 --
Principal collected on mortgage-backed securities.................... 54,951 22,077 38,860
Purchases of mortgage-backed securities.............................. (58,661) -- (66,922)
Loans purchased...................................................... (148,405) (103,524) (190,333)
Net change in loans receivable....................................... (94,006) (43,299) (20,931)
(Increase) decrease in other real estate owned....................... (151) 4,871 6,472
Proceeds from sales of loan servicing rights......................... -- -- 7,288
Purchases of office properties and equipment......................... (2,868) (2,333) (785)
------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES.............................. (271,884) (90,742) (149,649)
FINANCING ACTIVITIES
Net change in time deposits.......................................... 23,058 94,581 5,863
Net change in other deposits......................................... 18,666 10,510 (31,070)
Proceeds from notes payable, securities sold under agreements
to repurchase and other borrowed money............................. 309,040 203,000 255,627
Payments on maturity of notes payable, securities sold under
agreements to repurchase and other borrowed money.................. (121,482) (213,851) (130,652)
Net change in advance payments by borrowers and investors
held in escrow..................................................... 479 (4,022) (51,626)
Proceeds from issuance of stock...................................... 9,055 346 11
Purchases of Treasury stock/warrants................................. (3,499) (44) --
Reduction of leveraged ESOP debt..................................... (63) (36)
------------------------------------------
Net cash provided by financing activities.......................... 235,254 90,484 48,117
------------------------------------------
Decrease in cash and cash equivalents.............................. (9,651) (11,459) (58,678)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR........................ 22,440 33,899 92,577
------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR........................... $ 12,789 $ 22,440 $ 33,899
==========================================
Supplemental disclosures of cash flow information:
Interest paid...................................................... $ 61,689 $ 60,222 $ 49,937
Income taxes paid (refunded)....................................... $ 299 397 (4,650)
Noncash investing activities:
Transfer of loans to other real estate owned....................... $ 3,373 $ 1,936 $ 2,861
Loans to facilitate sale of other real estate owned................ $ -- $ -- $ 782
Securitization of loans into mortgage-backed securities............ $119,717 $ -- $ 15,086
</TABLE>
See Notes to Consolidated Financial Statements.
26
<PAGE> 17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
D&N Financial Corporation, December 31, 1996
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
D&N Financial Corporation ("the Company") is a financial services holding
company whose sole subsidiary is D&N Bank ("the Bank"), a federally-chartered
stock savings bank. D&N Financial Corporation's primary business is the
delivery of financial services to consumers and businesses through its network
of 48 community banking and financial services offices in Michigan.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements
include the accounts and transactions of the Company and the Bank and the
Bank's wholly-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents represent short-term
highly liquid investments with original maturities of three months or less and
include cash, demand deposits in other banks and interest-bearing deposits in
other banks.
INVESTMENT CLASSIFICATIONS: Securities are classified as either held to
maturity (amortized cost), available for trading (fair value, with unrealized
gains and losses reported in income), or available for sale (fair value, with
unrealized gains and losses reported directly in equity, net of taxes).
INVESTMENT AND MORTGAGE-BACKED SECURITIES: Investment and mortgage-backed
securities which the Company has the ability and the intent to hold until
maturity are stated at amortized cost. Investment and mortgage-backed
securities available for sale are carried at fair value. Fair value
adjustments are included in stockholders' equity, net of tax. Gains or losses
realized on the sale of investment and mortgage-backed securities are
determined by the specific identification method and are included in securities
gains (losses). Interest income is adjusted using the level-yield method for
amortization of premiums and accretion of discounts.
MORTGAGE DERIVATIVE PRODUCTS: The Bank's interest only certificates are
classified as available for sale and are recorded at fair value. Fair value
adjustments are included in stockholders' equity and are classified on the
Statements of Condition with mortgage-backed securities.
ALLOWANCE FOR LOAN LOSSES: The Company adopted SFAS 114, "Accounting by
Creditors for Impairment of a Loan", as amended by SFAS 118, as of January 1,
1994. Under this standard, a loan is considered impaired, based on current
information and events, if it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
is generally based on the present value of expected future cash flows
discounted at the historical effective interest rate, except that all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral. The adoption of SFAS 114 did not result in any additional
provision for loan losses as of January 1, 1994.
The allowance for possible losses on loans is maintained at a level
believed adequate by management to absorb potential losses from impaired loans
as well as losses from the remainder of the portfolio. Management's
determination of the level of the allowance is based upon evaluation of the
portfolio, past experience, current economic conditions, size and composition
of the portfolio, collateral location and values, cash flow positions, industry
concentrations, delinquencies and other relevant factors.
MORTGAGE LOANS HELD FOR SALE: The Bank enters into commitments to
originate and does originate mortgage loans for sale to investors and in the
secondary market.
Loans held for sale are carried at the lower of cost or market value,
determined on an aggregate basis. Commitment fees are amortized either over
the commitment period or the combined commitment and loan period depending upon
the probability of performance under the commitment.
27
<PAGE> 18
INTEREST ON LOANS: interest on loans is credited to income when earned.
An allowance for interest on loans is provided when management considers the
collection of these loans doubtful and the accrual of interest is suspended
when a loan becomes more than 90 days past due.
LOAN FEES: loan origination and commitment fees and certain direct loan
origination costs are deferred and recognized over the lives of the related
loans as an adjustment of the yields using the level-yield method.
OTHER REAL ESTATE OWNED: Real estate acquired through foreclosure and
similar proceedings is recorded at the lower of the related loan balance or
estimated fair value of the property at the acquisition date. Subsequent to
the acquisition date, properties are carried at their fair value, less cost to
sell. Operating expenses of such properties, net of any income, are charged to
expense.
DEPRECIATION: Provisions for depreciation are computed using the
straight-line method over the estimated useful lives of office properties and
equipment.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The Company enters into
sales of investment and mortgage-backed securities under agreements to
repurchase the same or essentially identical securities. The agreements are
short-term and are accounted for as secured borrowings. The obligations to
repurchase securities sold are reflected as a liability , and the securities
which collateralize the agreements are reflected as an asset in the Statement
of Condition.
INTEREST RATE INSTRUMENTS: Interest rate instruments are used to adjust
the maturity structure of liabilities and assets to manage the Company's
exposure to fluctuating interest rates. These instruments include interest
rate exchange agreements and interest rate floors and caps. These instruments
are used only to hedge specifically identified assets and liabilities and not
for speculative purposes. Fees associated with swaps, floors and caps are
amortized to expense on a straight-line basis over the lives of the agreements.
Gains or losses upon termination of these instruments are deferred and
amortized over the shorter of the remaining term to maturity of the related
hedged asset or liability or the remaining life of the instrument. Interest
paid or received associated with interest rate swap, floor or cap agreements,
is reflected as a component of net interest margin. At December 31, 1996 and
1995, the Company was not party to any interest rate instruments.
MORTGAGE SERVICING RIGHTS: The Company services mortgage loans for
investors. Fees earned for and in connection with this activity are recognized
as income when the related mortgage payments are received. Mortgage servicing
costs are charged to expense as incurred.
