EXHIBIT 99(C)
Published on October 23, 1997
Exhibit 99(c)
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
Consolidated Statements of Cash Flows
(Dollars in Thousands)
See accompanying notes to consolidated financial statements.
Consolidated Statements of Shareholders' Equity
(Dollars in Thousands)
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization and Nature of Operations
First Michigan Bank Corporation (FMB) is a bank holding company with 14
subsidiary community banks engaged in the business of commercial banking (the
Banks). FMB has four non-bank subsidiaries providing trust, brokerage, credit
and title insurance services to customers of the Banks.
The Banks are engaged in the business of general commercial, retail and
mortgage banking. The Banks offer a variety of deposit products including
checking accounts, savings accounts, time deposits and short-term deposits. The
Banks conduct lending activities in the residential and commercial mortgage
markets, in the general commercial market and in the consumer installment
marketplace. These financial services and products are delivered through a
network of full-service branches, specialized offices, automatic teller machines
and various electronic delivery channels.
The principal markets for the Banks' financial services are the Michigan
communities in which each of the banks is located and the areas immediately
surrounding these communities. The Banks serve these markets through 90 branch
offices in or near these communities.
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of FMB and its
subsidiaries. Upon consolidation, all significant intercompany accounts and
transactions have been eliminated. Goodwill is being amortized over periods up
to 20 years.
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles held and used by an entity be reviewed for impairment and reported
at the lower of carrying amount or fair value, less cost to sell, whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.
Management periodically reviews goodwill and other long-lived assets for
impairment based upon the projected, undiscounted net cash flows of the
subsidiaries to which the goodwill relates or the long-lived assets belong. FMB
has not experienced any impairment of its goodwill and long-lived assets.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." The Statement
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are borrowings and for derecognition of
liabilities that have been extinguished. This Statement also requires that
liabilities and derivatives incurred or obtained as part of a transfer be
measured initially at fair value. SFAS No. 125 also amends SFAS No. 122
(discussed under "Mortgage Banking Operations") to provide further guidance on
measurement of servicing rights relating to assets transferred. The Statement is
effective for transfers, servicing or extinguishments occurring after December
31, 1996, except for certain provisions which are effective after December 31,
1997. Adoption of the accounting provisions of this standard is not expected to
have a material effect upon FMB's financial condition or results of operations.
Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported revenues and expenses during the reporting
period. The amount of those assets actually realized and liabilities actually
settled in future periods could differ from those estimates. The differences, if
any, would be reflected in the reported amounts of revenues and expenses in
future periods.
Cash and Cash Equivalents
For the purposes of reporting cash flows, cash equivalents include amounts due
from banks and federal funds sold. Generally, federal funds are purchased and
sold for one-day periods.
Securities
Management has identified as "available-for-sale" certain securities which may
be sold in the future to meet FMB's investment objectives of quality, liquidity
and yield and to avoid significant market value deterioration. Securities
available-for-sale are adjusted to fair market value each reporting period with
unrealized gains and losses reported as a separate component of shareholders'
equity, net of tax. Securities held-to-maturity are stated at cost adjusted for
amortization of premium and accretion of discount. The adjusted cost of the
specific security sold is used to compute gain or loss on all securities
transactions.
Loans and Allowance for Loan Losses
Loans are stated at their principal balance outstanding, net of unearned income.
The allowance for loan losses is maintained at a level considered by management
to be adequate to absorb possible future loan losses inherent in
the current portfolio. Management's assessment of the adequacy of the allowance
is based upon type and volume of the loan portfolio, past loan loss experience,
existing and anticipated economic conditions, and other factors which deserve
current recognition in estimating possible future loan losses.
A portion of the total allowance for loan losses is related to impaired
loans. A loan is impaired when it is probable that the creditor will be unable
to collect all principal and interest amounts due according to the contracted
terms of the loan agreement. FMB considers loans that have been placed on
non-accrual status or which have been renegotiated in a troubled debt
restructuring to be impaired. The allowance for loan losses for an impaired loan
is recorded at the amount by which the outstanding recorded principal balance
exceeds the fair value of the collateral on the impaired loan. For a loan that
is not collateral-dependent, the allowance for loan losses is recorded at the
amount by which the outstanding recorded principal balance exceeds the current
best estimate of the future cash flows on the loan, discounted at the loan's
effective interest rate. FMB adopted the accounting provisions for impaired
loans prospectively as of January 1, 1995. Accordingly, the required disclosures
are presented for 1995 and 1996 only.
