-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Bzx2TzhMZ0orLxKyUzrn3yQp971yWwA5KDqZXFPlHHb69sXbjfrgs/ypKBpokaWr I0to6QHFcIBBu1BwwktK4g== 0000950124-99-002246.txt : 19990402 0000950124-99-002246.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950124-99-002246 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCHANTS & MANUFACTURERS BANCORPORATION INC CENTRAL INDEX KEY: 0000753682 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 391413328 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21292 FILM NUMBER: 99580971 BUSINESS ADDRESS: STREET 1: 573 W LINCOLN AVE CITY: MILWAUKEE STATE: WI ZIP: 53207 BUSINESS PHONE: 4146492073 MAIL ADDRESS: STREET 1: 573 W LINCOLN AVE CITY: MILWAUKEE STATE: WI ZIP: 53207 10-K405 1 FORM 10-K405 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------------- ------------------ Commission file number 0-21292 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. ------------------------------------------------ (Exact name of registrant as specified in its charter) Wisconsin 39-1413328 --------- ---------- (State or other jurisdiction of incorporation or (I.R.S. Employer organization) Identification Number) 14100 West National Avenue, PO Box 511160 New Berlin, Wisconsin 53151-1160 -------------------------------- (Address of principal executive office) Registrant's telephone number, including area code: (414) 827-6713 Securities registered pursuant to Section 12(b) of the Act: Not Applicable --------------- Securities registered pursuant to section 12(g) of the Act: COMMON STOCK, PAR VALUE $1.00 PER SHARE --------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K [X] As of March 1, 1999, 1,488,621 shares of Common Stock were outstanding, and the aggregate market value of the shares (based upon the closing price) held by non-affiliates was approximately $52,114,000. 2 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. ***** ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998
PART I Page Item 1. Business 3 Item 2. Properties 5 Item 3. Legal Proceedings 6 Item 4. Submission of Matters to a Vote of Security Holders 6 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder's Matters 6 Item 6. Selected Financial Data 7 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 20 Item 8. Financial Statements and Supplementary Data 21 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 21 PART III Item 10. Directors and Executive Officers of the Registrant 22 Item 11. Executive Compensation 22 Item 12 Security Ownership of Certain Beneficial Owners and Management 22 Item 13. Certain Relationships and Related Transactions 22 PART IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K 22 SIGNATURES 23
2 3 PART I ITEM 1. BUSINESS GENERAL Merchants and Manufacturers Bancorporation, Inc. (the Corporation), is a registered multi-bank holding company under the Bank Holding Company Act of 1956, as amended. The Corporation was organized in 1982, and in 1983 and 1984 acquired all of the outstanding stock of Lincoln State Bank, Milwaukee, Wisconsin and Franklin State Bank, Franklin, Wisconsin, respectively. In 1993, the Corporation acquired all of the outstanding shares of Lincoln Savings Bank, S.A., Milwaukee, Wisconsin. Lincoln State Bank and Franklin State Bank were chartered as commercial banks under the Wisconsin Banking Statutes, while Lincoln Savings Bank operated as a stock savings bank until 1997. In 1997 Lincoln Savings Bank converted from a Wisconsin stock savings bank to a Wisconsin commercial bank. Upon conversion Lincoln Savings Bank changed its name to Lincoln Community Bank. The Corporation operates seventeen banking facilities in Milwaukee and Waukesha counties. In addition to its subsidiary banks (Lincoln State Bank, Franklin State Bank and Lincoln Community Bank), the Corporation owns three non-bank subsidiaries, the Lincoln Neighborhood Redevelopment Corporation, which was organized for the purpose of redeveloping and rejuvenating certain areas located primarily on the near south side of Milwaukee, M&M Services, Inc., which was formed in 1994 to provide operational services to the Corporation's subsidiary banks and Achieve Mortgage Corporation, which was formed in 1997 to act as the Corporation's mortgage broker. This report contains various forward-looking statements concerning the Corporation's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may also be made by the Corporation from time to time in other reports and documents as well as oral presentations. When used in written documents or oral statements, the words anticipate, believe, estimate, expect, objective and similar expressions are intended to identify forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Corporation's control, that could cause the Corporation's actual results and performance to differ materially from what is expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Corporation: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; disintermidiation; the cost of funds; general market rates of interest; interest rates or investment returns on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; and changes in the quality or composition of the Corporation's loan and investment portfolio. PRODUCTS AND SERVICES Through the banking subsidiaries, the Corporation provides a broad range of services to individual and commercial customers. These services include accepting demand, savings, and time deposits, including regular checking accounts, NOW accounts, money market accounts, certificates of deposit, individual retirement accounts, and club accounts. The subsidiary banks also make secured and unsecured commercial, mortgage, construction, and consumer term loans on both a fixed and variable rate basis. Historically, the terms on these loans range from one month to five years and are retained in the Bank's portfolios. The subsidiary banks also provide lines of credit to commercial borrowers and to individuals through home equity loans. COMPETITION The subsidiary banks primarily serve the southern half of Milwaukee County and the southeastern portion of Waukesha County, including suburbs located to the south and west of the City of Milwaukee. There are presently in excess of one hundred other financial institutions in the primary service area that directly compete with Lincoln State Bank, Franklin State Bank and Lincoln Community Bank. In addition to competing with other commercial banks, the subsidiaries compete with savings and loan associations, credit unions, mortgage brokers, small-loan companies, insurance companies, investment banking firms and large retail companies. The principal methods of competition include interest rates paid on deposits and charged on loans, personal contacts and efforts to obtain deposits and loans, types and quality of services provided and convenience of the locations. Many of the Corporation's competitors are larger and have significantly greater financial resources than the Corporation and its subsidiaries. EMPLOYEES At December 31, 1998, the Corporation and its subsidiaries employed 141 full-time and 55 part-time employees. The Corporation provides a wide range of benefits to employees, including educational activities, and considers its employee relations to be excellent. The Corporation conducts extensive training programs in order to enhance job-related knowledge and skills of its people and to train its employees with a sales-orientated approach to customers. Eligible employees participate in a 401K plan as well as group life and major medical insurance programs. 3 4 THE BANKS AND OTHER SUBSIDIARIES At or for the year ended December 31, 1998, the subsidiary banks (each consolidated with its appropriate subsidiaries; see "Other Subsidiaries") had total assets, total loans, total deposits, stockholder's equity, net income, and return on assets as follows (dollars in thousands):
LINCOLN STATE BANK LINCOLN COMMUNITY BANK FRANKLIN STATE BANK ---------------------------- ------------------------ ----------------------------- ----------------------- Total assets 182,027 $ 97,061 $ 52,065 Total loans 150,650 61,038 42,428 Total deposits 154,141 88,161 47,561 Stockholders' equity 14,533 8,639 4,464 Net income 1,770 1,191 458 Return on average assets 1.07% 1.20% 0.99%
The Banks have consistent products, services and delivery systems and comply with similar regulatory guidance. As such they are not segments as that term is defined in Financial Accounting Standards Board Statement 131. LINCOLN STATE BANK Lincoln State Bank was organized as a state banking association under the laws of the State of Wisconsin in 1919. It operates full service branch offices in the southeastern Wisconsin communities of Muskego, New Berlin, Brookfield and Pewaukee. In addition it operates eight limited hours facilities in Milwaukee County. At December 31, 1998, Lincoln State Bank comprised 54.4% of the consolidated assets of the Corporation. LINCOLN COMMUNITY BANK Lincoln Community Bank was organized as a state chartered mutual savings and loan association under the laws of the State of Wisconsin in 1910. It operates two full service branch offices in the city of Milwaukee. In April 1993, it converted from the mutual to stock form of organization, and all of the shares of stock issued by the converted association were acquired by the Corporation. In 1997 Lincoln Community Bank converted from a Wisconsin stock savings bank to a Wisconsin commercial bank. Its principal office and a branch office are located in Milwaukee, Wisconsin. At December 31, 1998, Lincoln Community Bank comprised 29.0% of the consolidated assets of the Corporation. FRANKLIN STATE BANK Franklin State Bank was organized as a state banking association under the laws of the State of Wisconsin in 1982. Its principal office and a branch office are located in Franklin, Wisconsin. At December 31, 1998, Franklin State Bank comprised 15.6% of the consolidated assets of the Corporation. LINCOLN NEIGHBORHOOD REDEVELOPMENT CORPORATION The Lincoln Neighborhood Redevelopment Corporation (the Redevelopment Corporation) was formed in June of 1988 and is a wholly owned subsidiary of the Corporation. The Redevelopment Corporation was established to redevelop and rejuvenate certain areas located on the south-side of Milwaukee by, among other things, arresting decay and deterioration, working with local businesses to keep commercial areas strong and attractive, pursuing means to preserve and create jobs, encouraging appropriate land-use, involving community residents in economic planning and retaining and attracting businesses. As of December 31, 1998, Lincoln Neighborhood Redevelopment Corporation had assets of $103,000, $68,000 in liabilities and equity of $35,000. M&M SERVICES, INC. M&M Services was formed in January of 1994 and is a wholly owned subsidiary of the Corporation. M&M Services provides operational activities to the Corporation's subsidiary banks. These activities include: human resources, auditing, marketing, financial analysis, loan document preparation, loan credit analysis and check processing. ACHIEVE MORTGAGE CORPORATION Achieve Mortgage Corporation was formed in January of 1997 and is a wholly owned subsidiary of the Corporation. The subsidiary was formed to expand the origination of secondary market real estate mortgages on behalf of the Corporation and the Banks. 