In May 1995, the Financial Accounting Standards Board issued SFAS 122,
"Accounting For Mortgage Servicing Rights", which requires the Company to
recognize as separate assets rights to service mortgage loans for others,
however those servicing rights are acquired. As the Company acquires mortgage
servicing rights through either the purchase or origination of mortgage loans
and sells or securitizes those loans with servicing rights retained, it must
allocate the total cost of the mortgage loans to the mortgage servicing rights
and the loans (without the mortgage servicing rights) based on their relative
fair values. The capitalized cost of mortgage servicing rights is amortized in
proportion to, and over the period of, estimated net servicing income
(servicing revenue in excess of servicing costs).
Capitalized mortgage servicing rights are periodically assessed for
impairment based on the fair value of those rights calculated on a discounted
basis. This assessment is performed on a disaggregate basis, stratified by
mortgage type, term and rate. Identified impairments are recognized through a
valuation allowance.
As permitted by SFAS 122, the Company adopted the provisions of the
Statement effective July 1, 1995. The effect of adopting SFAS 122 was to
increase net income for the year ended December 31, 1995 by $621,000 or $0.08
per share.
INCOME TAXES: The Company uses the liability method in accounting for
income taxes. Under this method, deferred income taxes result from temporary
differences between the tax bases of assets and liabilities and the bases
reported in the consolidated financial statements. The deferred taxes are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
28
<PAGE> 19
PER SHARE DATA: Per share amounts are based on the weighted average
number of shares outstanding during the year. For 1996, 1995 and 1994 there
were 8,080,333, 7,718,700 and 7,419,636 average shares outstanding,
respectively, used in computing primary earnings per share. For 1996, 1995 and
1994 there were 8,229,812, 7,932,142 and 7,419,636 average shares outstanding,
respectively, used in computing fully diluted earnings per share.
RECLASSIFICATIONS: Certain amounts in previously issued consolidated
financial statements have been reclassified to conform with the current year
presentation.
NOTE B: BUSINESS COMBINATION
On April 10, 1996, Macomb Federal Savings Bank ("Macomb") was merged into the
Company. The Company issued 716,497 shares of common stock and cash in lieu of
fractional shares for all of the outstanding shares of Macomb. At the time of
the merger, Macomb had assets and stockholders' equity (unaudited) of
$41,932,000 and $6,268,000, respectively. The merger was accounted for as a
pooling-of-interests and accordingly, the financial statements, have been
restated to include the results of Macomb.
A reconciliation of previously reported net interest income and net income is
as follows:
<TABLE>
<CAPTION>
1995 1994
- -----------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share)
<S> <C> <C>
Net interest income (as previously reported).............. $33,632 $22,614
Macomb Federal Savings Bank - net interest income......... 1,118 1,172
---------------------------------------
Total net interest income............................. $34,750 $23,786
=======================================
Net income (as previously reported)....................... $10,140 $ 3,091
Macomb Federal Savings Bank - net income.................. 277 292
---------------------------------------
Total net income...................................... $10,417 $ 3,383
=======================================
</TABLE>
A reconciliation of previously reported per share income is as follows:
<TABLE>
<CAPTION>
1995 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Primary earnings per share:
Net income (as previously reported)................... $ 1.45 $ 0.46
Macomb Federal Savings Bank........................... (0.10) --
---------------------------------------
Primary earnings per share....................... $ 1.35 $ 0.46
=======================================
Fully diluted earnings per share:
Net income (as previously reported)................... $ 1.40 $ 0.46
Macomb Federal Savings Bank........................... (0.09) --
---------------------------------------
Fully diluted earnings per share................. $ 1.31 $ 0.46
=======================================
</TABLE>
NOTE C: RESTRICTIONS ON CASH AND NONINTEREST-BEARING BALANCES
The Company is required to maintain reserve balances with the Federal Reserve
Bank. The average amounts of those reserve balances for the year ended
December 31, 1996 and December 31, 1995 were $418,000 and 491,000,
respectively.
29
<PAGE> 20
NOTE D: INVESTMENT SECURITIES
Investment securities consisted of the following:
<TABLE>
<CAPTION>
December 31
------------------------------------------------------------
1996 1995
------------------------------------------------------------
BOOK MARKET Book Market
VALUE VALUE Value Value
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
U.S. Treasury securities......................... $ 40,737 $ 40,781 $ 35,100 $ 35,229
Other securities................................. 20 20 -- --
Investment in Federal Home Loan Bank stock....... 19,959 19,959 19,953 19,953
Other equity securities.......................... 23 23 186 186
-----------------------------------------------------------
Held to maturity............................. 60,739 60,783 55,239 55,368
U.S. Treasury securities......................... 57,996 58,000 40,656 40,899
Other securities................................. 1,032 1,038 110 298
Valuation allowances............................. 10 -- 431 --
-----------------------------------------------------------
Available for sale........................... 59,038 59,038 41,197 41,197
-----------------------------------------------------------
$119,777 $119,821 $ 96,436 $ 96,565
===========================================================
</TABLE>
An analysis of gross unrealized gains and losses is as follows:
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------
1996 1995
---------------------------------------------------------------
GROSS GROSS Gross Gross
UNREALIZED UNREALIZED Unrealized Unrealized
GAINS LOSSES Gains Losses
- -------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Held to maturity
U.S. Treasury securities ...................... $ 79 $ (35) $ 137 $ (7)
---------------------------------------------------------------
79 (35) 137 (7)
Available for sale
U.S. Treasury securities....................... 31 (27) 244 --
Other equity securities........................ 6 -- 187 --
---------------------------------------------------------------
37 (27) 431 --
---------------------------------------------------------------
$ 116 $ (62) $ 568 $ (7)
===============================================================
</TABLE>
Proceeds from sales of investment securities available for sale during 1996
were $298,000. Gross gains of $188,000 were realized on those sales. Proceeds
from sales of investment securities available for sale during 1995 were
$10,070,000. Gross losses of $120,000 were realized on those sales. Proceeds
from sales of investment securities available for sale during 1994 were
$20,779,000. Gross losses of $221,000 were realized on those sales.
The book value and market value of debt securities at December 31, 1996, by
contractual maturity, were as follows:
<TABLE>
<CAPTION>
Less than one year 1 - 5 Years
------------------------------------------------------------------
Book Market Average Book Market Average
Value Value Yield Value Value Yield
- ------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities held to maturity............... $20,146 $20,165 5.93% $20,591 $20,616 6.02%
Other Securities held to maturity....................... -- -- -- 20 20 6.00
------------------------------------------------------------------
20,146 20,165 5.93 20,611 20,636 6.02
U.S. Treasury securities available for sale............. 53,975 53,959 5.62 4,021 4,041 6.33
------------------------------------------------------------------
$74,121 $74,124 5.71% $24,632 $24,677 6.07%
==================================================================
</TABLE>
30
<PAGE> 21
NOTE E : MORTGAGE-BACKED SECURITIES
Mortgage-backed securities consisted of the following:
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------
1996 1995
-----------------------------------------------------------
BOOK MARKET Book Market
VALUE VALUE Value Value
- --------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Government agency securities.................... $ 127,677 $ 126,576 $ 12,149 $ 12,451
Collateralized mortgage obligations............. 85,755 85,311 60,305 60,550
Accrued interest receivable..................... 1,417 1,417 646 646
Net discounts................................... (159) -- (432) --
-------------------------------------------------------------
Held to maturity.............................. 214,690 213,304 72,668 73,647
Government agency securities.................... 18,815 19,255 28,324 29,135
Collateralized mortgage obligations............. 14,767 15,005 22,810 23,110
Interest-only certificates...................... 639 2,023 984 2,400
Accrued interest receivable..................... 283 283 396 396
Net premiums.................................... 160 -- 421 --
Valuation allowances............................ 1,902 -- 2,106 --
-------------------------------------------------------------
Available for sale.......................... 36,566 36,566 55,041 55,041
-------------------------------------------------------------
$ 251,256 $ 249,870 $ 127,709 $ 128,688
=============================================================
</TABLE>
Mortgage-backed securities with a carrying value of $44,847,000 are
specifically pledged as collateral for advances from the Federal Home Loan Bank
of Indianapolis (FHLB). Mortgage-backed securities with a carrying value of
$9,160,000 are pledged as collateral for other borrowings.