Net Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed by the straight-line method for financial reporting
purposes. Accelerated depreciation methods are used for income tax purposes.
Other Real Estate
Other real estate, which is included in other assets, is comprised of properties
in the possession of the subsidiary banks which are generally acquired through
foreclosure proceedings or deed in lieu of foreclosure. These properties are
held for sale and are carried at the lower of the amount of the related loan or
the fair market value of the property minus estimated costs to sell the property
(net realizable value). Losses which may result from the acquisition of such
properties are charged against the allowance for loan losses. Losses in net
realizable value during the holding period are expensed immediately, while gains
are recognized in other operating income only upon disposition.
Employee Benefit Plans
FMB has a noncontributory pension plan for the benefit of all full-time
employees and part-time employees working more than 1,000 hours per year.
Benefits under the plan are based on the employee's years of service and
compensation during the five consecutive highest paid plan years of the last ten
plan years preceding retirement. FMB's funding policy is to contribute an
actuarially-determined amount that can be deducted for federal income tax
purposes.
FMB also sponsors a defined contribution 401(k) plan for the benefit of all
employees over 21 years old. For those employees who work 1,000 or more hours
per year, FMB matches employee contributions at levels that management
determines to be appropriate.
FMB acts as a self-insurer for employees' medical, dental and accident
insurance whereby it assumes limited liabilities with the excess liability
assumed by underwriters. Claims for active employees are charged to operations
during the year in which they occur.
FMB has a postretirement benefit plan that provides medical and dental
coverage between the ages of 60 and 65 to any full-time employee who elects
early retirement after 10 or more years of service. The plan contains the same
cost-sharing features of deductibles and copayments that are contained in the
medical and dental insurance plans provided to active employees. Partial funding
of the plan is accomplished through monthly contributions to a self-insurance
trust fund which was established to cover the medical and dental benefits of
both retirees and active participants. The monthly contribution to the
self-insurance trust fund for each retiree is equivalent to the amount
contributed each month for an active participant.
Mortgage Banking Operations
FMB originates mortgage loans which it sells into the secondary market. Closed
mortgage loans are held for sale generally less than 15 days, and book value
approximates market value. FMB retains the servicing rights when it sells the
mortgage loans. Servicing income is recognized in other non-interest income when
received and expenses are recognized in operating expenses when incurred.
On January 1, 1996, FMB prospectively adopted the accounting provisions for
mortgage servicing rights promulgated by SFAS No. 122, "Accounting for Mortgage
Servicing Rights," which is an amendment to SFAS No. 65, "Accounting for Certain
Mortgage Banking Activities." SFAS No. 122 amends SFAS No. 65 to require that an
asset be recognized for the rights to service mortgage loans including those
rights that are created by the origination of mortgage loans which are sold or
securitized with the servicing rights retained by the originator. The amount of
the asset for these originated mortgage servicing rights (OMSR) is determined
based upon the relative fair value of the underlying mortgage loans without the
OMSR and the OMSR itself. Recognition of these assets results in an increase in
the gains recognized upon the sale of the underlying loans. The OMSR assets are
being amortized in proportion to and over the life of the estimated net future
servicing income. FMB
stratifies the mortgage loans sold by sale date, term and interest rate for
purposes of applying SFAS No. 122 both for the origination valuation of the OMSR
and for evaluating the remaining book value of the OMSR assets for impairment.
Any impairment is recognized as a separate valuation allowance for each impaired
stratum. Due to the prospective adoption of these accounting provisions, the
required disclosures are presented for 1996 only. The overall impact of adoption
was not material to FMB's results of operations for the year.
Stock Options
FMB applies the intrinsic value method of accounting promulgated under
Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to
Employees," and related interpretations for its fixed-price, stock option plan.
Accordingly, no compensation cost is recognized as a result of options awarded
to employees under the plan.
SFAS No. 123, "Accounting for Stock-Based Compensation," which became
effective January 1, 1996, establishes a fair value method of accounting for all
stock-based compensation, but it allows companies to continue to account for
stock options granted to employees under the intrinsic value method in
accordance with APB Opinion 25. Companies electing to maintain their accounting
for employee stock compensation under APB Opinion 25 are required to provide pro
forma net income and earnings per share disclosures, determined as if the
company had applied the fair value accounting method under SFAS No. 123. FMB has
elected to continue to account for its stock option plans in accordance with APB
Opinion 25 and, accordingly, has provided the supplemental disclosures for 1995
and 1996 that are required by this new accounting standard.