4 5 OTHER SUBSIDIARIES Lincoln State Bank and Lincoln Community Bank each have a wholly owned subsidiary. In 1991 an investment subsidiary known as M&M - Lincoln Investment Corporation was formed to manage the majority of Lincoln State Bank's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $13 million of mortgage-backed and other investment securities from Lincoln State Bank in exchange for 100% of the stock of the subsidiary. In 1995 an investment subsidiary known as Lincoln Investment Management Corporation was formed to manage the majority of Lincoln Community Bank's investment portfolio and to enhance the overall return of the portfolio. The subsidiary received a capital contribution of approximately $21 million of mortgage-backed and other investment securities from Lincoln Community Bank in exchange for 100% of the stock of the subsidiary. These subsidiaries are an intrinsic component of their respective parent banks and assets there of are included in the total assets of the respective Bank above. SUPERVISION AND REGULATION The operations of financial institutions, including bank holding companies, commercial banks and savings banks, are highly regulated, both at federal and state levels. Numerous statutes and regulations affect the businesses of the Corporation and its financial service subsidiaries. The Corporation's own activities are regulated by the federal Bank Holding Company Act (the "Act"), which requires each holding company to obtain the prior approval of the Federal Reserve Board (the "Board") before acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank or before engaging, directly or indirectly, in certain enumerated activities. While the act, with certain exceptions, previously prohibited the acquisition of banks located in other states, recently enacted legislation now generally authorizes such interstate acquisitions, subject to regulatory approval. The Act also prohibits, with certain exceptions acquisition of more than five percent of the voting shares of any company (directly or indirectly) doing business other than banking or performing services for its subsidiaries, without prior approval of the Board. Pursuant to the Act, the Corporation is supervised and regularly examined by the Board. Lincoln State Bank, Franklin State Bank and Lincoln Community Bank are subject to extensive regulation and supervision by the Wisconsin Department of Financial Institutions. Because the deposits of all three banks are insured by the Federal Deposit Insurance Corporation (FDIC), they are also subject to supervision by the FDIC. In that connection, the banks must comply with applicable state and federal statutes and a wide range of rules and regulations promulgated by bank regulatory agencies under such statutes. To assure compliance with such laws and to ascertain their safety and soundness, the banks are periodically examined by the FDIC and the Wisconsin Department of Financial Institutions. In addition, the Corporation itself is periodically examined by the Federal Reserve Bank of Chicago. Such supervision and regulation is intended primarily to ensure the safety of deposits accepted by the banks. ITEM 2. PROPERTIES The Corporation's offices are located in a two-story building at 14100 West National Avenue in New Berlin, Wisconsin. The building constructed in 1997, contains 20,000 square feet, of which the majority is used by the Corporation and the remainder leased to a tenant. At this location, the Corporation maintains its corporate operations and personnel. The main office of Lincoln State Bank is at 2266 South 13th Street, Milwaukee, Wisconsin. The South 13th Street location consists of a one-story building containing approximately 11,000 square feet. An adjacent building of approximately 750 square feet contains the two walk-up facilities operated by Lincoln State Bank. In addition, there are three drive-up facilities, and the parking lot provides space for 51 cars. One branch of Lincoln State Bank is located in a one-story, 1,700 square foot building at 13500 Janesville Road, Muskego, Wisconsin. The Muskego branch has three drive-up windows and parking facilities for 25 vehicles. Another branch of Lincoln State Bank was opened in May 1990 at 14000 West National Avenue, New Berlin, Wisconsin. The New Berlin branch contains approximately 7,000 square feet and has 4 drive-up facilities, 4 walk-up windows and parking for 27 vehicles. During 1995 Lincoln State Bank opened two other full-service branch locations one located at 17600 West Capitol Drive, Brookfield, Wisconsin and at 585 Ryan Street, Pewaukee, Wisconsin. Both facilities offer drive-up and walk-up facilities along with parking for both customers and employees. In addition, Lincoln State Bank operates customer facilities at Villa St. Francis located at South 20th and Ohio Streets in Milwaukee, at Clement Manor located at South 92nd Street and West Howard Avenue in Milwaukee, at Friendship Village located at North 73rd and West Dean Road in Milwaukee, at Stoney Creek Adult Community in Muskego, at the Milwaukee Protestant Home located on North Downer Avenue in Milwaukee and at Forest Ridge located in Hales Corners, Wisconsin. In 1998 Lincoln State Bank opened two new limited hour facilities. These offices are located in Landmark of West Allis and Lexington Village in the City of Greenfield. 5 6 Franklin State Bank's main office is located in a three-story building at 7000 South 76th Street in Franklin, Wisconsin. The building contains 21,308 square feet, has five drive-up lanes and three automatic tellers. The parking lot accommodates 165 cars. The building is owned by the Corporation and leases space to Franklin State Bank. Portions of the building that are not used by Franklin State Bank are leased to various tenants. In 1998 Franklin State Bank opened a branch facility at 9719 South Franklin Drive in the Franklin Business Park, Franklin, Wisconsin. Franklin State Bank owns the facility. Lincoln Community Bank's main office is located at 3131 South 13th Street, Milwaukee, Wisconsin in a one-story building. Lincoln Community Bank also operates a branch facility at 5400 West Forest Home Avenue, Milwaukee, Wisconsin. Lincoln Community Bank owns both facilities. Achieve Mortgage Corporation leases office space at the Forest Home Avenue location. M&M Services is located in the New Berlin corporate headquarters. At that location, M&M Services maintains its subsidiary service support facilities and personnel. ITEM 3. LEGAL PROCEEDINGS From time to time, the Corporation and its subsidiaries are party to legal proceedings arising out of their general lending activities and other operations. However, there are no pending legal proceedings to which the Corporation or its subsidiaries are a party, or to which their property is subject, which, if determined adversely to the Corporation, would individually or in the aggregate have a material adverse effect on its consolidated financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS The stock of the Corporation is not listed on any stock exchange or quoted on the National Association of Securities Dealers Quotation Automated Quotation System. The Corporation's stock has been quoted on "Pink Sheets", an inter-broker quotation medium, since April 1993, and in the Over The Counter Bulletin Board, an electronic quotation service. Robert W. Baird & Co., Incorporated, a regional securities and investment banking firm headquartered in Milwaukee, Wisconsin, acts as a market maker for the Corporation's stock. The Corporation's stock is quoted in the "Other Stocks" section of the Milwaukee Journal/Sentinel. The Corporation's common stock trading symbol is "MMBI." Holders of the Corporation's stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors from funds legally available for such payments. The Corporation's ability to pay cash dividends is dependent primarily on the ability of its subsidiaries to pay dividends to the Corporation. The ability of each subsidiary to pay dividends depends on its earnings and financial condition and on compliance with banking statutes and regulations. The following table sets forth the quarterly "bid/ask" range for the period indicated.
Quotation or Price Quarter Ended Bid Ask -------------------------------------------------------------- March 31, 1997 $ 18.79 $ 19.39 June 30, 1997 19.55 19.55 September 30, 1997 20.15 20.15 December 31, 1997 28.03 28.33 MARCH 31, 1998 $ 30.30 $ 30.30 JUNE 30, 1998 31.25 31.25 SEPTEMBER 30, 1998 40.00 39.00 DECEMBER 31, 1998 39.50 39.50
6 7 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes certain historical financial data regarding the Corporation. This information is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Corporation presented elsewhere herein (dollars in thousands, except per share data):
At or For the Year Ended December 31, -------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- SELECTED BALANCE SHEET DATA Total assets $ 334,503 $ 296,678 $ 267,723 $ 264,247 $ 248,181 Loans receivable, net 251,815 227,178 189,791 163,650 149,925 Investment securities held to maturity 0 0 0 0 4,326 Investment securities available for sale 15,721 12,649 15,499 15,833 9,464 Mortgage-related securities available for sale 22,850 28,169 27,154 44,251 54,634 Deposits 289,230 264,669 232,933 233,083 223,446 Short-term borrowings 13,260 1,500 6,850 3,000 0 Stockholders' equity 30,997 29,496 26,380 26,543 23,573 Realized stockholders' equity(2) 31,631 29,505 26,583 26,724 25,512 SELECTED INCOME STATEMENT DATA Total interest income (taxable-equivalent)(1) $23,336 $21,126 $19,401 $ 18,479 $ 16,212 Total interest expense 10,589 9,090 8,362 7,921 6,155 -------------------------------------------------------------------- Net interest income 12,747 12,036 11,039 10,558 10,057 Provision for loan losses 250 192 460 132 43 -------------------------------------------------------------------- Net interest income after provision for loan losses 12,497 11,844 10,579 10,426 10,014 Net gain (loss) on security sales 217 78 70 61 (244) Other noninterest income 2,113 1,578 1,485 1,267 1,185 -------------------------------------------------------------------- Total noninterest income 2,330 1,656 1,555 1,328 941 Noninterest expense 10,532 9,620 10,021 9,040 8,484 -------------------------------------------------------------------- Income before income taxes 4,295 3,880 2,113 2,714 2,471 Income taxes 1,468 1,439 730 917 874 Less taxable equivalent adjustment 121 32 73 96 73 -------------------------------------------------------------------- Net income $ 2,706 $ 2,409 $ 1,310 $ 1,701 $ 1,524 ==================================================================== PER SHARE DATA(3) Net income - basic $ 1.81 $ 1.67 $ 0.91 $ 1.16 $ 1.04 Net income - diluted $ 1.78 $ 1.65 $ 0.90 $ 1.15 $ 1.03 Cash dividend declared $ 0.59 $ 0.48 $ 0.48 $ 0.39 $ 0.31 Book value $ 20.80 $ 19.78 $ 18.48 $ 18.06 $ 16.10 Average shares outstanding 1,497,763 1,442,723 1,439,560 1,467,967 1,469,581 OTHER DATA Net interest margin 3.64% 3.95% 3.87% 3.86% 3.93% Allowance for loan losses to non-accrual loans 225.47% 299.42% 206.87% 232.92% 189.64% Nonperforming assets to total assets 0.31% 0.24% 0.35% 0.25% 0.35% Stockholders' equity to total assets 9.27% 9.94% 9.85% 10.04% 9.50% Average stockholders' equity to average assets 9.69% 9.77% 9.94% 10.01% 9.87% Return on assets (ratio of net income to average total assets) 0.86% 0.86% 0.50% 0.67% 0.62% Return on stockholders' equity (ratio of net income to average equity) 8.92% 8.82% 5.00% 6.71% 6.27% Dividend payout ratio 32.85% 29.18% 52.75% 33.45% 29.79% Facilities: Number of full-service offices 9 8 8 8 6 Number of limited services offices 8 6 6 6 4
(1) Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes. A 34% incremental income tax rate, consistent with the Corporation's historical experience, is used in the conversion of tax-exempt interest income to a tax-equivalent basis. (2) Excludes SFAS 115 mark-to-market equity adjustment. (3) All per share information presented in this report has been retroactively restated to give effect to the 3 for 2 stock split, declared in April 1998 and the 10% stock dividend declared in October 1998, as if each occurred as of January 1, 1994. 7 8 The following table sets forth certain unaudited income and expense data on a quarterly basis for the periods indicated (dollars in thousands, except per share data):
1998 1997 ---------------------------------------------------------------------------------------------------- 3/31 6/30 9/30 12/31 3/31 6/30 9/30 12/31 ---------------------------------------------------------------------------------------------------- Interest income (taxable-equivalent) (1) $5,643 $5,709 $5,940 $6,044 $4,952 $5,173 $5,386 $5,615 Interest expense 2,512 2,606 2,719 2,752 2,168 2,201 2,321 2,400 ---------------------------------------------------------------------------------------------------- Net interest income 3,131 3,103 3,221 3,292 2,784 2,972 3,065 3,215 Provision for loan losses 75 75 50 50 48 48 48 48 Noninterest income 450 559 529 792 396 390 433 437 Noninterest expense 2,965 2,546 2,545 2,476 2,625 2,318 2,343 2,334 ---------------------------------------------------------------------------------------------------- Income before taxes 541 1,041 1,155 1,558 507 996 1,107 1,270 Income taxes 180 367 382 539 196 366 408 469 Less taxable equivalent adjustment 12 16 50 43 6 6 8 12 ==================================================================================================== Net income $349 $658 $723 $976 $305 $624 $691 $789 ==================================================================================================== Basic earnings per share $0.24 $0.44 $0.48 $0.65 $0.21 $0.44 $0.48 $0.54 ==================================================================================================== Diluted earnings per share $0.23 $0.44 $0.47 $0.64 $0.21 $0.43 $0.48 $0.53 ==================================================================================================== Dividends per share $0.12 $0.13 $0.15 $0.20 $0.12 $0.12 $0.12 $0.12 ====================================================================================================