An analysis of gross unrealized gains and losses is as follows:
<TABLE>
<CAPTION>
December 31
----------------------------------------------------------------
1996 1995
----------------------------------------------------------------
GROSS GROSS Gross Gross
UNREALIZED UNREALIZED Unrealized Unrealized
GAINS LOSSES Gains Losses
- -----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Government agency securities..................... $ 764 $ (2,119) $ 302 $ --
Collateralized mortgage obligations.............. 294 (325) 711 (34)
--------------------------------------------------------------
Held to maturity............................... 1,058 (2,444) 1,013 (34)
Government agency securities..................... 287 (11) 425 (16)
Collateralized mortgage obligations.............. 270 (28) 314 (33)
Interest-only certificates....................... 1,384 -- 1,416 --
---------------------------------------------------------------
Available for sale........................... 1,941 (39) 2,155 (49)
---------------------------------------------------------------
$ 2,999 $ (2,483) $ 3,168 $ (83)
===============================================================
</TABLE>
There were no sales of mortgage-backed securities during 1996. Proceeds from
sales of mortgage-backed securities available for sale during 1995 were
$4,145,000. Gross gains of $267,000 were realized on those sales. Proceeds
from sales of mortgage-backed securities available for sale during 1994 were
$52,348,000. Gross gains of $865,000 and gross losses of $22,000 were realized
on those sales.
31
<PAGE> 22
The book value and market value of mortgage-backed securities at December 31,
1996, by contractual maturity, were as follows :
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
----------------------------------------------------------------------
Book Market Average Book Market Average
Value Value Yield Value Value Yield
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Government agency securities
Less than one year........... $ -- $ -- --% $ -- $ -- --%
One to five years............ -- -- -- -- -- --
Five to ten years............ 1,832 1,778 6.78 -- -- --
After ten years.............. 126,099 124,798 7.10 18,979 19,255 6.64
-----------------------------------------------------------------------
127,931 126,576 7.09 18,979 19,255 6.64
Collateralized mortgage obligations
Less than one year........... -- -- -- -- -- --
One to five years............ -- -- -- -- -- --
Five to ten years............ 224 229 17.63 -- -- --
After ten years.............. 85,118 85,082 6.90 14,763 15,005 7.02
-----------------------------------------------------------------------
85,342 85,311 6.93 14,763 15,005 7.02
Interest-only certificates
Less than one year........... -- -- -- -- -- --
One to five years............ -- -- -- -- -- --
Five to ten years............ -- -- -- 5 16 430.67
After ten years.............. -- -- -- 634 2,007 110.68
-----------------------------------------------------------------------
-- -- -- 639 2,023 113.18
-----------------------------------------------------------------------
$213,273 $211,887 7.03% $34,381 $36,283 8.78%
========================================================================
</TABLE>
Mortgage-backed securities will mature according to the repayment
characteristics of the underlying mortgage loans which collateralize the
securities. Expected maturities for mortgage-backed securities will differ from
contractual maturities because borrowers have the right to prepay.
The aggregate book value and aggregate market value of the securities of any
one issuer, other than U.S. Government agencies, did not exceed 10% of
stockholders' equity at December 31, 1996 or 1995.
NOTE F: LOANS RECEIVABLE
The carrying amounts and fair values of loans receivable consisted of the
following:
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------
1996 1995
---------------------------------------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
- ----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Residential mortgages ........................ $ 592,712 $ 598,390 $ 573,089 $ 570,798
Residential mortgages held for sale .......... 5,218 5,218 21,713 21,963
Mortgages on income producing property ....... 84,983 79,704 88,491 79,985
Construction loans ........................... 39,535 39,404 40,882 37,160
Consumer loans ............................... 337,178 338,180 237,873 235,557
Commercial loans ............................. 12,262 11,959 7,717 7,298
Accrued interest receivable .................. 5,940 5,940 5,588 5,588
---------------------------------------------------------------
1,077,828 1,078,795 975,353 958,349
Less:
Discounts on purchased loans .............. (2,035) -- (1,709) --
Allowance for loan losses .................. 11,042 -- 10,081 --
Undisbursed portion of loan proceeds ....... 12,085 -- 13,198 --
Deferred income............................. 860 -- 1,424 --
---------------------------------------------------------------
$ 1,055,876 $1,078,795 $ 952,359 $ 958,349
===============================================================
</TABLE>
Credit is extended based on evaluation of the borrower's financial condition,
the value of the collateral and, in the case of income producing property, the
sufficiency of net cash flows from the property's operation to service the
debt. When loans are made to businesses, personal guarantees may also be
required of owners or partners.
32
<PAGE> 23
Loans collateralized by income producing property are categorized as follows:
<TABLE>
<CAPTION>
December 31
---------------------------
1996 1995
- -----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Multi-family apartments....................................... $ 25,404 $ 29,337
Motels/hotels................................................. 13,540 14,105
Shopping centers.............................................. 23,582 20,232
Mobile home parks............................................. 3,625 3,781
Offices....................................................... 6,667 8,698
Industrial.................................................... 4,565 6,584
Other......................................................... 7,600 5,754
---------------------------
$ 84,983 $ 88,491
===========================
</TABLE>
Loans collateralized by income producing property categorized by state are as
follows:
<TABLE>
<CAPTION>
December 31
---------------------------
1996 1995
- -----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Michigan...................................................... $ 65,645 $ 67,048
California.................................................... 11,738 12,202
New York...................................................... 2,037 3,413
Pennsylvania.................................................. 607 1,396
Other......................................................... 4,956 4,432
---------------------------
$ 84,983 $ 88,491
===========================
</TABLE>
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year................................. $ 10,081 $ 8,349 $ 11,570
Provision for loan losses.................................... 1,100 2,400 100
Transfers.................................................... -- -- 300
Net charge-offs.............................................. (139) (668) (3,621)
-----------------------------------------
Balance at end of year................................... $ 11,042 $ 10,081 $ 8,349
=========================================
</TABLE>
At December 31, 1996 and 1995, the total recorded investment in impaired
loans, as defined by SFAS 114, was $7,241,000 and $8,619,000, respectively. In
1996 the amount of the recorded investment in impaired loans for which there is
a related allowance for loan losses is $145,000, and the amount of the recorded
investment for which there is no related allowance for loan losses is
$7,096,000. In 1995 none of the impaired loans required a specific allowance
for loan losses. Interest income on impaired loans is recognized primarily on
a cash basis. During 1996 and 1995, the amount of interest income recognized
on impaired loans was insignificant.The balance of nonaccrual loans was
$6,621,000 and $8,225,000 at December 31, 1996 and 1995, respectively.