Interest Income and Fees on Loans
Interest on loans is accrued based upon the principal balance outstanding. The
recognition of interest income is discontinued when, in the opinion of
management, there is sufficient doubt that the borrower will be able to meet the
scheduled repayments. When the accrual of interest is discontinued, the balance
of interest accrued but not collected is eliminated from income.
For impaired loans that are on non-accrual status, cash payments received
are generally applied to reduce the outstanding recorded principal balance of
the loans. However, all or a portion of a cash payment received on a non-accrual
loan may be recognized as interest income to the extent allowed by the loan
contract, provided that the borrower's financial condition or the underlying
collateral on the loan support the collection in full of the remaining
outstanding recorded principal balance of the loan. For an impaired loan that
has been renegotiated in a troubled debt restructuring, interest income is
recognized on an accrual basis according to the modified contractual terms so
long as the restructured loan continues to perform in accordance with the
modified contractual terms.
For loans with an initial term exceeding one year, loan origination and
commitment fees and related lending costs are deferred, and the net amount is
amortized as an adjustment of the related loan's yield over its original term.
The net unamortized amount related to a loan that is subsequently sold is
recognized currently as other operating income. For loans with an initial term
of one year or less, the effect of the deferral of loan fees and costs is
immaterial to the operations of FMB.
Interest Rate Swap Agreements
Interest rate swap agreements are derivative financial instruments entered into
for the purpose of hedging short-term interest sensitivity positions against the
impact of changes in interest rates. The interest rate differential to be paid
or received is recognized in interest income over the life of the agreements.
Advertising Costs
All advertising costs incurred are expensed in the period in which they are
incurred.
Income Taxes
FMB and its subsidiaries file a consolidated federal income tax return. The
parent company and its subsidiaries each report current income tax expense as
allocated under a consolidated tax sharing agreement. Deferred tax assets and
liabilities are computed by each member of the consolidated group based on the
difference between the financial statement and income tax basis of assets and
liabilities using enacted tax rates. The reversal of these temporary differences
will result in taxable or deductible amounts in future years when the related
asset or liability is recovered or settled within each entity.
Trust Assets and Income
Property, other than cash deposits, held by subsidiary banks in fiduciary or
agency capacities for their customers is not included in the accompanying
consolidated balance sheets since such property is not an asset of FMB. Trust
income is reported on an accrual basis.
Income Per Share
Income per share is computed based on the average number of shares outstanding
during each period including the assumed exercise of dilutive stock options, and
is retroactively adjusted for stock dividends and splits.
Note 2. Acquisitions
On April 15, 1996, FMB acquired Arcadia Financial Corporation (Arcadia) and its
wholly-owned subsidiary, which was subsequently renamed FMB-Arcadia Bank. The
acquisition was effected through the exchange of 1.648 shares of FMB common
stock (653,749 shares in total) for each outstanding share of Arcadia. The
acquisition was accounted for as a pooling-of-interests. Accordingly, the
accompanying consolidated financial statements have been restated to include the
balances and results of operations of Arcadia prior to the acquisition.
Separate pro forma results of operations of the combined entities for the
periods prior to their respective acquisition dates are as follows (dollars in
thousands, except for per share data):
Note 3. Securities
The amortized cost and carrying value, which is estimated market value, of
securities available-for-sale are as follows (dollars in thousands):
The carrying value and estimated market value of securities held-to-maturity are
as follows (dollars in thousands):
As permitted by the transition provisions in the guide to implementation of
SFAS No. 115 issued by the FASB in November 1995, FMB transferred securities
with an amortized cost of $110,674,000 from the held-to-maturity to the
available-for-sale category on December 27, 1995. The net unrealized gain on the
securities transferred amounted to $421,000.
As of December 31, 1996, all holdings of debt securities were of investment
grade with over 95% of the holdings rated A or better by either Moody's or
Standard and Poor's. Securities not rated by a nationally recognized
organization represent smaller local issues which in management's opinion, if
rated, would qualify as A or better. Securities with a carrying value of
$171,380,000 at December 31, 1996 were pledged for various purposes as required
or permitted by law.