(1) Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes. A 34% incremental income tax rate, consistent with the Corporation's historical experience, is used in the conversion of tax-exempt interest income to a tax-equivalent basis. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion is intended as a review of significant factors affecting the Corporation's financial condition and results of operations as of and for the period ended December 31, 1998, as well as providing comparisons with previous years. This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes and the selected financial data presented elsewhere in this report. NET INTEREST INCOME Net interest income equals the difference between interest earned on assets and the interest paid on liabilities and is a measure of how effectively management has balanced and allocated the Corporation's interest rate sensitive assets and liabilities. Net interest income is the most significant component of earnings. Taxable-equivalent adjustments to interest income involve the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes on a fully tax equivalent basis. A 34% incremental income tax rate, consistent with the Corporation's historical experience, is used in the conversion of tax-exempt interest income to a taxable-equivalent basis. Net interest income on a fully tax equivalent basis increased to $12.7 million in 1998, compared with $12.0 million in 1997 and $11.0 million in 1996. This increase of $711,000 in net interest income in 1998 was due primarily to an increase in the volume of earning assets in 1998 (a $2.8 million increase). This gain was partially offset by an increase in the volume of interest bearing liabilities (a $1.4 million increase). The total increase in average earning assets was primarily due to an increase in average loans of $29.2 million. All of the loan growth was internally generated. Interest bearing deposits increased $27.6 million in 1998. The Corporation's entrance into new markets, introduction of new products and its pricing of time deposits were contributing factors to the growth in deposits. 8 9 The following table sets forth, for the periods indicated, information regarding the average balances of assets and liabilities and the total dollar amount of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resulting yields, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities, and net interest margin. Average balances have been calculated using average daily balances during such periods (dollars in thousands):
At or for the Year Ended December 31, -------------------------------- -------------------------------- -------------------------------- 1998 1997 1996 -------------------------------- -------------------------------- -------------------------------- AVERAGE AVERAGE Average Average Average Average BALANCE INTEREST RATE Balance Interest Rate Balance Interest Rate ASSETS ------- -------- ------- ------- -------- ------- ------- -------- ------- Loans(1),(2) $237,977 $19,985 8.40% $208,807 $17,972 8.61% $176,790 $15,230 8.61% Loans exempt from federal income taxes(3) 600 71 11.83% 683 77 11.27% 753 88 11.69% Taxable investment securities(4) 11,896 715 6.01% 16,043 967 6.03% 17,260 1,028 5.96% Mortgage-related securities(4) 28,350 1,761 6.21% 23,629 1,508 6.38% 38,475 2,407 6.26% Investment securities exempt from federal income taxes(3),(4) 4,194 285 6.80% 233 18 7.73% 2,003 126 6.29% Other securities 10,079 519 5.15% 11,091 584 5.27% 10,139 522 5.15% ---------------------- ---------------------- --------------------- Interest earning assets 293,096 23,336 7.96% 260,486 21,126 8.11% 245,420 19,401 7.91% Non interest earning assets 20,258 19,082 18,238 ----------- ----------- ---------- Average Assets $313,354 $279,568 $263,658 =========== =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY NOW deposits $23,656 592 2.50% $21,466 405 1.89% $23,011 479 2.08% Money market deposits 7,407 176 2.38% 6,448 155 2.40% 6,291 158 2.51% Savings deposits 60,032 1,318 2.20% 61,575 1,327 2.16% 64,345 1,400 2.18% Time deposits 151,590 8,363 5.52% 125,600 7,010 5.58% 109,862 6,109 5.56% Other borrowings 2,454 140 5.70% 3,425 193 5.64% 3,564 216 6.06% ---------------------- ---------------------- --------------------- Interest bearing liabilities 245,139 10,589 4.32% 218,514 9,090 4.16% 207,073 8,362 4.04% ----------- ----------- ----------- Demand deposits and other non interest bearing liabilities 37,846 33,745 30,369 Stockholders' equity 30,369 27,309 26,216 ----------- ----------- ---------- Average Liabilities and stockholders' Equity $313,354 $279,568 $263,658 =========== =========== ========== Net interest income/spread $12,747 3.64% $12,036 3.95% $11,039 3.87% ===================== ===================== ===================== Net interest earning assets $47,957 $41,972 $38,347 =========== =========== ========== Net yield on interest earning assets 4.35% 4.62% 4.50% ========== ========== ========== Ratio of average interest-earning assets to average interest- bearing liabilities 1.20 1.19 1.19 =========== =========== ==========
(1) For the purpose of these computations, nonaccrual loans are included in the daily average loan amounts outstanding. (2) Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from nonaccrual status during the period indicated. (3) Taxable-equivalent adjustments were made using a 34% corporate tax rate for all years presented in calculating interest income and yields. (4) Average balances of securities available-for-sale are based on amortized cost. 9 10 The following table sets forth the effects of changing interest rates and volumes of interest earning assets and interest bearing liabilities on net interest income of the Corporation. Information is provided with respect to (i) effect on net interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on net interest income attributable to changes in rate (changes in rate multiplied by prior volume), (iii) changes in a combination of rate and volume (changes in rate multiplied by changes in volume), and (iv) net change (in thousands):
For the Year Ended December 31, --------------------------------------------- --------------------------------------------- 1998 VS. 1997 1997 vs. 1996 --------------------------------------------- --------------------------------------------- INCREASE/(DECREASE) Increase/(Decrease) DUE TO ---------------------------------- TOTAL --------------------------------- Due to VOLUME INCREASE Volume Increase VOLUME RATE & RATE (DECREASE) Volume Rate & Rate (Decrease) ------ ---- ------ ---------- ------ ---- ------ ---------- Interest-Earning Assets: Loans receivable(1) $2,511 ($437) ($61) $2,013 $2,758 ($14) ($2) $2,742 Loans exempt from federal income taxes(2) (10) 4 0 (6) (8) (3) 0 (11) Taxable investment securities (250) (3) 1 (252) (74) 12 1 (61) Mortgage-related securities 301 (40) (8) 253 (928) 48 (19) (899) Investment securities exempt from federal income taxes(2) 306 (2) (37) 267 (112) 29 (25) (108) Other securities (53) (13) 1 (65) 49 12 1 62 --------------------------------------------- --------------------------------------------- Total interest-earning assets $2,805 ($491) ($104) 2,210 $1,685 $84 ($44) 1,725 ==================================----------- =================================------------ Interest-Bearing Liabilities: NOW deposits $42 $132 $13 $187 ($32) ($45) $3 ($74) Money market deposits 23 (2) 0 21 4 (7) 0 (3) Savings deposits (33) 25 (1) (9) (61) (13) 1 (73) Time deposits 1,451 (81) (17) 1,353 875 23 3 901 Other borrowings (54) 2 (1) (53) (9) (15) 1 (23) --------------------------------------------- --------------------------------------------- Total interest-bearing liabilities $1,429 $76 ($6) $1,499 $777 ($57) $8 $728 ==================================----------- =================================------------ Net change in net interest income $711 $997 =========== ============
(1) Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from nonaccrual during the period indicated. (2) Taxable-equivalent adjustments were made using a 34% corporate tax rate for all years presented in calculating interest income and yields. PROVISION FOR LOAN LOSSES During 1998, the Corporation made a provision of $250,000 to the allowance for loan losses, as compared to a provision of $192,000 in 1997 and $460,000 in 1996. The 1996 increase did not reflect deteriorating quality in the loan portfolio but primarily reflected an increase in loan volume and management's assessment of general economic conditions. Loan charge-offs for 1998 increased by $10,000, over 1997 to $48,000. This compares to charge-offs of $82,000 in 1996. Although management considers the allowance for loan losses to be adequate to provide for potential losses in the loan portfolio, there can be no assurance that losses will not exceed estimated amounts or that the subsidiary banks will not be required to make further and possibly larger additions to their allowance in the future. NON-INTEREST INCOME Non-interest income increased $674,000 in 1998 and $101,000 in 1997. The composition of non-interest income is shown in the following table (in thousands).
For the Year Ended December 31, 1998 1997 1996 ---------------------------------------------------- Service charges on deposit accounts $743 $746 $725 Service charges on loans 255 141 172 Net gain on securities sales 217 78 70 Other 1,115 691 588 ==================================================== Total noninterest income $2,330 $1,656 $1,555 ====================================================
10 11 Service charge income on deposit accounts decreased $3,000 in 1998 and increased $21,000 from 1996 to 1997. The decrease in the charges on eligible accounts caused the change in 1998 income, while the 1997 increase can be attributed to raising of fees assessed on deposit accounts. Service charges on loans increased $114,000 from $141,000 in 1997 to $255,000 in 1998. The 1998 increase can be attributed to the high volume of loan refinancing and the sizable increase in new loans generated. The Corporation recorded a net gain of $217,000 on the sale of $26.8 million of securities in 1998, $78,000 on the sale of $12.3 million of securities in 1997 and $70,000 on the sale of $15.8 million of securities in 1996. The proceeds from the sale of the investments were used to purchase short term variable rate securities and to meet existing loan demand. Other non-interest income increased $424,000 in 1998 and increased $103,000 in 1997. Two items were primarily responsible for the 1998 increase. The first was a $124,000 gain on the sale of $9.7 million of residential mortgage loans. The proceeds from the sale of these loans were used to fund new commercial loans and to meet the liquidity needs of the banks. The other component of increased fee income is the charge assessed non-customers for the use of the Corporation's automated teller machines. The Corporation initiated a surcharge in late 1997 that charged non-customers $1.00 per ATM transaction. This new source of income generated $309,000 of additional income in 1998 over 1997. The Corporation anticipates this income may decline in the future as consumers adjust their ATM use habits and as the Corporation shares these revenues with merchants that allow the banks to place machines in their businesses. NON-INTEREST EXPENSE Non-interest expense increased $912,000 (9.5%) for the year ended December 31, 1998, and decreased $401,000 (4.0%) for the year ended December 31, 1997. The major components of non-interest expense are shown in the following table (in thousands).