Changes in capitalized mortgage servicing rights, included in other assets in
the Consolidated Statements of Condition, are summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year................................. $ 1,113 $ 968 $ 9,870
Additions.................................................... 630 621 --
Amortization, sales and writedowns........................... (300)
(476)
(8,902)
-----------------------------------------
Balance at end of year................................... $ 1,443 $ 1,113 $ 968
=========================================
</TABLE>
33
<PAGE> 24
Changes in the valuation allowance for mortgage servicing rights are summarized
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year...................................... $ 291 $ -- $ --
Additions:
Purchased morgage servicing rights............................ 151 222 --
Originated morgage servicing rights........................... 55 77 --
-----------------------------------------
Total additions .......................................... 206 299 --
Reductions:
Purchased morgage servicing rights............................ 158 8 --
Originated morgage servicing rights........................... 118 -- --
------------------------------------------
Total reductions ......................................... 276 8 --
Balance at end of year............................ $ 221 $ 291 $ --
==========================================
</TABLE>
At December 31, 1996 and 1995, the fair value of capitalized mortgage servicing
rights was $1,770,000 and $1,161,000 respectively.
Loans serviced for others amounted to $415,156,000, $278,051,000, and
$243,834,000 at December 31, 1996, 1995 and 1994, respectively.
NOTE G: OTHER REAL ESTATE OWNED
Other real estate owned (OREO) consisted of the following:
<TABLE>
<CAPTION>
December 31
-----------------------
1996 1995
- ----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Real estate acquired through foreclosure......................... $ 1,365 $ 1,226
Real estate in judgment.......................................... 105 226
-------------------------
1,470 1,452
Less allowance for losses........................................ -- 133
-------------------------
$ 1,470 $ 1,319
=========================
</TABLE>
Changes in the allowance for possible losses on OREO are summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year.................................... $ 133 $ 330 $ 650
Provision for losses............................................ -- 150 --
Net charge-offs................................................. (133) (347) (320)
------------------------------------------
Balance at end of year.......................................... $ -- $ 133 $ 330
==========================================
</TABLE>
The Company recorded writedowns of other real estate owned amounting to $75,000
during 1996. The Company did not record any writedowns of other real estate
owned in 1995 or 1994.
The Company recognized gains on sale of OREO amounting to $164,000, $1,139,000
and $2,407,000 during 1996, 1995 and 1994 respectively.
34
<PAGE> 25
NOTE H: OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are summarized as follows:
<TABLE>
<CAPTION>
December 31
-------------------------------------
1996 1995
- -------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Cost:
Land................................................. $ 2,634 $ 2,634
Buildings and improvements........................... 17,174 16,229
Furniture and equipment.............................. 16,839 15,780
--------------------------------------
36,647 34,643
Less accumulated depreciation.......................... 20,883 19,793
--------------------------------------
$ 15,764 $ 14,850
======================================
</TABLE>
Depreciation and amortization expense was $1,954,000, $1,843,000 and $1,841,000
in 1996, 1995 and 1994, respectively.
Rental expense for leased properties and equipment was $938,000, $643,000 and
$488,000 in 1996, 1995 and 1994, respectively. The aggregate minimum annual
rental commitments under these leases are approximately $1,003,000 in 1997,
$771,000 in 1998, $619,000 in 1999, $573,000 in 2000, $500,000 in 2001 and
$992,000 thereafter.
NOTE I: DEPOSITS
The carrying amounts and fair values of deposits and the nominal rate of
interest paid were as follows:
<TABLE>
<CAPTION>
December 31
--------------------------------------------------------------------------
1996 1995
--------------------------------------------------------------------------
WEIGHTED Weighted
CARRYING FAIR AVERAGE Carrying Fair Average
AMOUNT VALUE RATE Amount Value Rate
- -------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Checking accounts........................ $ 46,882 $ 46,882 --% $ 37,939 $ 37,939 --%
NOW accounts............................. 60,668 60,668 1.52 53,682 53,682 1.52
Money market accounts.................... 89,321 89,321 4.01 86,080 86,080 4.18
Savings deposits......................... 149,226 149,226 2.82 149,728 149,728 2.91
Certificates of deposit.................. 617,102 622,040 5.79 594,044 598,070 6.00
Accrued interest......................... 934 934 -- 1,459 1,459 --
-----------------------------------------------------------------------------
$ 964,133 $ 969,071 4.61% $ 922,932 $ 926,958 4.82%
=============================================================================
</TABLE>
Included in deposits are $107,386,000 and $81,442,000 of deposit accounts with
balances in excess of $100,000 as of December 31, 1996 and 1995, respectively.
Certificates of deposit had the following maturities at December 31, 1996:
<TABLE>
<CAPTION>
Weighted
Amount Average Rate
- -----------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
1997............................................ $ 392,752 5.54%
1998............................................ 159,122 6.12
1999............................................ 25,894 6.93
2000............................................ 8,655 6.64
2001 and beyond................................. 30,679 6.04
---------------------------------------------
$ 617,102 5.79%
=============================================
</TABLE>
35
<PAGE> 26
The average balance, interest expense and average rate on deposits were as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------------------------------------------------------------------
AVERAGE INTEREST AVERAGE Average Interest Average Average Interest Average
BALANCE EXPENSE RATE Balance Expense Rate Balance Expense Rate
- ---------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Checking accounts ............ $ 40,349 $ -- --% $ 36,886 $ -- --% $ 36,138 $ -- --%
NOW and money
market accounts ............ 146,863 4,490 3.06 137,867 4,261 3.09 133,079 3,197 2.40
Savings deposits ............. 153,701 4,446 2.89 139,685 3,723 2.67 172,875 4,174 2.41
Certificates of deposit ...... 597,571 34,923 5.84 537,944 30,655 5.70 480,020 22,435 4.67
------------------------------------------------------------------------------------------------
$ 938,484 $43,859 4.67% $852,382 $ 38,639 4.53% $822,112 $29,806 3.63%
================================================================================================
</TABLE>
NOTE J: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase, in which the Company will
repurchase identical securities, consisted of the following:
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------
1996 1995
---------------------------------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Collateral pledged:
Mortgage-backed securities with a book
value including accrued interest of
$59,835,000 and a market value of
$59,750,000 ................................. $ 58,040 $ 58,040 $ -- $ --
=========================================================
</TABLE>
Securities sold under agreements to repurchase averaged $40,095,000 and
$24,020,000 during 1996 and 1995, respectively, and the maximum amounts
outstanding at any month-end during 1996 and 1995 were $74,621,000 and
$52,579,000, respectively.
The securities underlying the agreements were delivered to the dealers who
arranged the transactions. The dealers may have sold, loaned or otherwise
disposed of such securities to other parties in the normal course of their
operations, and have agreed to resell to the Company essentially identical
securities at the maturities of the agreements.