The carrying value and estimated market value of debt securities, by
contractual maturity, are shown in the table below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties. For the
purposes of this table, the maturities of mortgage-backed securities have been
determined using weighted-average expected lives, taking into account
anticipated future prepayments. Maturities of investments in debt securities as
of December 31, 1996 are as follows (dollars in thousands):
Proceeds from sales of securities during 1996, 1995 and 1994 were $27,906,000,
$6,240,000 and $16,097,000, respectively. Gross gains of $19,000, $339,000 and
$45,000 and gross losses of $103,000, $15,000 and $342,000 were realized on
those sales for 1996, 1995 and 1994, respectively.
Note 4. Loans
The composition of the loan portfolio is as follows (dollars in thousands):
The Banks have granted loans to directors and executive officers of FMB and
its significant subsidiaries and to their associates. These related party loans
are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than normal risk of collectibility.
The aggregate dollar amount of these loans was $28,295,000 and $31,797,000 at
December 31, 1996 and 1995, respectively. During 1996, $12,791,000 of new loans
were made, repayments amounted to $12,387,000 and changes in persons included,
decreased the aggregate loans to related parties by $3,906,000.
Note 5. Allowance for Loan Losses
A summary of the activity in the allowance for loan losses is as follows
(dollars in thousands):
Information about FMB's impaired loans as of and for the year ended (dollars in
thousands):
Note 6. Premises and Equipment
Premises and equipment consists of the following (dollars in thousands):
Note 7. Mortgage Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The total unpaid principal balance of mortgage
loans serviced for others was $815,367,834 and $709,385,980 at December 31, 1996
and 1995, respectively. Custodial escrow balances maintained in connection with
the foregoing loan servicing are included in demand deposits and amounted to
$942,060 and $1,189,389 at December 31, 1996 and 1995, respectively.
Beginning January 1, 1996, FMB began to account for the rights to service
mortgage loans that the Banks have originated and sold to others under SFAS No.
122. A summary of the activity relating to mortgage servicing rights is as
follows (dollars in thousands):
Note 8. Other Borrowed Funds
Other borrowed funds consist of the following (dollars in thousands):
FMB's only significant category of short-term borrowings during the year is
securities sold under agreements to repurchase, of which over 95% are one-day
retail repurchase agreements. The securities underlying all of these repurchase
agreements remain under FMB's control for the duration of the agreement. The
amounts and interest rates for this category for the applicable periods are as
follows (dollars in thousands):
At both December 31, 1995 and 1994, other short-term borrowings included
$10,000,000 that had been advanced under a line of credit and standby loan
agreement with another financial institution. Advances on the agreement bore
interest at seven-tenths of a percent over the daily federal funds rate. This
replaces the previous $10,000,000 line of credit. All amounts advanced on the
loan agreement were converted to a term note as of August 15, 1996, which is
recorded as long-term debt. Various of the Banks have obtained advances from the
Federal Home Loan Bank of which they are members. The advances are secured by
blanket collateral agreements covering certain unpledged assets of the
respective bank. Federal Home Loan Bank advances for all of the Banks consist of
the following (dollars in thousands):
Note 9. Long-Term Debt
Long-term debt consists of the following (dollars in thousands):
The term note is payable to another financial institution. The note bears
interest at seven-tenths of a percent over the daily federal funds rate and is
scheduled to mature on August 15, 2002. The term note is unsecured and provides
for various restrictions related to nonperforming loans, equity, regulatory
capital, total indebtedness and dividend payments. FMB is in compliance with all
requirements of the note as of December 31, 1996. The 10% subordinated
debentures are payable to former shareholders of Northwestern Bank Corporation.
Interest is payable semiannually on January 30 and July 30 of each year. The
debentures are scheduled to mature on May 31, 2001. The debentures may not be
called for redemption by FMB prior to May 31, 1998. FMB does not have any
long-term debt maturing until 2001, at which time $4,537,000 will become due.
Note 10. Shareholders' Equity
Common stock consists of 50,000,000 shares authorized, at $1 par value, of which
26,304,157 and 18,848,338 were outstanding at December 31, 1996 and 1995,
respectively. On June 13, 1996, the Board of Directors declared a four-for-three
stock split to shareholders of record on July 1, 1996, payable July 26, 1996.