For the Year Ended December 31, 1998 1997 1996 ---------------------------------------------------- Salaries and employee benefits $6,099 $5,453 $5,223 Premises and equipment 1,580 1,412 1,340 Data processing fees 623 612 561 SAIF Assessment 0 0 604 Federal deposit insurance premiums 95 75 159 Other 2,135 2,068 2,134 ==================================================== Total noninterest expense $10,532 $9,620 $10,021 ====================================================
Salaries and employee benefits increased $646,000 in 1998, reflecting additional staff hires, higher benefit costs, changes in personnel and normal pay raises. The 1998 increase in the cost of employee benefits, particularly medical insurance amounted to $75,000. Premises and equipment expense increased $168,000 in 1998. The increase was due to the first full year operation of the corporate headquarters completed in May 1997 and the construction of the Franklin State Bank branch office that was completed in October 1998. The $72,000 increase in 1997 was the result of the construction of the corporate headquarters and increase in regular occupancy expenses. Data processing fees increased $11,000 in 1998 and $51,000 in 1997. The increases were due to increased volume and new services being provided by the service bureau. During the third quarter of 1996 Lincoln Community Bank incurred a $604,000 charge from the FDIC which represented its share of the recapitalization of the Savings Association Insurance Fund (SAIF). This charge was set at 0.657% of Lincoln Community Bank's deposit liabilities as of March 31, 1995. Although this charge adversely impacted results of operations, it is expected to provide long-term benefits to the Corporation in the form of lower federal insurance premiums. Federal deposit insurance fees represent premiums paid for FDIC insurance on the banks' deposits. The FDIC assesses the banks based on the level of deposits. The 1998 insurance premium increased $22,000, due to the higher level of deposits. In 1995 the Bank Insurance Fund (BIF) reached its prescribed capitalization level mandated by Congress as part of FDIC Institutions Improvement Act of 1991. As a result the bank's premium was reduced by $84,000 in 1997. Other expenses increased $67,000 in 1998. These increases are the result of changes in operating expenses such as consulting fees, examination costs, insurance costs, robberies and check losses. In 1997 other expenses decreased $66,000. The decrease was primarily due to a reduction in service charges being paid to the Corporation's corespondent bank and a decrease in the Corporation's annual fee to the Lincoln Neighborhood Redevelopment Corporation. 11 12 INCOME TAXES The Corporation's consolidated income tax rate varies from statutory rates principally due to interest income from tax-exempt securities and loans and interest income on securities in the M&M Lincoln Investment Corporation portfolio and Lincoln Investment Management Corporation for which state taxes are not imposed. The Corporation recorded provisions for income taxes totaling $1.4 million in 1998, $1.4 million in 1997 and $730,000 in 1996. Although the 1998 tax expense increased $29,000, the effective tax rate declined from 37.4% in 1997 to 35.2% in 1998. This was achieved by increasing the balance of tax-exempt securities. The increase in 1997 income taxes is a result of higher taxable income. NET INCOME For the years ended December 31, 1998, 1997 and 1996, the Corporation posted net income of $2.706 million, $2.409 million and $1.310 million, respectively. LOANS RECEIVABLE Net loans receivable increased $24.6 million, or 10.8%, from $227.2 million at December 31, 1997, to $251.8 million at December 31, 1998. Loans receivable consist mainly of mortgages secured by residential properties located in the Corporation's primary market area and commercial loans secured by business assets, real estate, and guarantees. The following table shows the composition of the Corporation's loan portfolio on the dates indicated (in thousands):
At December 31, 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------------- First Mortgage: Conventional single-family residential $43,912 $58,821 $58,358 $57,629 $55,478 Commercial and multifamily residential 112,015 78,365 61,707 44,594 42,046 Construction and land 15,853 18,191 12,872 12,619 8,254 -------------------------------------------------------------------------------------- 171,780 155,377 132,937 114,842 105,778 Commercial business loans 64,094 56,846 45,036 36,605 35,118 Consumer and installment loans 13,578 12,220 10,984 10,810 7,377 Leases 2,599 2,311 599 0 0 Home equity loans 1,346 1,496 1,367 1,695 1,577 Other 763 1,081 883 1,326 1,644 -------------------------------------------------------------------------------------- 82,380 73,954 58,869 50,436 45,716 Less: Deferred loan fees 43 60 76 95 105 Allowance for loan losses 2,302 2,093 1,939 1,533 1,464 ====================================================================================== $251,815 $227,178 $189,791 $163,650 $149,925 ======================================================================================
The following table presents information as of December 31, 1998 regarding first mortgage and commercial business loan maturities and contractual principal repayments of loans during the periods indicated. Loans with adjustable interest rates are shown maturing in the year of their contractual maturity. Also provided are the amounts due after one year classified according to the sensitivity to changes in interest rates.
AFTER ONE BUT WITHIN WITHIN AFTER ONE YEAR FIVE YEARS FIVE YEARS TOTAL ---------------------------------------------------------------------- COMMERCIAL BUSINESS LOANS $34,829 $29,042 $ 223 $ 64,094 FIRST MORTGAGE LOANS 56,281 81,478 34,021 171,780 ---------------------------------------------------------------------- $91,110 $110,520 $34,244 $235,874 ====================================================================== LOANS MATURING AFTER ONE YEAR WITH: FIXED INTEREST RATES $103,506 $11,337 VARIABLE INTEREST RATES 7,013 22,907 ---------------------------------- $110,519 $34,244 ==================================
12 13 ALLOWANCE FOR LOAN LOSSES The Corporation maintains an allowance for loan losses to absorb estimated losses in its loan portfolio. Management's determination of the adequacy of the allowance is based on review of specific loans, past loan loss experience, general economic conditions and other pertinent factors. If, as a result of charge-offs or increases in the risk factors of the loan portfolio, the allowance is below the level considered to be adequate to absorb estimated losses, the periodic provision to the allowance is increased. Loans deemed uncollectible are charged off and deducted from the allowance. The allowance for loan losses increased from $2.093 million at December 31, 1997, to $2.302 million at December 31, 1998. This increase was because of growth in loan volume in general, and growth in commercial business loans specifically, and the Corporation's decision to maintain or increase its allowance for loan losses as a percentage of outstanding loans because of growing uncertainty regarding economic conditions. The ratio of the allowance for loan losses to total loans was 0.91% for 1998 and 0.91% in 1997. Based on the present economic environment and its present analysis of the financial condition of the borrowers, the Corporation considers the present allowance to be appropriate and adequate to cover potential losses inherent in the loan portfolio, however, changes in future economic conditions and in the financial condition of borrowers cannot be predicted at this time. Deterioration in such conditions could result in increases in charge-offs or adversely classified loans and accordingly, in additional provisions for loan losses. The balance of the allowance for loan losses and actual loss experience for the last five years is summarized in the following table (dollars in thousands):
At or for the Year Ended At December 31, 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------------- Balance at beginning of year $2,093 $1,939 $1,533 $1,464 $1,356 Charge-offs: Conventional single-family mortgage residential 0 0 70 20 0 Commercial business loans 21 4 5 27 6 Consumer and installment loans 27 34 8 16 6 -------------------------------------------------------------------------------------- Total charge-offs 48 38 83 63 12 Recoveries (7) 0 (29) 0 (77) -------------------------------------------------------------------------------------- Net charge-offs (recoveries) 41 38 54 63 (65) Provisions charged to operations 250 192 460 132 43 ====================================================================================== Balance at end of year $2,302 $2,093 $1,939 $1,533 $1,464 ====================================================================================== Ratios: Net charge-offs (recoveries) to average loans outstanding 0.02% 0.02% 0.03% 0.04% (0.05)% Net charge-offs (recoveries) to total allowance 1.78% 1.81% 2.78% 4.11% (4.44)% Allowance to year end gross loans outstanding 0.91% 0.91% 1.01% 0.93% 0.97%
13 14 NON-PERFORMING AND DELINQUENT LOANS When in the opinion of management, serious doubt exists as to the collectibility of a loan, the loan is placed on non-accrual status and interest previously accrued but unpaid is deducted from interest income. The Corporation does not recognize income on any loans past due 90 days or more. In 1998, $24,000 of additional income on nonaccrual loans would have been reported if the loans had been current in accordance with their original terms and had been outstanding throughout the year. Additionally in 1998 the Corporation recorded $68,000 of interest income on non-accrual loans that was included in net income for the year. The following table summarizes non-performing assets on the dates indicated (dollars in thousands):
At December 31, 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------------- Nonaccrual loans $ 1,021 $699 $938 $658 $772 Real estate in judgment 0 0 0 0 24 Other real estate owned 0 0 0 0 73 ====================================================================================== Total non-performing assets $ 1,021 $699 $938 $658 $869 ====================================================================================== Ratios: Non-accrual loans to total loans 0.40% 0.30% 0.49% 0.40% 0.51% Allowance to non-accrual loans 225.47% 299.42% 206.72% 232.98% 189.64% Non-performing assets to total assets 0.31% 0.24% 0.35% 0.25% 0.35%
INVESTMENT AND MORTGAGE RELATED SECURITIES Investment securities at December 31, 1998, are made up of U.S. Treasury and agency securities of $1.517 million, government agency mortgage-backed securities of $20.659 million, SBA certificates of $628,000, state and political subdivision certificates of $10.517 million, collateralized mortgage obligations of $2.191 million and mutual funds of $3.059 million. Total investment securities equaled $38.571 million. This compares to $40.818 million on December 31, 1997. Management determines the appropriate classification of securities (including mortgage-related securities) at the time of purchase. Held-to-maturity securities are stated at amortized cost where as available for sale securities are stated at fair value with changes in fair value reflected as a component of net income, net of tax . See notes one and two to Consolidated Financial Statements for further details. Securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. The amortized cost of debt securities are adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the security. Such amortization is included in interest income from the related security. Interest and dividends are included in interest income from the related securities. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method. The reason for the decrease in investment securities is the increase in demand for funds for lending purposes. Funding for additional loans came primarily from government agency mortgage-backed securities which either matured or prepaid. The following table sets forth the Corporations estimated fair value of investment securities available-for-sale at the dates indicated (in thousands):
At December 31, 1998 1997 1996 --------------------------------------------------- Mutual funds $3,059 $3,104 $3,098 U.S. Treasury and other U.S. government securities 1,517 7,801 11,321 Small Business Administration certificates 628 930 1,080 State and political subdivision securities 10,517 814 0 Collateralized mortgage obligations 2,191 1,488 2,943 Government agency mortgage-backed securities 20,659 26,681 24,211 =================================================== $38,571 $40,818 $42,653 ===================================================
14 15 The maturity distribution (based upon the average life), and weighted average yield of the securities portfolio of the Corporation as of December 31, 1998 are summarized in the following table (dollars in thousands):
WITHIN ONE YEAR ONE TO FIVE YEARS FIVE TO TEN YEARS OVER TEN YEARS ---------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE AVERAGE AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD ---------------------------------------------------------------------------------------------- MUTUAL FUNDS $3,059 5.43% $ -- -- % $ -- -- % $ -- --% U.S. TREASURY AND OTHER U.S. GOVERNMENT SECURITIES -- -- 1,517 5.18 -- -- -- -- SMALL BUSINESS ADMINISTRATION CERTIFICATES 628 8.20 -- -- -- -- -- -- STATE AND POLITICAL SUBDIVISION CERTIFICATES -- -- 814 5.25 4,343 5.42 5,360 4.29 COLLATERALIZED MORTGAGE OBLIGATIONS 1,204 6.00 492 5.96 495 6.32 -- -- GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES 846 6.59 12,539 6.41 5,598 5.97 1,676 6.77 ---------------------------------------------------------------------------------------------- $5,737 6.02% $ 15,362 6.21% $ 10,436 5.76% $7,036 4.88% ==============================================================================================