Agreements to repurchase, as of December 31, 1996, are as follows:
<TABLE>
<CAPTION>
Average
Broker Borrowing Rate Maturity Date
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Morgan Stanley...................................... $ 23,397 5.52% January 1997
Federal National Mortgage Association............... 34,643 5.76 January 1997
-------------------------
$ 58,040 5.66%
=========================
</TABLE>
36
<PAGE> 27
NOTE K: FHLB ADVANCES AND OTHER BORROWED MONEY
The carrying amounts and fair values of FHLB advances and other borrowed money
consisted of the following:
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------------------------
1996 1995 1996 1995
-----------------------------------------------------------------------------------
Year of Weighted Carrying Fair Carrying Fair
Maturity Average Rate Amount Value Amount Value
- -----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Advances from Federal Home Loan Bank of Indianapolis:
Variable rate of interest:
5.81 - 6.38 %.................... 1996 --% 5.86% $ -- -- $124,000 $124,065
5.47 - 6.80...................... 1997 5.58 5.86 206,000 206,047 61,000 61,027
Fixed rate of interest:
5.20 - 5.42%..................... 1997 5.25 5.42 45,000 44,977 10,000 9,977
5.47 - 5.91...................... 1998 5.77 5.47 43,000 42,566 10,000 9,965
5.81 - 5.95...................... 1999 5.84 -- 43,000 42,233 -- --
4.00............................. 2005 4.00 4.00 1,003 802 1,003 857
- -----------------------------------------------------------------------------------------------------------------------
338,003 336,625 206,003 205,891
Other borrowed money:
Collateralized mortgage obligations................................ 7,994 8,606 10,292 11,250
----------------------------------------------
$345,997 $345,231 $216,295 $217,141
==============================================
</TABLE>
The Company is required to maintain qualifying loans, investments and
mortgage-backed securities as collateral for the FHLB advances.
The collateralized mortgage obligation (CMO) was issued through a special
purpose finance subsidiary established in 1986. The CMO is secured by
mortgage-backed securities with unpaid principal balances of $9,160,000 and
$11,709,000 at December 31, 1996 and December 31, 1995, respectively. The
notes underlying the obligations bear interest, payable quarterly, at rates
varying from 7.27% to 7.33%, with contractual maturity dates ranging from 2008
to 2010.
NOTE L: FEDERAL INCOME TAXES
Federal income tax expense (credit) consisted of the following:
<TABLE>
<CAPTION>
1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Current................................................... $ -- $ 100 $ 150
Deferred.................................................. 3,228 3,959 1,199
Change in valuation allowance for deferred tax assets..... (2,879) (5,734) (1,199)
----------------------------------------------------
$ 349 $ (1,675) $ 150
====================================================
</TABLE>
Deferred income tax expense (credit) included in stockholders' equity related
to unrealized holding gains (losses) on securities available for sale for 1996,
1995 and 1994 amounted to $(181,000), $850,000 and $-0-, respectively.
A reconciliation of the statutory federal income tax rate to the effective
income tax rate follows:
<TABLE>
<CAPTION>
1996 19951994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory tax rate............................................ 35.00% 35.00% 35.00%
Effect of:
Change in valuation allowance for deferred tax assets....... (30.81) (68.54) (38.79)
Adjustment to net operating loss carry forward.............. -- 12.46 --
Other items, net............................................ (0.45) 1.92 8.04
-------------------------------------------------
Effective tax rate............................................ 3.74% (19.16)% 4.25%
=================================================
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred and other tax assets and liabilities are as follows:
37
<PAGE> 28
<TABLE>
<CAPTION>
December 31
--------------------------------------
1996 1995
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Deferred tax assets:
Bad debt reserves not previously deducted.............. $ 3,036 $ 3,545
Net deferral required by SFAS 91....................... 229 400
Pension and other benefit obligations.................. 695 580
Tax effect of net of operating loss carryforward....... 3,258 6,307
Other items, net....................................... 381 416
--------------------------------------
Total deferred tax assets........................... 7,599 11,248
Valuation allowance for deferred tax assets............ -- (2,879)
--------------------------------------
Total deferred tax assets less valuation
allowance.................................... 7,599 8,369
Deferred tax liabilities:
Securities marked to market for tax purposes*.......... 289 433
Tax over book depreciation............................. 662 723
FHLB stock dividends................................... 1,075 1,075
Valuation adjustment on CMO residuals.................. 1,408 1,333
Excess general valuation allowances over base year
reserves .................................... -- 448
Other items, net....................................... 68 92
Total deferred tax liabilities...................... 3,502 4,104
Total net deferred tax assets.............................. 4,097 4,265
Current income tax receivable due to net operating loss.... --------------------------------------
carrybacks and other overpayments........................ 1,905 1,109
--------------------------------------
Total net federal income tax assets........................ $ 6,002 $ 5,374
======================================
</TABLE>
* The amount shown is net of the $669,000 and $822,000 tax effect of SFAS 115
unrealized holding gains at December 31, 1996 and December 31, 1995
respectively.
As of December 31, 1996, the Company had a net operating loss carryforward for
income tax purposes of $9,310,000 which expires on December 31, 2009.
NOTE M: STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
OTS regulations governing the payment of dividends by savings institutions
provide that an institution may only pay dividends with regulatory approval.
Unlike the Bank, the Company is not subject to these regulatory restrictions on
the payment of dividends to its stockholders. However, the source of future
dividends may depend upon the payment of dividends from the Bank to the
Company.
In December 1993, the Company issued 1,003,219 units in a shareholder rights
offering. Each unit consisted of three shares of common stock and one warrant.
Each warrant entitled the holder thereof to purchase one share of common stock
at an exercise price of $8.25 at any time no later than December 31, 1996.
During 1996, 1995 and 1994, 996,369, 2,553 and 390 warrants were excercised,
respectively. The warrant period ended with 3,907 warrants unexercised.
During 1996, the Company paid a one-time charge of $5.5 million pretax, ($3.6
million after tax) as the mandated contribution of its wholly-owned
subsidiary, D&N Bank, to replenish the Federal Deposit Insurance Corporation's
depleted Savings Association Insurance Fund ("SAIF"). This charge is the
result of federal legislation passed and signed into law on September 30, 1996,
which requires all thrifts to pay a one-time assessment to restore the SAIF
fund to its statutory reserve level. The assessment is 65.7 basis points
(b.p.) of the institution's deposits as of March 31, 1995.
Macomb had a leveraged Employee Stock Ownership Plan ("ESOP"), which was
terminated subsequent to the merger with the Company. The related ESOP debt was
paid in full in 1996.
On December 7, 1989, new capital standards were imposed on the thrift industry
as a result of the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA"). Regulatory standards impose the following capital
requirements: a risk-based capital standard expressed as a percent of
risk-adjusted assets, a leverage ratio of core capital to total adjusted
assets, and a tangible capital ratio expressed as a percent of total adjusted
assets. As of December 31, 1996, the Bank exceeded all regulatory capital
standards.