There are 1,904,553 common shares reserved for issuance under the dividend
reinvestment, employee stock purchase and stock option plans, and the deferred
compensation, deferred stock and current stock purchase plan for non-employee
directors. Preferred stock consists of 1,000,000 shares authorized, at no par
value, none of which are issued. There are 120,000 shares reserved for issuance
under the Shareholder Protection Rights Plan (Plan) Under the Plan, one
preferred share right (Right) was distributed as a dividend on each outstanding
share of common stock. The Plan is designed to protect shareholders against
unsolicited attempts to acquire control of FMB in a manner that does not offer a
fair price to all shareholders. Each right will entitle shareholders to buy one
one-hundredth of a share of preferred stock from FMB at an exercise price of
$20.99. The Rights will be exercisable only if a person or group acquires 15
percent or more of the common stock. If any person or group does acquire 15
percent or more of FMB common stock, each Right will entitle its holder to
purchase, for the exercise price, shares of FMB's common stock having a market
value of twice the exercise price. Also, if any person or group acquires between
15 percent and 50 percent of FMB's common stock, the Board of Directors may
elect to exchange one share of FMB's common stock or one one-hundredth of a
share of preferred stock for each Right. FMB will be entitled to redeem the
Rights at one cent per Right at any time before a 15 percent position has been
acquired.
Note 11. Stock Option Plan
At December 31, 1996, 1,069,326 shares of common stock were reserved for
issuance in connection with FMB's stock option plan. Options may be granted to
certain executives and key employees at the fair market value of the stock on
the date of grant. The plan provides that 100% of the shares become exercisable
one year following the date granted and expire 10 years following the grant
date.
The activity in FMB's stock option plan is as follows:
Stratification and additional detail regarding the options outstanding at
December 31, 1996 is as follows:
The weighted-average grant-date fair value of stock options granted to employees
during the year and the weighted-average significant assumptions used to
determine those fair values, using a modified Black-Sholes option pricing model,
and the pro forma effect on earnings of the fair value accounting for stock
options under SFAS No. 123 are as follows:
*The expected option life considers historical option exercise patterns and
future changes to those exercise patterns anticipated at the date of grant.
Note 12. Income Taxes
Income tax components are as follows (dollars in thousands):
The tax effect of temporary differences which give rise to a significant portion
of FMB's deferred tax assets (liabilities) are as follows (dollars in
thousands):
The amounts shown for income tax expense on the consolidated statements of
income are less than amounts computed by applying the statutory federal income
tax rate to income before taxes. A reconciliation of such amounts is as follows
(dollars in thousands):
Note 13. Employees' Benefit Plans
Net pension cost includes the following components (dollars in thousands):
The pension plan's funded status and amounts recognized in FMB's consolidated
balance sheets are as follows (dollars in thousands):
The matching contributions to FMB's defined contribution 401(k) plan amounted to
$933,000 for 1996, $769,000 for 1995 and $568,000 for 1994.
Net periodic postretirement benefit cost includes the following components
(dollars in thousands):
Changes to, and refinement of, the retirement age assumptions during 1995 and
1996 also had a significant impact on the net periodic postretirement benefit
cost from year to year.
The postretirement benefit plan's funded status and amounts recognized in FMB's
consolidated balance sheet are as follows (dollars in thousands):
The health care cost trend rate is assumed to decrease 0.5% annually through the
year 1997 and 1.0% annually through the year 2002 to a rate of 5.0% and remain
at that level thereafter. The health care cost trend rate assumption has a
significant effect on the amounts reported. An increase of 1.0% each year in the
assumed health care cost trend rate would increase the accumulated
postretirement benefit obligation at December 31, 1996 by $388,000 and the
aggregate of the service and interest cost components of the net periodic
postretirement benefit cost for 1996 by $71,000.
Note 14. Data Processing Commitments
FMB is a party to an agreement with a service company under which the latter
furnishes data processing services and equipment to FMB and certain of its
subsidiaries. FMB is required to pay minimum charges under the agreement and
additional service fees depending on the volume of accounts. FMB furnishes the
facilities to house the service center and is responsible for utilities,
maintenance and other related costs. Total expense for services under this
agreement was $4,754,000 for 1996, $3,888,000 for 1995 and $3,503,000 for 1994,
including charges for data processing and professional services and amortization
of software costs. The remaining minimum charges are payable as follows (dollars
in thousands):
Note 15. Supplemental Income Statement Information
The components of other operating expenses that are detailed pursuant to various
reporting requirements are as follows (dollars in thousands):
Note 16. Financial Instruments with Off-Balance-Sheet Risk
FMB is party to financial instruments with off-balance-sheet risk, all of which
are entered into for purposes other than trading. These instruments are used in
the normal course of business to meet the financing needs of its customers and
reduce its own exposure to fluctuations in interest rates and include
commitments to extend credit, letters of credit, foreign exchange forward
contracts, interest rate forward contracts and interest rate swap agreements. To
varying degrees, they involve elements of credit and interest rate risk in
excess of the amounts recognized in the consolidated balance sheets. The
contract or notional amounts of these instruments reflect the extent of
involvement FMB has in these particular categories of financial instruments.