Weighted average yield is calculated by dividing income within each maturity range by the outstanding amount of the related investment based on carrying value. TOTAL DEPOSITS The Corporation continues to stress its philosophy of core deposit accumulation and retention as the fundamental basis for sound growth and profitability. Core deposits consist of all deposits other than public funds and certificates of deposit in excess of $100,000. Total deposits increased $24.6 million to $289.2 million on December 31, 1998, from $264.7 million on December 31, 1997. This compares to a $31.7 million increase in 1997. The average increase in time deposits occurred via increases in retail certificates of deposits and retail jumbo certificates of deposits, while the increase in non-interest bearing demand deposits can be attributed to the additional commercial account relationships being established by the Banks. The following table sets forth the average amount of and the average rate paid by the Banks on deposits by deposit category (dollars in thousands):
At December 31, 1998 1997 1996 ------------------------------------------------------------------------------------ AVERAGE AVERAGE RATE Average Average Rate Average Average Rate AMOUNT Amount Amount ------------------------------------------------------------------------------------ Non-interest-bearing demand deposits $ 37,184 0.00% $ 32,749 0.00% $ 29,362 0.00% NOW and money market deposits 31,063 2.47 27,914 2.01 29,302 2.17 Savings deposits 60,032 2.20 61,575 2.16 64,345 2.18 Time deposits 151,590 5.52 125,600 5.58 109,862 5.51 ------------------------------------------------------------------------------------ Total $ 279,869 3.74% $ 247,838 3.59% $ 232,871 3.46% ====================================================================================
Maturities of time deposits and certificate accounts with balances of $100,000 or more, outstanding at December 31, 1998, are summarized as follows (in thousands): 3 MONTHS OR LESS $22,702 OVER 3 THROUGH 6 MONTHS 4,917 OVER 6 THROUGH 12 MONTHS 4,445 OVER 12 MONTHS 1,202 ============== TOTAL $33,266 ==============
CAPITAL RESOURCES AND ADEQUACY Stockholders' equity increased from $29.496 million at December 31, 1997 to $30.997 million at December 31, 1998. The $2.706 million increase from net earnings retention was primarily offset by the net purchase of 21,311 shares of treasury stock and the payment of $889,000 in cash dividends to shareholders. 15 16 Pursuant to regulations promulgated by the Federal Reserve Board, bank holding companies are required to maintain minimum levels of core capital as a percent of total assets and total capital as a percent of risk-based assets. The minimum core capital requirement ranges from 3% to 5% of total assets, depending upon the Federal Reserve Board's determination of the financial institution's strength. Similar capital guidelines are also established for the individual banking subsidiaries of the Corporation. Most financial institutions are required to meet a minimum core capital requirement of 4% or more of total assets. The regulations assign risk weightings to assets and off-balance sheet items and require minimum risk-based capital ratios. Bank holding companies generally are required to have total capital equal to not less than 8% of risk weighted assets. Core capital consists principally of shareholders' equity less intangibles, while qualifying total capital consists of core capital, certain debt instruments and a portion of the reserve for loan losses. As of December 31, 1998, the Corporation had a core-capital to total assets ratio of 9.27%, and Lincoln State Bank, Franklin State Bank and Lincoln Community Bank had risk-based capital ratios of 9.27%, 10.42% and 12.10%, respectively. These ratios are above the 1998 minimum requirements established by regulatory agencies. For a summary of the Banks' regulatory capital ratios at December 31, 1998, please see Note Seven to Consolidated Financial Statements. Management strives to maintain a strong capital position to take advantage of opportunities for profitable geographic and product expansion and to maintain depositor and investor confidence. Conversely, management believes that capital must be maintained at levels that provide adequate returns on the capital employed. Management actively reviews capital strategies for the Corporation and for each of its subsidiaries to ensure that capital levels are appropriate based on perceived business risks, growth and regulatory standards. LIQUIDITY Liquidity is the ability to meet withdrawal requirements on deposit accounts and satisfy loan demand. The principal sources of liquidity for the subsidiary banks include additional deposits, repayments on loans and investment securities, collections of interest, sales of investments, borrowings and the retention of earnings. The Corporation's liquidity, represented by cash and cash equivalents, is a product of its operating activities, investing activities and financing activities. These activities are summarized below (dollars in thousands):
Year Ended December 31, 1998 1997 1996 ---------------------------------------------------- Cash and cash equivalents at beginning of period $15,358 $22,272 $28,447 Operating Activities: Net income 2,706 2,409 1,310 Adjustments to reconcile net income to net cash provided by operating activities (143) 661 1,074 ---------------------------------------------------- Net cash provided by operating activities 2,563 3,070 2,384 Net cash used by investing activities (24,389) (36,967) (10,511) Net cash provided by financing activities 35,096 26,983 1,952 ---------------------------------------------------- Increase (decrease) in cash equivalents 13,270 (6,914) (6,175) ---------------------------------------------------- Cash and cash equivalents at end of period $28,628 $15,358 $22,272 ====================================================
Net cash was provided by operating activities during the year ended December 31, 1998, 1997 and 1996 primarily as a result of normal ongoing business operations. The non-cash items, such as the provisions for loan losses and depreciation and the net amortization of premiums, also contributed to net cash provided by operating activities during these periods. Liquidity is also necessary at the parent company level. The parent company's primary source of funds are dividends from subsidiaries, borrowings and proceeds from issuance of equity. The parent company manages its liquidity position to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries and satisfy other operating requirements. Dividends received from subsidiaries totaled $4.8 million, $1.9 million and $1.9 million for the years ended December 31, 1998, 1997 and 1996 respectively, and will continue to be the parent's main source of long-term liquidity. The dividends from the Banks were sufficient to pay cash dividends to the Corporation's shareholders of $889,000, $703,000 and $691,000 for the years ended December 31, 1998, 1997 and 1996, respectively. At December 31, 1998, the parent company had a $2.0 million line of credit with an unaffiliated bank, which had a $260,000 outstanding balance. 16 17 INTEREST RATE SENSITIVITY MANAGEMENT Financial institutions are subject to interest rate risk to the extent their interest-bearing liabilities (primarily deposits) mature or reprice at different times and on a different basis than their interest-earning assets (consisting primarily of loans and securities). Interest rate sensitivity management seeks to match maturities on assets and liabilities and avoid fluctuating net interest margins while enhancing net interest income during periods of changing interest rates. The difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within the same time period is referred to as an interest rate gap. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During periods of rising interest rates, a negative gap tends to adversely affect net interest income while a positive gap tends to result in an increase in net interest income. During a period of falling interest rates, a negative gap tends to result in an increase in net interest income while a positive gap tends to adversely affect net interest income. The following table shows the interest rate sensitivity gap for four different time intervals as of December 31, 1998. Assumptions regarding prepayment and withdrawal rates are based upon the Corporation's historical experience, and management believes such assumptions are reasonable.
AMOUNT MATURING OR REPRICING --------------------------------------------------------------------------- WITHIN SIX TO TWELVE ONE TO FIVE OVER SIX MONTHS MONTHS YEARS FIVE YEARS TOTAL -------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) INTEREST-EARNING ASSETS: FIXED-RATE MORTGAGE LOANS $24,785 $22,269 $76,929 $11,187 $135,170 ADJUSTABLE-RATE MORTGAGE LOANS 13,185 7,116 15,753 556 36,610 -------------------------------------------------------------------------- TOTAL MORTGAGE LOANS 37,970 29,385 92,682 11,743 171,780 COMMERCIAL BUSINESS LOANS 33,375 3,788 26,781 150 64,094 CONSUMER LOANS 6,054 1,435 5,686 523 13,698 LEASES 0 0 2,599 0 2,599 HOME EQUITY LOANS 1,346 0 0 0 1,346 TAX-EXEMPT LOANS 600 0 0 0 600 MORTGAGE-RELATED SECURITIES 13,729 386 6,414 2,321 22,850 FIXED RATE INVESTMENT SECURITIES AND OTHER 500 0 2,382 9,704 12,586 VARIABLE RATE INVESTMENT SECURITIES AND OTHER 21,817 1,057 0 0 22,874 -------------------------------------------------------------------------- TOTAL INTEREST-EARNING ASSETS $115,391 $36,051 $136,544 $24,441 $312,427 ========================================================================== INTEREST-BEARING LIABILITIES: DEPOSITS TIME DEPOSITS $113,572 $33,869 $12,456 $6 $159,903 NOW ACCOUNTS 1,274 1,274 12,745 5,946 21,239 SAVINGS ACCOUNTS 3,463 3,463 34,631 15,999 57,556 MONEY MARKET ACCOUNTS 503 503 5,032 2,509 8,547 ADVANCE PAYMENTS FOR TAXES AND INSURANCE 0 52 0 0 52 BORROWINGS 13,260 0 0 0 13,260 -------------------------------------------------------------------------- TOTAL INTEREST-BEARING LIABILITIES $132,072 $39,161 $64,864 $24,460 $260,557 ========================================================================== INTEREST-EARNING ASSETS LESS INTEREST-BEARING LIABILITIES ($16,681) ($3,110) $71,680 ($19) $51,870 ========================================================================== CUMULATIVE INTEREST RATE SENSITIVITY GAP ($16,681) ($19,791) $51,889 $51,870 ============================================================ CUMULATIVE INTEREST RATE SENSITIVITY GAP AS A PERCENTAGE OF TOTAL ASSETS (4.99%) (5.92%) 15.51% 15.51% ============================================================
At December 31, 1998, the Corporation's cumulative ratio of interest-rate sensitive assets to interest-rate sensitive liabilities was a negative 4.99% for six months and a negative 5.92% for one year maturities. Therefore the Corporation is negatively gapped and may benefit from falling interest rates. 17 18 Certain shortcomings are inherent in the method of analysis presented in the table above. For example, although certain assets and liabilities have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features that restrict changes in interest rates on a short term basis over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the schedule. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. YEAR 2000 PREPAREDNESS The Year 2000 poses a potential risk to normal operations of both Information Technology (IT) and non-IT systems. The Year 2000 problem is pervasive and complex. The majority of computer operating systems and programs currently in use have been developed utilizing six digit date fields (YYMMDD). For example, December 31st, 1999, would be represented by "991231" in computer code. The two digit field for the year (in example "99") is the basis for all calculation formulas within most computer systems, particularly those processed through mainframe computers. Up until now, this two-digit field has sufficed, using a subtraction of current date from some future date (up to 12-31-99). As the industry enters the year 2000, the digit-field "00" will not permit accurate calculations based on the current formulas. January 1, 2000 would be read as the year 000101. Many computer systems will recognize this date as the year 1900 or other erroneous dates. The potential impact is that data could cause system failures. This could affect all forms of financial accounts, pensions, personnel benefits, investments, legal commitments, record keeping, inventories, maintenance, and file retention. Systems that work independently of IT equipment have the same potential for failure due to the prevalence of embedded computer chips. These "hidden" chips have forced the Corporation to review all of it's environmental, security, and communication systems. YEAR 2000 PROJECT STATUS The Corporation has taken the Year 2000 issue very seriously. The Corporation sees the Year 2000 as an opportunity to help increase service, functionality, and performance to its customers. Outdated systems, procedures, and products are being replaced or renovated with those that will meet the challenges of the new millennium. A Year 2000 project team was assembled early in 1997 to assess the scope of the project as it relates to all of the Corporation's banks and subsidiaries. Once this assessment was completed, an aggressive project plan was put into place that consists of renovating or replacing affected systems, validation and testing of any changes, effective risk management and employee and consumer awareness. In developing it's Year 2000 Project Plan, the Corporation defined the Year 2000 problem in 5 stages: Awareness: The need to define the scope of the Year 2000 problem. Assessment: Identify all systems and components which are affected. Renovation: The problem should be "fixed" by the appropriate means. Validation: Year 2000 compliance must be tested. Implementation: Final confirmation of Year 2000 compliance.