38
<PAGE> 29
The table below summarizes as of December 31, 1996, the Bank's capital
requirements under FIRREA and its actual capital ratios at that date:
<TABLE>
<CAPTION>
Regulatory Bank Actual
Requirements Capital
------------------------------------------------------------------
Amount Percent Amount Percent
- -----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Risk-based capital.............................. $ 69,740 8.00% $ 86,669 9.94%
Core capital.................................... 44,598 3.00 76,012 5.11
Tangible capital................................ 22,299 1.50 76,012 5.11
</TABLE>
The FDIC Improvement Act of 1992 ("FDICIA") requires each federal banking
agency to implement prompt corrective actions for institutions that it
regulates. The OTS has adopted rules, based upon FDICIA's five capital tiers:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Under FDICIA, the OTS is
required to take supervisory action against institutions that are not deemed
either "well capitalized" or "adequately capitalized". The rules generally
provide that a savings institution is "well capitalized" if its total
risk-based capital ratio is 10% or greater, its ratio of core capital to
risk-based assets (tier 1 risk-based capital) is 6% or greater, its core
capital (leverage) ratio is 5% or greater, and the institution is not subject
to a capital directive. The Bank's tier 1 risk-based capital ratio at December
31, 1996 was 8.72%. As of December 31, 1996, the Bank was considered
adequately capitalized.
NOTE N: EMPLOYEE BENEFIT PLANS
The Company sponsors an employee savings and investment plan in which all
employees may participate after completing a minimum of 1,000 hours in an
eligibility period. The plan allows participants to make contributions by
salary deductions equal to 15% or less of their salary pursuant to Section
401(k) of the Internal Revenue Code. Employee contributions are matched by the
Company at the rate of 100 cents per dollar, up to 6% of the employee's salary.
Employees vest immediately in their own contributions and over a six-year
period in the Company's contributions. Employee contributions may be invested
in a variety of instruments, including the Company's common stock. The first 3%
of the Company's contribution for each individual is invested in the Company's
common stock, the remainder of the Company's contribution, (up to 6%, total) is
invested at the direction of the participant. The Company's contributions to
the plan were $621,000, $273,000 and $193,000 in 1996, 1995 and 1994,
respectively.
The Company terminated its noncontributory defined benefit retirement plan
during 1996, with all assets of the plan being distributed to participants. No
gain or loss was recorded on this transaction.
The following table sets forth the market value of assets and distribution
thereof on December 16, 1996, the date of distribution.
<TABLE>
<CAPTION>
Before Effect of After
Termination Termination Termination
- -----------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Assets and obligations
Accumulated benefit obligation............................ $ (8,419) $ 8,419 $ --
Plan assets at fair value................................. 11,238 (11,238) --
---------------------------------------------------
Excess assets............................................. $ 2,819 $ (2,819) $ --
===================================================
</TABLE>
Benefits under the plan were based on years of service and the employee's
compensation during the last five years of employment.
39
<PAGE> 30
Pension expense included the following components:
<TABLE>
<CAPTION>
1996* 1995* 1994
- ----------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Service cost-benefits earned during the period ............... $ -- $ 620 $ 728
Interest cost on projected benefit obligation ................ -- 1,071 1,055
Return on plan assets ........................................ -- (2,030) (362)
Net amortization ............................................. -- 512 (1,046)
-----------------------------------------
$ -- $ 173 $ 375
=========================================
</TABLE>
* Benefits were frozen as of September 30, 1995; therefore, no cost or
amortization was subsequently recorded.
NOTE O: POSTRETIREMENT BENEFITS
The Company has a contributory unfunded benefit plan which provides
postretirement medical benefits to certain employees who have retired prior to
September 30, 1995. The Company is recognizing its accumulated postretirement
benefit obligation over a prospective 20-year period. During 1994, the plan
was changed to provide certain caps on benefits for existing retirees and
eliminate benefits for future retirees. The effect of the plan change was to
reduce the accumulated postretirement benefit obligation by approximately
$1,425,000.
The following table sets forth the plan's status and amounts recognized in the
Company's Consolidated Statement of Condition:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
- ------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
Accumulated postretirement benefit obligation............ $ 1,358 $ 1,322
Unrecognized net loss ................................... (233) (178)
Unrecognized transition obligation ...................... (829) (877)
-------------------------------
Accrued postretirement benefit cost ................ $ 296 $ 267
===============================
</TABLE>
Postretirement benefit expense included the following components:
<TABLE>
<CAPTION>
1996 1995 1994
- -----------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Service cost ............................................ $ -- $ -- $ 44
Interest cost ........................................... 97 99 132
Amortization of transition obligation ................... 48 49 80
------------------------------------------
$ 145 $ 148 $ 256
==========================================
</TABLE>
A weighted average discount rate of 7.00% in 1996 and 1995 was used in
determining the accumulated post retirement benefit obligation. The 1996
health care trend rate was projected to be 9.5% for participants under the age
of 65, and this rate is assumed to trend downward until it reaches 5.5% and
remains at that level thereafter. This trend rate assumption does not have a
significant effect on the plan; therefore, a one percent change in the trend
rate is not material in the determination of the accumulated postretirement
benefit obligation or the ongoing expense.
NOTE P: STOCK OPTION PLAN
The Company has stock option plans in which 1,340,000 shares of common stock
have been reserved for issuance as of December 31, 1996. Under the plans, the
exercise price of any option will not be less than the fair market value of the
common stock on the date of grant. The dates on which the options are first
exercisable is determined by the Stock Option Committee of the Board of
Directors, and have generally vested over a two year period from the date of
grant. The term on any option may not exceed ten years from the date of grant.
During 1996, the Company adopted the disclosure requirements of Statements of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation." Accordingly, the fair value of each option grant in
1996 and 1995 was estimated using the Black-Scholes option pricing model with
the following assumptions used:
40
<PAGE> 31
<TABLE>
<CAPTION>
1996 1995
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Estimated weighted average fair value
per share of options granted ............................. $ 4.61 $ 2.63
Assumptions:
Annualized dividend yield ............................ --% --%
Common-stock price volatility ........................ 25.1% 25.1%
Weighted average risk free rate of return ............ 5.9% 7.4%
Weighted average expected option term (in years) ..... 5 4
</TABLE>
The Company has elected to continue to measure compensation cost using the
intrinsic value method, in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Accordingly, since all options are granted at a
fixed price not less than the fair market value of the Company's common stock
on the date of grant, no compensation cost has been recognized for its stock
option plans. Had stock option costs of these plans been determined based on
the fair value at the 1996 and 1995 grant dates for awards under those plans
consistent with the methodology of SFAS 123, the pro forma effects on the
Company's net income and earnings per share would be as follows:
<TABLE>
<CAPTION>
1996 1995
- ----------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share)
<S> <C> <C>
Net income (as reported) ........................... $ 8,995 $ 10,417
Stock option compensation cost ..................... (396) (74)
---------------------------------------------
Pro forma net income ........................... $ 8,599 $ 10,343
=============================================
Primary earnings per share (as reported) ........... $ 1.11 $ 1.35
Stock option compensation cost ..................... (0.05) (0.01)
---------------------------------------------
Pro forma primary earnings per share ........... $ 1.06 $ 1.34
=============================================
Fully diluted earnings per share ................... $ 1.09 $ 1.31
Stock option compensation cost ..................... (0.05) (0.01)
---------------------------------------------
Pro forma fully diluted earnings per share ..... $ 1.04 $ 1.30
=============================================
</TABLE>
The following table sets forth changes in options outstanding:
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------------------------------------------
WEIGHTED Weighted
Amount Avg. Price AMOUNT AVG. PRICE AMOUNT
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Shares under option:
Outstanding at beginning of year ... 594,505 $ 8.32 638,602 $ 8.18 681,052
Granted ............................ 287,208 13.49 74,880 8.01 50,298
Forfeited .......................... (19,851) 10.39 (4,029) 7.86 (91,748)
Canceled ........................... (5,775) 16.06 (62,150) 8.50 --
Exercised .......................... (109,775) 7.94 (52,798) 6.06 (1,000)
-------------------------------------------------------------------------------
Outstanding at end of year ......... 746,312 10.24 594,505 8.32 638,602
-------------------------------------------------------------------------------
Exercisable at end of year ......... 537,144 $ 9.24 512,062 $ 8.40 472,347
-------------------------------------------------------------------------------
</TABLE>
41
<PAGE> 32
The following table sets forth details of options outstanding at December 31,
1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 6.00 - 8.38 397,104 6.7 Years $ 7.69 371,409 $ 7.68
11.19 - 13.25 267,708 7.9 Years 12.51 129,235 12.10
14.25 - 15.44 81,500 8.5 Years 15.23 36,500 14.98
-------------------------------------------------------------------------------------------------------
$ 6.00 - 15.44 746,312 7.3 Years $ 10.24 537,144 $ 9.24
=======================================================================================================
</TABLE>
NOTE Q: LITIGATION
The Company is a defendant in a number of matters of litigation, substantially
all of which have arisen in the ordinary course of business. It is the opinion
of management that the resulting liabilities, if any, from these actions will
not materially affect the Consolidated Financial Statements.