Commitments to extend credit are agreements to lend to customers as long as
there are no violations of any conditions established in the contracts.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Letters of credit are conditional commitments issued by the Banks to
guarantee the performance of customers to third parties. Letters of credit are
written for a fixed period of time, usually one year or less, and generally
require payment of a fee. The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending loan facilities to
customers.
For both commitments to extend credit and letters of credit, the Banks
evaluate each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Banks upon extension of
credit, is based on management's credit evaluation. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
FMB enters into foreign exchange forward contracts to purchase or sell
foreign currencies at a future date at a predetermined exchange rate. These
contracts are used to assist customers with international transactions based
upon foreign denominated currencies. There is credit risk and exposure to
foreign currency exchange fluctuations inherent in these transactions to the
extent that the customer would fail to fulfill its purchase or delivery
responsibility and FMB would execute the transaction at the prevailing currency
valuation, which may be different than the value of the original contract.
Interest rate forward contracts are utilized by FMB in its mortgage banking
operations to hedge the value of residential real estate loans that are being
underwritten for anticipated sale to secondary market investors. Changes in
market interest rates, between the time that a customer receives a rate-lock
commitment and the sale of the fully-funded loan, can change the sale value of
the loan. FMB enters into forward contracts to sell exchange traded instruments
whose change in value, due to the same change in market interest rates,
substantially offsets the change in sale value of the underlying rate-locked
loans which are anticipated to be funded.
FMB and its subsidiaries enter into interest rate swap agreements as part
of the asset/liability management process to hedge its short-term interest
sensitivity position against the impact of changes in interest rates. Interest
rate swap agreements generally involve the exchange of fixed and floating
interest payment obligations without the exchange of the underlying principal
amounts. The interest rate differential to be paid or received is recognized in
interest income over the life of the agreements.
The exposure to credit loss in the event of nonperformance by the other
party to the financial instruments for commitments to extend credit and letters
of credit written is represented by the contractual amount of those instruments.
The Banks use the same credit policies in making commitments and conditional
obligations as they do for on-balance-sheet instruments. For foreign exchange
and interest rate forward contracts and interest rate swap agreements, the
notional or contract amounts do not represent exposure to credit loss. FMB
controls the credit risk for these instruments through credit approvals, limits
and monitoring procedures.
Substantially all of FMB's business during the years presented is with
customers in the State of Michigan with no group concentration of credit.
The contract or notional amounts of financial instruments with
off-balance-sheet risk, held for purposes other than trading, are as follows
(dollars in thousands):
Note 17. Disclosures About Estimated Fair Value of Financial Instruments
Most of FMB's assets and liabilities are considered financial instruments. Many
of FMB's financial instruments lack an available trading market, and it is the
intent and general practice of FMB to hold its financial instruments to
maturity. As a result, significant assumptions and present value calculations
were used in determining estimated fair values.
For financial instruments bearing a variable interest rate, it is presumed
that recorded book values are reasonable estimates of fair value. For all other
financial instruments, the following methods and assumptions were used to
estimate fair values:
Cash and cash equivalents
Recorded book value of cash and due from banks and federal funds sold is a
reasonable estimate of fair value.
Interest bearing deposits with banks
The present value of future cash flows from interest bearing deposits with banks
is used to determine estimated fair value. The discount rates used are the
current rates that FMB would receive for similar deposits.
Securities
Quoted market prices for the specific instruments owned, or for similar
securities, are used to determine estimated fair value.
Loans
FMB holds in its portfolio few loans of the type that are readily salable in the
secondary market, or that are commonly used to collateralize investment
securities. Therefore, the present value of estimated future cash flows from the
loan portfolio is used to determine fair value. The discount rates used are the
current rates at which loans with similar terms would be made to borrowers with
similar credit ratings.