The Corporation began working on its Year 2000 project in the spring of 1997. The project plan was written, personnel recruited and timetables established. AWARENESS: Completed Summer-Fall 1997 The awareness phase consisted of analyzing the effects that the Year 2000 posed to the Corporation. It was during this phase that the project plan was written, our company consultant was retained, the project time-lines established and introductory information was sent to our employees. ASSESSMENT: Completed Fall 1997 - Spring 1998 The assessment phase consisted of a complete inventory of all the Corporation's facilities. This inventory was used to prioritize those systems considered mission-critical and to assign project team members to determine their Year 2000 compliance. RENOVATION: 95% Completed The renovation phase consisted of replacing or upgrading those systems that had been found non-Year 2000 compliant. Based on the type of systems in place, the renovation phase is projected to be completed by May 1, 1999. 18 19 VALIDATION: 95% Completed For those systems being renovated, they must be tested to ensure Year 2000 compliance. Each system is tested by individuals familiar with its operation and all tests are documented for support purposes. Validation will be completed along with renovation and implementation. No apparent problems inherent to the Year 2000 have been observed in the completed testing. During the first week of March 1999, the Corporation concluded its proxy testing and validation of its outside service bureau. IMPLEMENTATION: 90% Completed The implementation phase consists of implementing those renovated and validated systems. Based on the type of systems in place, the implementation phase is estimated to be completed in the 2nd quarter of 1999. CORPORATE CUSTOMERS The Corporation and its subsidiary banks have prepared a corporate contingency plan for addressing the Year 2000 problem and implementing the necessary changes. One of the facets of this contingency plan is to ensure that its customers are made aware of this problem and that they are involved at some level in reviewing their company's ability to handle and effectively deal with the year 2000. Each of the lending officers within the Corporation is aware of the Year 2000 Problem and has or will be reviewing those businesses to which funds have been borrowed to assure that they are also becoming Year 2000 ready. The same review process is being used with all new applicants. The Corporation is currently revisiting businesses to review their state of Year 2000 readiness and efforts. PUBLIC AWARENESS The Corporation fully realizes the impact that the media has on public perception regarding the Year 2000. A campaign of public awareness has been implemented that consists of informational pieces directly mailed to customers or available throughout the Corporation. These, in addition to lobby displays are intended to assure customers of the Corporation's efforts. Employees of the Corporation have been trained on answering questions and where to direct customers for additional information. The Corporation's web site also contains information regarding this topic. THIRD PARTY VENDORS A third party vendor is a supplier, processor, or governmental agency that has material interfaces directly with the Corporation. SIGNIFICANT VENDORS The Corporation is working directly with all vendors with material interfaces. It is the Corporation's goal that these interfaces be ready by April 1st, 1999. Currently, 90% of all interfaces have been tested and no apparent problems have been discovered. Below are several key interfaces and their project status: Deposit and Loan Processing: Currently Completed Loan Preparation: Currently Completed Payroll: Target March - 1999 Credit Card Processing: Currently Completed Asset Liability Management: Target March - 1999 OTHER THIRD PARTY VENDORS Other third party vendors are suppliers that provide services or products to the Corporation. All vendors have been queried as to their Year 2000 readiness. Approximately 95% of all vendors currently supply Year 2000 ready products or services. The remaining 5% have indicated that their products or services will be ready during the first half of 1999. To date, the Corporation is not aware of any vendor with a Year 2000 issue that would significantly impact the Corporation's operations, liquidity or capital resources. The Corporation has tested for readiness wherever possible and feels comfortable with the results. Should a vendor be unable to supply a Year 2000 ready product or services, the Corporation will follow the guidelines set forth in it's Year 2000 contingency plan. COSTS Managing the Year 2000 issue will result in direct and indirect costs to the Corporation. Based on the program to date the Corporation has incurred $12,000 in fees to an external consultant. In addition, over the past months nearly all-existing hardware has been replaced and financed out of regular operating sources. These items of equipment would normally have been replaced irrespective of the Year 2000 issue. Internal staff costs incurred due to the project have amounted to approximately $20,000 to $30,000. 19 20 The Corporation anticipates that it will incur expenses, both internal and external for 1999 in the range of $30,000 to $50,000. Most of these costs will be incurred due to staff time being allocated to the project and for contingency planning preparation. The Corporation intends to fund these costs out of normal operating sources. The estimated costs of, and timetable for, becoming Year 2000 compliant constitute "forward looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such estimates are based on numerous assumptions by management, including assumptions regarding the continued availability of certain resources, the accuracy of representations made by third parties concerning their compliance with Year 2000 issues, and other factors. The estimated costs of Year 2000 compliance also do not give effect to any future corporate acquisitions made by the Corporation or its subsidiaries. RISK OF NON-COMPLIANCE AND CONTINGENCY PLANS Management of the Corporation believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. The major applications which pose the greatest Year 2000 risk if the implementation of the Year 2000 Compliance Program is not successful are the Corporation's data processing system (which processes various documents to allow for accurate record keeping of transactional data), teller system and transaction interfaces (which provide customer access to accounts), loan system (which monitors and transacts loan payments by customers), and internal network system (which supports the computer components throughout the Corporation). Most of these systems are supported by external vendors. Failure by any of these systems could have a negative impact on the Corporation's ability to process its customers' transactions. Although the Corporation intends to complete all Year 2000 activities in a timely fashion, and although the Corporation has initiated Year 2000 Communications with significant customers, vendors and other important parties, and is monitoring the progress of such communications, such third parties nonetheless represent a risk that cannot be assessed with precision nor absolutely controlled despite the Corporation's best efforts. For that reason, the Corporation is modifying its existing a business resumption contingency plan to address alternatives in the event of some kind of a Year 2000 failure. A completed contingency plan is targeted for May 1, 1999. Once finalized, the contingency plan will be thoroughly tested throughout the second and third quarters of 1999. PENDING ACQUISITION On March 9, 1999, the Corporation entered into a definitive agreement to acquire Pyramid Bancorp., Inc. (PBI) through the exchange of nine shares of the Corporation's stock for each outstanding common share of PBI. Upon closing, PBI will be merged into the Corporation. The transaction is expected to close in the second quarter of 1999, and will be accounted for as a pooling of interests. At December 31, 1998, PBI had total assets and shareholder's equity of $106.9 million and $8.4 million, respectively. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Corporation's financial performance is impacted by, among other factors, interest rate risk and credit risk. The Corporation utilizes no derivatives to mitigate its credit risk, relying instead on loan review and an adequate loan loss reserve (see Management's Discussion and Analysis of Financial Condition and Results of Operation). Interest rate risk is the risk of loss of net interest income due to changes in interest rates. This risk is addressed by the Corporation's Asset Liability Management Committee ("ALCO"), which includes senior management representatives. The ALCO monitors and considers methods of managing interest rate risk by monitoring changes in net interest income under various interest rate scenarios. The ALCO attempts to manage various components of the Corporation's balance sheet to minimize the impact of sudden and sustained changes in interest rate on net interest income. The Corporation's exposure to interest rate risk is reviewed on at least a quarterly basis by the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Corporation's change in net interest income in the event of hypothetical changes in interest rates and interest liabilities. If potential changes to net interest income resulting from hypothetical interest rate swings are not within the limits established by the ALCO, the asset and liability mix may be adjusted to bring interest rate risk within approved limits. In order to reduce the exposure to interest rate fluctuations, the Corporation has developed strategies to manage its liquidity, shorten the effective maturities of certain interest-earning assets, and increase the effective maturities of certain interest-bearing liabilities. One strategy used is focusing its residential lending on adjustable rate mortgages, which generally reprice within one to three years. Another strategy used is concentrating its non-residential lending on adjustable or floating rate and/or short-term loans. The Corporation has also focused its investment activities on short and medium-term securities, while attempting to maintain and increase its savings account and transaction deposit accounts, which are considered to be relatively resistant to changes in interest rates. 20 21 Along with the analysis of the interest rate sensitivity gap, determining the sensitivity of future earnings to a hypothetical +/- 200 basis parallel rate shock can be accomplished through the use of simulation modeling. In addition to the assumptions used to measure the interest rate sensitivity gap, simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project income based on a hypothetical change in interest rates. The resulting pretax income for the next 12 month period is compared to the pretax income calculated using flat rates. This difference represents the Corporation's earning sensitivity to a +/- 200 basis point parallel rate shock. The table below illustrates these amounts as of December 31, 1998.
ESTIMATED 1999 PRETAX NET INTEREST INCOME PERCENT CHANGE IN NET CHANGE IN INTEREST RATES (DOLLARS IN THOUSANDS) ACTUAL CHANGE INTEREST INCOME --------------------------------------------------------------------------------------------------------------- 200 BASIS POINT RISE $12,981 422 3.36% 150 BASIS POINT RISE 12,886 327 2.61% 100 BASIS POINT RISE 12,772 213 1.70% 50 BASIS POINT RISE 12,660 101 0.81% BASE SCENARIO 12,559 0 0.00% 50 BASIS POINT DECLINE 12,465 (94) (0.75%) 100 BASIS POINT DECLINE 12,352 (207) (1.65%) 150 BASIS POINT DECLINE 12,266 (293) (2.33%) 200 BASIS POINT DECLINE 12,143 (416) (3.31%)
These results are based solely on immediate and sustained parallel changes in market rates and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve, the change in spread between key market rates, or accounting recognition for impairment of certain intangibles. The above results are also considered to be conservative estimates due to the fact that no management action to mitigate potential income variances are included within the simulation process. This action would include, but would no be limited to, adjustments to the repricing characteristics of any on or off balance sheet item with regard to short-term rate projections and current market value assessments. Another component of interest rate risk, fair value at risk, is determined by the Corporation through the technique of simulating the fair value of equity in changing rate environment. This technique involves determining the present value of all contractual asset liability cash flows (adjusted for prepayments) based on predetermined discount rate. The net result of all these balance sheet items determine the fair value of equity. The fair value of equity resulting from the current flat rate scenario is compared to the fair value of equity calculated using discount rates +/- 200 basis points from flat rates to determine the fair value of equity at risk. Currently, fair value of equity at risk is less than 1.0% of the market value of the Corporation as of December 31, 1998. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated statements of financial condition of the Corporation and its subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, along with the related notes to the consolidated financial statements and the report of Ernst & Young LLP, independent auditors are attached. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 21 22 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end or three (3) weeks prior to the Corporation's Annual Meeting which shall be held on May 25, 1999, which ever comes first. ITEM 11. EXECUTIVE COMPENSATION The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end or three (3) weeks prior to the Corporation's Annual Meeting which shall be held on May 25, 1999, which ever comes first. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end or three (3) weeks prior to the Corporation's Annual Meeting which shall be held on May 25, 1999, which ever comes first. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in response to this item is incorporated herein by reference to the Corporation's proxy statement, which shall be filed with the Securities and Exchange Commission no later than 120 days after the Corporation's fiscal year end or three (3) weeks prior to the Corporation's Annual Meeting which shall be held on May 25, 1999, which ever comes first. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED: 1 and 2. Financial Statements and Financial Statement Schedules. The following financial statements of Merchants and Manufacturers Bancorporation, Inc. and subsidiaries are filed as a part of this report under Item 8. "Financial Statements and Supplementary Data": Report of Independent Auditors Consolidated Statements of Financial Position as of December 31, 1998 and 1997 Consolidated Statements of Income for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements All financial statement schedules have been omitted as they are not applicable or because the information is included in the financial statements or notes thereto. 3. Exhibits. All required exhibits have been furnished in connection with and are incorporated by reference to previous filings. (B) REPORTS ON FORM 8-K: No reports on Form 8-K were filed during the last quarter of the period covered by this report. 22 23 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. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. By: /s/ James F. Bomberg ------------------------------------------- James F. Bomberg President & Chief Executive Officer Director Date: March 27, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PRINCIPAL EXECUTIVE OFFICERS /s/ James F. Bomberg President & Chief Executive Officer March 27, 1999 ------------------------------------ James F. Bomberg /s/ James C. Mroczkowski Vice President & Chief Financial Officer March 27, 1999 ------------------------------------ James C. Mroczkowski DIRECTORS /s/ Michael J. Murry Chairman of the Board of Directors March 27, 1999 ------------------------------------ Michael J. Murry /s/ James F. Bomberg Director March 27, 1999 ------------------------------------ James F. Bomberg /s/ Thomas F. Gapinski Director March 27, 1999 ------------------------------------ Thomas F. Gapinski /s/ Nicholas S. Logarakis Director March 27, 1999 ------------------------------------ Nicholas S. Logarakis /s/ Conrad C. Kaminski Director March 27, 1999 ------------------------------------ Conrad C. Kaminski /s/ David A. Kaczynski Director March 27, 1999 ------------------------------------ David A. Kaczynski /s/ Keith C. Winters Director March 27, 1999 ------------------------------------ Keith C. Winters /s/ Duane P. Cherek Director March 27, 1999 ------------------------------------ Duane P. Cherek /s/ James A. Sass Director March 27, 1999 ------------------------------------ James A. Sass
23 24 /s/ John M. Krawczyk Director March 27, 1999 ------------------------------------ John M. Krawczyk /s/ Robert V. Donaj Director March 27, 1999 ------------------------------------ Robert V. Donaj /s/ Longin C. Prazynski Director March 27, 1999 ------------------------------------ Longin C. Prazynski /s/ Gervase Rose Director March 27, 1999 ------------------------------------ Gervase Rose /s/ J. Michael Bartels Director March 27, 1999 ------------------------------------ J. Michael Bartels /s/ Casimir S. Janiszewski Director March 27, 1999 ------------------------------------ Casimir S. Janiszewski
24 25 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Financial Statements Years ended December 31, 1998 and 1997 CONTENTS Report of Independent Auditors ...............................................1 Consolidated Financial Statements Consolidated Statements of Financial Condition ...............................2 Consolidated Statements of Income ............................................3 Consolidated Statements of Stockholders' Equity ..............................4 Consolidated Statements of Cash Flows ........................................5 Notes to Consolidated Financial Statements ...................................7 26 Report of Independent Auditors The Board of Directors and Stockholders Merchants and Manufacturers Bancorporation, Inc. and subsidiaries We have audited the accompanying consolidated statements of financial condition of Merchants and Manufacturers Bancorporation, Inc. and subsidiaries (the Corporation) as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation'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 Merchants and Manufacturers Bancorporation, Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP - ---------------------- Ernst & Young LLP February 26, 1999 Milwaukee, Wisconsin 1 27 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Statements of Financial Condition
DECEMBER 31 1998 1997 ------------------------------------ (Dollars In Thousands) ASSETS Cash and due from banks $ 9,946 $ 10,694 Interest-bearing deposits at other banks 10,095 821 Federal funds sold 8,587 3,843 ------------------------------------ Cash and cash equivalents 28,628 15,358 Securities available-for-sale at fair value: Investment securities 15,721 12,649 Mortgage-related securities 22,850 28,169 Loans receivable 251,815 227,178 Accrued interest receivable 1,674 1,553 Federal Home Loan Bank stock 1,057 1,050 Premises and equipment 10,130 8,891 Other assets 2,628 1,830 ------------------------------------ Total assets $334,503 $296,678 ==================================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits $289,230 $264,669 Borrowings 13,260 1,500 Accrued interest payable 421 332 Advance payments by borrowers for taxes and insurance 52 179 Other liabilities 543 502 ------------------------------------ Total liabilities 303,506 267,182 Stockholders' equity: Common stock $1.00 par value; 3,000,000 shares authorized; shares issued: 1,507,788--1998; 1,491,241--1997; shares outstanding: 1,490,331--1998; 1,490,812--1997 1,508 1,491 Additional paid-in capital 10,820 10,421 Net unrealized gain (loss) on securities available-for-sale (88) 19 Retained earnings 19,391 17,574 Treasury stock, at cost (17,457 shares--1998; 429 shares--1997) (634) (9) ------------------------------------ Total stockholders' equity 30,997 29,496 ------------------------------------ Total liabilities and stockholders' equity $334,503 $296,678 ====================================
See accompanying notes. 2 28 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Statements of Income
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------------------------ (In Thousands, Except Per Share Amounts) Interest income: Loans, including fees $20,032 $18,023 $15,288 Investment securities: Taxable 715 967 1,028 Exempt from federal income taxes 188 12 83 Mortgage-related securities 1,761 1,508 2,407 Other 519 584 522 ------------------------------------------------------ Total interest income 23,215 21,094 19,328 Interest expense: Deposits 10,449 8,896 8,146 Borrowings 140 194 216 ------------------------------------------------------ Total interest expense 10,589 9,090 8,362 Net interest income 12,626 12,004 10,966 Provision for loan losses 250 192 460 ------------------------------------------------------ Net interest income after provision for loan losses 12,376 11,812 10,506 Noninterest income: Service charges on deposits 743 746 725 Service charges on loans 255 141 172 Net gain on securities sales 217 78 70 Other 1,115 691 588 ------------------------------------------------------ 2,330 1,656 1,555 Noninterest expenses: Salaries and employee benefits 6,099 5,453 5,223 Premises and equipment 1,580 1,412 1,340 Data processing fees 623 612 561 SAIF special assessment - - 604 Federal deposit insurance premiums 95 75 159 Other 2,135 2,068 2,134 ------------------------------------------------------ 10,532 9,620 10,021 ------------------------------------------------------ Income before income taxes 4,174 3,848 2,040 Income taxes 1,468 1,439 730 ------------------------------------------------------ Net income $ 2,706 $ 2,409 $ 1,310 ====================================================== Basic earnings per share $ 1.81 $ 1.67 $ .91 ====================================================== Diluted earnings per share $ 1.78 $ 1.65 $ .90 ====================================================== Dividends per share $ .59 $ .48 $ .48 ======================================================
See accompanying notes. 3 29 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity
Common Stock Unrealized And Gain (Loss) Additional on Securities Paid-in Available- Retained Treasury Capital for-Sale Earnings Stock Total ---------------------------------------------------------- (In Thousands, Except Per Share Amounts) Balance at January 1, 1996 $11,657 $(181) $15,249 $ (182) $26,543 Comprehensive income: Net income - - 1,310 - 1,310 Other comprehensive income - Change in unrealized loss on securities available-for-sale, net of deferred income taxes of $7 - (22) - - (22) ------------ Total comprehensive income 1,288 Sale of 16,988 shares of treasury stock - - - 186 186 Purchase of 87,316 shares of treasury stock - - - (946) (946) Cash dividends declared - $.48 per share - - (691) - (691) ---------------------------------------------------------- Balance at December 31, 1996 11,657 (203) 15,868 (942) 26,380 Comprehensive income: Net income - - 2,409 - 2,409 Other comprehensive income - Change in unrealized loss on securities available-for-sale, net of deferred income taxes of $118 - 222 - - 222 ------------ Total comprehensive income 2,631 Sale of 8,595 shares of common stock in connection with dividend reinvestment program 123 - - - 123 Sale of 110,986 shares of treasury stock 72 - - 1,184 1,256 Purchase of 22,273 shares of treasury stock - - - (251) (251) Cash dividends declared--$.48 per share - - (703) - (703) Exercise of stock options 60 - - - 60 ---------------------------------------------------------- Balance at December 31, 1997 11,912 19 17,574 (9) 29,496 Comprehensive income: Net income - - 2,706 - 2,706 Other comprehensive income - Change in unrealized loss on securities available-for-sale, net of deferred income taxes of $68 - (107) - - (107) ------------ Total comprehensive income 2,599 Issuance of new shares 349 - - (12) 337 Fractional shares issued due to stock split and stock dividend (10) - - - (10) Sale of 4,088 shares of common stock in connection with dividend reinvestment program 132 - - - 132 Sale of 1,544 shares of treasury stock 6 - - 104 110 Purchase of 22,855 shares of treasury stock - - - (845) (845) Cash dividends declared - $.59 per share - - (889) - (889) Exercise of stock options (61) - - 128 67 ---------------------------------------------------------- Balance at December 31, 1998 $12,328 $ (88) $19,391 $ (634) $30,997 ==========================================================
See accompanying notes. 4 30 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31 1998 1997 1996 ---------------------------------------- (In Thousands) OPERATING ACTIVITIES Net income $ 2,706 $ 2,409 $ 1,310 Adjustments to reconcile net income to cash provided by operating activities: Provision for loan losses 250 192 460 Provision for depreciation 577 511 484 Net amortization of investment securities premiums and discounts 92 112 287 Net realized gains on investment securities (217) (78) (70) Decrease (increase) in accrued interest receivable (121) (83) 62 Increase (decrease) in accrued interest payable 89 (63) (180) Other (813) 70 31 ---------------------------------------- Net cash provided by operating activities 2,563 3,070 2,384 INVESTING ACTIVITIES Purchases of securities available-for-sale (30,735) (20,733) (12,718) Proceeds from sales of securities available-for-sale 26,779 12,308 15,848 Proceeds from redemption and maturities of securities available-for-sale 6,153 10,566 14,054 Net increase in loans (24,763) (37,627) (26,700) Purchases of premises and equipment (1,816) (1,602) (679) Proceeds from sales of real estate - 53 100 Redemption (purchases) of Federal Home Loan Bank stock (7) 68 (416) ----------------------------------------- Net cash used in investing activities (24,389) (36,967) (10,511)
(continued) 5 31 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31 1998 1997 1996 ----------------------------------------- (In Thousands) FINANCING ACTIVITIES Net increase (decrease) in deposits $24,561 $31,736 $ (150) Net increase (decrease) in borrowings 11,760 (5,350) 3,850 Increase (decrease) in advance payments by borrowers for taxes and insurance (127) 112 (297) Payments of cash dividends to stockholders (889) (703) (691) Purchase of treasury stock (845) (251) (946) Proceeds from the sale of treasury stock 110 1,256 186 Proceeds from issuing additional common stock 394 60 - Proceeds from dividend reinvestment plan 132 123 - ----------------------------------------- Net cash provided by financing activities 35,096 26,983 1,952 ----------------------------------------- Increase (decrease) in cash and cash equivalents 13,270 (6,914) (6,175) Cash and cash equivalents at beginning of year 15,358 22,272 28,447 ----------------------------------------- Cash and cash equivalents at end of year $28,628 $15,358 $22,272 ======================================== Supplemental cash flow information and non-cash transactions: Interest paid $10,566 $ 9,169 $ 8,521 Income taxes paid 1,483 1,232 759