D&N Bank is a plaintiff, like approximately 120 other institutions, in a
currently pending claim in the United States Court of Federal Claims seeking
substantial damages as a result of the 1989 Financial Institutions Reform,
Recovery and Enforcement Act's mandatory phase-out of the regulatory capital
treatment of supervisory goodwill. Arguments concerning the extent of damages
in the cases of three initial plaintiffs are scheduled to begin March 17, 1997.
The other cases, including D&N's, are scheduled to be considered after the
initial cases are resolved. The ultimate outcome of these matters cannot be
ascertained at this time.
NOTE R: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk (in
the normal course of its business) to meet the financial needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments may include commitments to originate or purchase loans,
standby letters of credit, recourse arrangements on sold assets, and forward
commitments. The instruments involve, to varying degrees, elements of credit
and interest rate risk in addition to the amounts recognized in the
Consolidated Statements of Condition. The contract amounts of those
instruments reflect the extent of the Company's involvement in particular
classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments, standby letters
of credit and recourse arrangements is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as for on-balance sheet instruments.
For forward commitments, the contract amounts do not represent exposure to
credit loss. The Company controls the credit risk of those instruments through
credit approvals, limits and monitoring procedures.
The following table sets forth financial instruments with off-balance sheet
risk and their contract amounts and fair values:
<TABLE>
<CAPTION>
--------------------------------------------------------------
December 31
--------------------------------------------------------------
1996 1995
CONTRACT FAIR Contract Fair
- ----------------------------------------------------------------------------------------------------------------
AMOUNT VALUE Amount Value
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial instruments whose contract amounts
represent credit risk:
Commitments to originate and purchase loans .. $ 69,383 $ (694) $ 60,443 $ (604)
Unused lines of credit ....................... 78,303 (783) 56,867 (569)
Standby letters of credit .................... 367 (4) 1,210 (12)
Loans sold with recourse ..................... 3,004 (150) 3,563 (178)
Financial instruments whose contract amounts
exceed the amount of credit risk:
Forward commitments to sell loans ............ 4,000 (40) -- --
</TABLE>
42
<PAGE> 33
Commitments to originate loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected
to expire without being drawn on, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's evaluation of the borrower's credit worthiness.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Additionally, the Company has
retained credit risk on certain residential and commercial mortgage loans sold
with recourse with outstanding balances at December 31, 1996 of $1,430,000 and
$1,574,000, respectively. These balances as of December 31,1995 were $1,769,000
and $1,794,000, respectively. The maximum amount of loss to which the Company
is subject, under the recourse provisions, is $1,587,000 at December 31, 1996.
Management does not believe the recourse provisions subject the Company to any
material risk of loss. This credit risk is considered to be no more onerous
than that existing on similar loans in the Company's loan portfolio.
Forward commitments to sell loans are contracts the Company negotiates for the
purpose of reducing the market risk associated with rate lock agreements with
customers for new loan applications that have not yet been closed. In order to
fulfill a forward commitment, the Company typically exchanges through FNMA,
FHLMC or GNMA,its current production of loans for mortgage-backed securities
which are then delivered to a national securities firm at a future date at
prices or yields specified by the contracts. Risks may arise from the possible
inability of the Company to originate loans to fulfill the contracts, in which
case the Company would normally purchase securities in the open market to
deliver against the contracts.
NOTE S: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of financial
instruments at the dates indicated. SFAS 107, "Disclosures about Fair Value of
Financial Instruments", defines the fair value of a financial instrument as the
amount at which the instrument could be exchanged in a current transaction
between willing parties, other than in a forced or liquidation sale.
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------
1996 1995
-------------------------------------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Cash and cash equivalents .................... $ 12,789 $ 12,789 $ 22,440 $ 22,440
Investment securities (Note D) ............... 119,777 119,821 96,436 96,565
Mortgage-backed securities (Note E) .......... 251,256 249,870 127,709 128,688
Loans receivable (Note F) .................... 1,055,876 1,078,795 952,359 958,349
Deposits (Note I) ............................ (964,133) (969,071) (922,932) (926,958)
Securities sold under agreement
to repurchase (Note J) ................... (58,040) (58,040) -- --
Debt (Note K) ................................ (345,997) (345,231) (216,295) (217,141)
Commitments to originate and
purchase loans (Note R) .................. -- (694) -- (604)
Unused lines of credit (Note R) .............. -- (783) -- (569)
Standby letters of credit (Note R)............ -- (4) -- (12)
Loans sold with recourse (Note R) ............ -- (150) -- (178)
Forward commitments to sell loans (Note R) ... -- (40) -- --
</TABLE>
ESTIMATION OF FAIR VALUES
SFAS 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the Statement of Condition, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could
not be realized in immediate settlement of the instrument. SFAS 107 excludes
certain financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
43
<PAGE> 34
The carrying amounts reported in the Statement of Condition for cash and cash
equivalents approximate those assets' fair value. Fair values for investment
securities and mortgage-backed securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments. Fair values for the
Company's loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The carrying amount of accrued interest
approximates its fair value.
The fair values of checking and NOW accounts, money market accounts and savings
deposits are the amounts payable on demand at the reporting date. The fair
value for fixed-maturity time deposits is estimated using a discounted cash
flow analysis using the rates currently offered for deposits with similar
remaining maturities. The fair values of securities sold under agreement to
repurchase and the Company's debt are estimated using discounted cash flow
analyses, based on the Company's current incremental borrowing rates for debt
with similar terms and remaining maturities. Fair values for the Company's
off-balance sheet instruments (guarantees and credit commitments) are based on
current settlement or termination values and on fees currently charged to enter
into similar agreements, given the remaining terms of the agreements and the
counterparties' credit standing.