Mortgage servicing rights
The estimated fair value of mortgage servicing rights is computed by discounting
the projected future net cash flows relating to mortgage loans sold with
servicing retained given period-end assumptions regarding, among other things,
market servicing costs and estimated long-term prepayments.
Deposits without stated maturities
Recorded book value of non-interest bearing demand deposits and savings and NOW
account deposits, representing the amount payable on demand at the reporting
date, is a reasonable estimate of fair value.
The relationship value of these instruments, commonly referred to as the
core deposit intangible, is not considered a financial instrument and is not
included in the fair value disclosure. The value of the core deposit intangible
would significantly increase the estimated fair value of FMB's financial assets.
Deposits with stated maturities
The present value of future cash flows for time deposits is used to determine
estimated fair value. The discount rates used are the current rates offered for
time deposits with similar maturities.
Other borrowed funds
For short-term borrowings, recorded book value is a reasonable estimate of fair
value due to the relatively short period between origination and expected
repayment of these instruments.
For Federal Home Loan Bank advances, the present value of future cash flows
is used to determine estimated fair value. The discount rates used are the
current rates offered for advances with similar maturities.
Long-term debt
The present value of future cash flows for long-term debt issues is used to
determine estimated fair value. The discount rate used is the average of quoted
yields to maturity on trades of similarly-rated financial institution debt
issues.
Accrued interest
Accrued interest receivable and payable on financial instruments is included in
the reported values of the underlying instruments. For accrued interest
receivable and payable, the recorded book values are reasonable estimates of
fair value.
Off-balance-sheet financial instruments held for purposes other than trading
For foreign exchange and interest rate forward contracts and interest rate swap
agreements, dealer quotes for the specific instruments owned are used to
determine estimated fair value. These values represent the estimated amount FMB
would pay to terminate the agreements, taking into account the current interest
rates. For
commitments to extend credit and letters of credit, the fees currently charged
for similar agreements are used to determine estimated fair value. Given the
market in which it operates, FMB seldom charges fees on commitments to extend
credit.
The estimated fair values of FMB's financial instruments are as follows (dollars
in thousands):
The remaining balance sheet assets and liabilities of FMB are not considered
financial instruments and have not been valued differently than is customary
under historical cost accounting. Since assets and liabilities that are not
financial instruments are excluded above, the difference between total financial
assets and financial liabilities does not, nor is it intended to, represent the
market value of FMB. Furthermore, the estimated fair value information may not
be comparable between financial institutions due to the wide range of valuation
techniques permitted, and assumptions necessitated, in the absence of an
available trading market.
Note 18. First Michigan Bank Corporation (Parent Company Only) Financial
Information
Statements of Income (dollars in thousands, except per share data)
Note 19. Regulatory Restrictions
The Banks may, from time to time, be required to maintain certain average
reserve balances with the Federal Reserve Bank. During 1996 and 1995, these
reserves were $9,021,000 and $7,594,000, respectively.
Federal and state banking laws and regulations place certain restrictions
on the amount of dividends and loans that a bank must pay to its parent company.
Of the $263,349,000 in net assets of the Banks, $49,311,000 is available for
dividends to the parent company in 1997 (before considering 1997 net income),
and the remaining $214,038,000 is restricted based on minimum risk-based capital
requirements now in effect.
Note 20. Regulatory Capital Requirements
FMB and the Banks individually are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by the regulators that could have a direct
material effect on the financial statements of the Banks and of FMB as a whole.
Under the capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Banks must meet specific capital guidelines that involve
quantitative measures the Banks' assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. In
addition, the Banks' capital amounts and classifications are subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
The table below sets forth the quantitative measures established by regulation
to ensure capital adequacy for FMB and the Banks which are considered
significant subsidiaries (dollars in thousands):
As of December 31, 1996, the most recent notifications from the Federal Deposit
Insurance Corporation have respectively categorized the Banks as
well-capitalized under the regulatory framework for prompt corrective action.
There are no conditions or events since that notification that, in the opinion
of management, have changed the categories under which any of the Banks would be
classified.
First Michigan Bank Corporation
Holland, Michigan
We have audited the accompanying consolidated balance sheets of First Michigan
Bank Corporation and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of FMB'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 consolidated financial statements referred to above present
fairly, in all material aspects, the financial position of First Michigan
Bank Corporation and subsidiaries 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 ended December 31, 1996 in conformity with generally accepted
accounting principles.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
January 16, 1997
Grand Rapids, Michigan