NOTE T: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION> Before
Gain on Income Income
Net Provision Securities Tax Tax Net Earnings Per Share Stock Price
Interest Interest Interest For Loan & Other Expense Expense Income Fully Range
Income Expense Income Losses Assets (Credit) (Credit) (Loss) Primary Diluted High Low
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except earnings per share and stock price)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1st Quarter
1996 $ 24,000 $ 14,318 $ 9,682 $ 300 $ -- $ 2,689 $ (799) $ 3,488 $ 0.43 $ 0.42 13 3/4 12
1995 20,824 13,199 7,625 200 -- 1,452 28 1,424 0.18 0.18 9 1/8 7 1/4
2nd Quarter
1996 25,426 14,886 10,540 300 188 2,824 (537) 3,361 0.42 0.41 14 12
1995 22,853 14,125 8,728 800 779 2,619 30 2,589 0.35 0.33 10 1/2 8 3/8
3rd Quarter
1996 27,105 15,863 11,242 300 -- (1,127)(1) (42) (1,085)(1) (0.13) (0.13) 14 1/4 12 1/4
1995 23,125 14,298 8,827 500 -- 3,084 26 3,058(2) 0.39 0.39 13 1/2 10 1/8
4th Quarter
1996 27,778 16,479 11,299 200 -- 4,958 1,727 3,231 0.39 0.39 17 3/4 13 3/4
1995 23,963 14,393 9,570 900 -- 1,587 (1,759) 3,346(2) 0.42 0.42 12 3/4 11 3/16
Year
1996 104,309 61,546 42,763 1,100 188 9,344 349 8,995 1.11 1.09 17 3/4 12
1995 90,765 56,015 34,750 2,400 779 8,742 (1,675) 10,417(2) 1.35 1.31 13 1/2 7 1/4
</TABLE>
(1)Included in this loss is the one-time charge of $5.5 million to replenish
the Federal Deposit Insurance Corporation's Savings Association
Insurance Fund (see Note M).
(2)Included income of $458,000, $163,000 and $621,000 in the third quarter of
1995, forth quarter of 1995 and year 1995, respectively, resulting from the
adoption of SFAS122.
44
<PAGE> 35
NOTE U: D&N FINANCIAL CORPORATION -PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
December 31
---------------------------
1996 1995
- ----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents ............................... $ 2 $ 2
Amounts receivable from subsidiary ...................... 6,104 879
Investments in subsidiary ............................... 80,014 71,108
Other assets ............................................ 65 --
--------------------------
$ 86,185 $ 71,989
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities ....................................... $ 64 $ 10
Stockholders' equity .................................... 86,121 71,979
--------------------------
$ 86,185 $ 71,989
==========================
</TABLE>
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Interest income from subsidiary ............................. $ 64 $ 40 $ 47
Equity in undistributed net income of subsidiary ............ 9,378 10,618 3,565
Noninterest expense
Compensation and benefits ................................. 13 9 9
Other ..................................................... 434 232 220
---------------------------------------------
Total noninterest expense ............................... 447 241 229
---------------------------------------------
Income before income tax expense ....................... 8,995 10,417 3,383
Federal income tax expense .................................. -- -- --
---------------------------------------------
Net income .................................................. $ 8,995 $ 10,417 $ 3,383
=============================================
</TABLE>
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Operating activities
Net income ................................................ $ 8,995 $ 10,417 $ 3,383
Items not affecting cash:
Equity in undistributed net income of subsidiary ........ (9,378) (10,618) (3,565)
Other ................................................... 115 37 (214)
-------------------------------------------
Net cash used by operating activities (268) (164) (396)
Investing activities ........................................
Change in intercompany receivable ......................... (5,225) (102) 421
Financing activities
Proceeds from issuance of stock ........................... 9,055 346 11
Purchases of Treasury stock/warrants ...................... (3,499) (44) --
Payment of ESOP debt ...................................... (63) (36) (36)
-------------------------------------------
Net cash used by financing activities .................. 5,493 266 (25)
Net change in cash and cash equivalents ................... -- -- --
Cash and cash equivalents at beginning of year .......... 2 2 2
-------------------------------------------
Cash and cash equivalents at the end of year .............. $ 2 $ 2 $ 2
===========================================
</TABLE>
45
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
<TABLE>
<CAPTION>
Percentage State of
of Incorporation
Parent Subsidiary Ownership or Organization
- ----------------------------------- ----------------------------- -------------- -----------------
<S> <C> <C> <C>
D&N Financial Corporation D&N Bank 100% Federal
D&N Bank D&N Enterprises, Inc. 100% Michigan
D&N Bank D&N Holdings, Inc. 100% Michigan
D&N Bank D&N Funding I Corp. 100% Delaware
D&N Bank D&N Mortgage Corporation 100% Michigan
D&N Holdings, Inc. Quincy Insurance Agency, Inc. 100% Michigan
</TABLE>
<PAGE> 1
EXHIBIT 23
[COOPERS & LYBRAND L.L.P. LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors
D&N Financial Corporation
400 Quincy Street
Hancock, MI 49930
Gentlemen:
We consent to the incorporation by reference in the Registration Statement of
D&N Financial Corporation on Form S-8 (Registration No. 33-94076) of our report
dated January 22, 1997 on our audits of the financial statements of D&N
Financial Corporation and Subsidiary as of December 31, 1996 and 1995 and for
each of the three years in the period ended December 31, 1996, which report is
incorporated by reference in this Annual Report on Form 10-K of D&N Financial
Corporation for the year ended December 31, 1996.
Coppers & Lybrand L.L.P.
Detroit, Michigan
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,847
<INT-BEARING-DEPOSITS> 1,342
<FED-FUNDS-SOLD> 8,600
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 95,604
<INVESTMENTS-CARRYING> 275,429
<INVESTMENTS-MARKET> 274,087
<LOANS> 1,066,918
<ALLOWANCE> 11,042
<TOTAL-ASSETS> 1,473,054
<DEPOSITS> 964,133
<SHORT-TERM> 58,040
<LIABILITIES-OTHER> 18,763
<LONG-TERM> 345,997
55,536
0
<COMMON> 0
<OTHER-SE> 30,585
<TOTAL-LIABILITIES-AND-EQUITY> 1,473,054
<INTEREST-LOAN> 86,151
<INTEREST-INVEST> 18,158
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 104,309
<INTEREST-DEPOSIT> 43,859
<INTEREST-EXPENSE> 61,546
<INTEREST-INCOME-NET> 42,763
<LOAN-LOSSES> 1,100
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 39,543
<INCOME-PRETAX> 9,344
<INCOME-PRE-EXTRAORDINARY> 9,344
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,995
<EPS-PRIMARY> 1.11
<EPS-DILUTED> 1.09
<YIELD-ACTUAL> 3.26
<LOANS-NON> 6,621
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 15,900
<ALLOWANCE-OPEN> 10,081
<CHARGE-OFFS> 1,530
<RECOVERIES> 1,391
<ALLOWANCE-CLOSE> 11,042
<ALLOWANCE-DOMESTIC> 11,042
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