See accompanying notes. 6 32 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 1998 (Dollars In Thousands, Except Share Amounts) 1. ACCOUNTING POLICIES BUSINESS Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries (the Corporation) provides a full range of personal and commercial financial services to customers through its subsidiaries. The Corporation and its subsidiaries are subject to competition from other financial institutions. They are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory agencies. BASIS OF FINANCIAL STATEMENT PRESENTATION The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the Corporation, its wholly owned subsidiaries, Lincoln State Bank (Lincoln), Franklin State Bank (Franklin) and Lincoln Community Bank (Lincoln Community)--collectively, "the Banks," M&M Services, which provides management services for the Banks, Achieve Mortgage Corporation, which provides mortgage banking services for the Banks and Lincoln's wholly owned subsidiary, Lincoln Investment Corp., and Lincoln Community's wholly owned subsidiary, Lincoln Investment Management Corporation, which manage an investment portfolio for the Banks. All significant intercompany accounts and transactions have been eliminated. In preparing the consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include amounts due from banks (both interest-bearing and noninterest-bearing) and federal funds sold. 7 33 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) INVESTMENT AND MORTGAGE-RELATED SECURITIES All of the Corporation's investment and mortgage-related securities are classified as available-for-sale and are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the security. Such amortization is included in interest income from the related security. Interest and dividends are included in interest income from the related securities. Realized gains and losses and declines in value judged to be other-than-temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method. INTEREST AND FEES ON LOANS Interest on loans is recorded as income when earned. Loans are placed on non-accrual status, generally recognizing interest as income when received, when in the opinion of management, the collectibility of principal or interest becomes doubtful. Loan origination and commitment fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related loans' yields. The Corporation is amortizing these amounts, using the level-yield method, adjusted for prepayments, over the contractual life of the related loans. ALLOWANCE FOR LOAN LOSSES A provision for loan losses is made when a loss is probable and can be reasonably estimated. The provision is based on past experience and on prevailing market conditions. Management's evaluation of loss considers various factors including, but not limited to, general economic conditions, loan portfolio composition, and prior loss experience. 8 34 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) The Corporation had no impaired loans in 1998 or 1997. A substantial portion of the Banks' loans are collateralized by real estate in metropolitan Milwaukee, Wisconsin. Accordingly, the ultimate collectibility of a substantial portion of the Banks' loan portfolio and the recovery of a substantial portion of the carrying amount of real estate owned are susceptible to changes in market conditions in metropolitan Milwaukee, Wisconsin. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses, future additions to the allowance may be necessary based on changes in economic conditions. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. Expenditures for normal repairs and maintenance are charged to operations as incurred. The cost of premises and equipment is depreciated, using the straight-line or double-declining-balance methods, over the estimated useful lives of the assets (five to thirty-two years). STOCK SPLITS Share data and equity amounts have been adjusted to recognize a three-for-two stock split on April 10, 1998, and a 10% stock dividend on October 15, 1998. EARNINGS PER SHARE INFORMATION Earnings per share of common stock have been computed based on the weighted average number of common stock and common stock equivalents, if dilutive, outstanding during each year. The resulting number of shares used in computing basic earnings per share is 1,497,763, 1,442,723 and 1,439,560 for the years ended December 31, 1998, 1997 and 1996, respectively. The number of shares used in computing diluted earnings per share is 1,517,605, 1,459,117 and 1,455,555, for the years ended December 31, 1998, 1997 and 1996, respectively. 9 35 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. ACCOUNTING POLICIES (CONTINUED) ACCOUNTING CHANGES Statement No. 131, "Disclosures About Segments of an Enterprise and Related Information," requires public companies to report financial and descriptive information about their operating segments using a "management approach." Operating segments are defined as revenue-producing components of the enterprise for which separate financial information is produced internally and are subject to evaluation the chief operating decision maker in deciding how to allocate resources to segments. Statement No. 131 is effective for 1998; however, the Corporation has determined that its only operating and reportable segment is community banking and therefore it is not required to present any further information under Statement No. 131. 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES The following is a summary of securities:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value -------------------------------------------------------- At December 31, 1998: Mutual funds $ 3,173 $ - $114 $ 3,059 U.S. treasury and other U.S. government securities 1,521 8 12 1,517 Small Business Administration certificates 597 31 - 628 State and political subdivision certificates 10,580 33 96 10,517 Collateralized mortgage obligations 2,195 2 6 2,191 Government agency mortgage-backed securities 20,653 129 123 20,659 -------------------------------------------------------- $38,719 $203 $351 $38,571 ======================================================== At December 31, 1997: Mutual funds $ 3,173 $ - $ 69 $ 3,104 U.S. treasury and other U.S. government securities 7,789 29 17 7,801 Small Business Administration certificates 886 44 - 930 State and political subdivision certificates 800 14 - 814 Collateralized mortgage obligations 1,498 3 13 1,488 Government agency mortgage-backed securities 26,644 117 80 26,681 -------------------------------------------------------- $40,790 $207 $179 $40,818 ========================================================
10 36 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES (CONTINUED) Securities carried at $1,100 at December 31, 1998 were pledged principally to secure liabilities to the Federal Reserve Bank. The amortized cost and market value of securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.
Amortized Cost Fair Value ----------------------------- Due in one year or less $ 492 $ 500 Due after one year through five years 2,005 2,012 Due after five years through ten years 9,122 9,067 Due after ten years 1,079 1,083 Mutual funds 3,173 3,059 Mortgage-related securities 22,848 22,850 ============================= $38,719 $38,571 =============================
Proceeds from sales of securities available-for-sale during the years ended December 31, 1998, 1997 and 1996, were $26,779, $12,308 and $15,848, respectively. Gross gains of $217, $83 and $87 were recorded on those sales for the years ended December 31, 1998, 1997 and 1996, respectively. Gross losses of $0, $5 and $17 were also recorded in the years ended December 31, 1998, 1997 and 1996, respectively. 11 37 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. LOANS RECEIVABLE Loans receivable consist of the following:
DECEMBER 31 1998 1997 ------------------------------------ First mortgage: Conventional single-family residential $ 43,912 $ 58,821 Commercial and multifamily residential 112,015 78,365 Construction 15,853 18,191 ------------------------------------- 171,780 155,377 Commercial business loans 64,094 56,846 Consumer and installment loans 13,578 12,220 Leases 2,599 2,311 Home equity loans 1,346 1,496 Other 763 1,081 ------------------------------------ 82,380 73,954 Less: Deferred loan fees 43 60 Allowance for loan losses 2,302 2,093 ------------------------------------ $251,815 $227,178 ====================================
Transactions in the allowance for loan losses are summarized as follows:
YEAR ENDED DECEMBER 31 1998 1997 1996 ----------------------------------------- Balance at beginning of year $2,093 $1,939 $1,533 Provisions charged to operations 250 192 460 Recoveries 7 - 29 Charge-offs (48) (38) (83) ----------------------------------------- Balance at end of year $2,302 $2,093 $1,939 =========================================
Total nonaccrual loans were $1,021 and $498 at December 31, 1998 and 1997, respectively. 12 38 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. PREMISES AND EQUIPMENT Premises and equipment consist of the following:
DECEMBER 31 1998 1997 -------------------------------- Land $ 2,351 $ 2,353 Office buildings and improvements 9,085 7,858 Furniture and equipment 4,402 3,807 -------------------------------- 15,838 14,018 Less accumulated depreciation (5,708) (5,127) -------------------------------- $10,130 $ 8,891 ================================
5. DEPOSITS Deposits consist of the following:
DECEMBER 31 1998 1997 -------------------------------- Negotiable Order of Withdrawal accounts: Noninterest-bearing $ 41,985 $ 39,405 Interest-bearing 21,239 20,137 Savings deposits 57,556 58,177 Money market investment accounts 8,547 8,425 Time deposits and certificate accounts 159,903 138,525 -------------------------------- $289,230 $264,669 ================================
The scheduled maturities of time deposits and certificate accounts at December 31, 1998 are as follows:
Maturities during the year ending December 31: ----------------------------------------------------------- 1999 $147,451 2000 6,187 2001 2,881 2002 1,541 2003 1,837 Thereafter 6 ---------------- $159,903 ================
At December 31, 1998 and 1997, time deposits and certificate accounts with balances greater than $100 amounted to $33,266 and $28,527, respectively. 13 39 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. BORROWINGS At December 31, 1998 and 1997, the Banks have overnight federal funds purchased of $9,500 and $1,500, respectively, with weighted-average interest of 5.40% and 6.00%, respectively. Lincoln also had a short-term advance of $3,500 from the Federal Home Loan Bank at December 31, 1998, which bears interest at 5.13%. Lincoln is required to maintain unencumbered mortgage loans in its portfolio aggregating at least 167% of the amount of outstanding advances from the Federal Home Loan Bank as collateral. In addition, these advances are collateralized by Federal Home Loan Bank stock. At December 31, 1998 and 1997, the Corporation had $260 and $0 outstanding, respectively, on a line of credit with an unaffiliated bank with a total available balance of $2,000. The line bears interest at the lender's prime rate (7.75% at December 31, 1998), and is collateralized by 100% of the capital stock of Franklin State Bank. 7. STOCKHOLDERS' EQUITY The Banks 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 regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table that follows) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998 and 1997, that the Banks meet all capital adequacy requirements to which they are subject. 14 40 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. STOCKHOLDERS' EQUITY (CONTINUED) As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized all the Banks as well capitalized under the regulatory framework for prompt corrective action. As of December 31, 1997, Lincoln Community Bank and Franklin State Bank were categorized as well capitalized and Lincoln State Bank as adequately capitalized. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks' classifications as of December 31, 1998.
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio ---------------------------------------------------------------------------- AS OF DECEMBER 31, 1998 Total Capital (to Risk- Weighted Assets): Lincoln State Bank $15,721 10.01% $12,570 8.00% $15,713 10.00% Lincoln Community Bank 9,326 13.20 5,652 8.00 7,065 10.00 Franklin State Bank 4,866 11.27 3,454 8.00 4,317 10.00 Tier 1 Capital (to Risk- Weighted Assets): Lincoln State Bank 14,567 9.27 6,285 4.00 9,428 6.00 Lincoln Community Bank 8,546 12.10 2,826 4.00 4,239 6.00 Franklin State Bank 4,498 10.42 1,727 4.00 2,590 6.00 Tier 1 Capital (to Average Assets): Lincoln State Bank 14,567 8.41 6,925 4.00 8,656 5.00 Lincoln Community Bank 8,546 8.34 4,097 4.00 5,121 5.00 Franklin State Bank 4,498 8.96 2,008 4.00 2,510 5.00
8. RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES Dividends are paid by the Corporation from funds which are mainly provided by dividends from the Banks. However, certain restrictions exist regarding the ability of the Banks to transfer funds to the Corporation in the form of cash dividends, loans or advances. Approval of the regulatory authorities is required to pay dividends in excess of certain levels of the Banks' retained earnings. 15 41 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES (CONTINUED) As of December 31, 1998, the subsidiary banks collectively had equity of $27,635,649 of which $3,419,574 was available for distribution to the Corporation as dividends without prior regulatory approval. Under Federal Reserve Board regulations, the Banks are limited as to the amount they may loan to their affiliates, including the Corporation, unless such loans are collateralized by specific obligations. At December 31, 1998, the maximum amount available for transfer from any one of these Banks to the Corporation in the form of loans approximates 8.6% of consolidated stockholders' equity. 9. EMPLOYEE BENEFIT PLANS The Corporation has an Incentive Stock Option Plan under which 23,100 shares of common stock are reserved for the grant of options to officers and key employees at a price not less than the fair market value of the stock on the date of the grant. The plan limits the options that may be granted to each employee to $100 (based on aggregate fair market value at the date of the grant) per calendar year, on a cumulative basis. Options must be exercised within ten years of the date of grant and can be regranted if forfeited. A summary of stock option transactions follows:
Weighted Exercise Average Weighted Average Number Price Exercise Price Remaining of Shares Per Share Per Share Contractual Life -------------- --------------------- ------------------ ------------------- Total outstanding at December 31, 1996 41,250 $9.86 - $15.15 $12.35 4.54 years Expired (1,013) 9.86 Exercised (12,187) 9.86 - 12.12 -------------- Total outstanding at December 31, 1997 28,050 12.18 - 15.15 13.13 4.83 years Granted 49,775 30.91 - 31.14 30.98 10 years Exercised (4,620) 12.18 - 15.15 12.68 -------------- Total outstanding at December 31, 1998 73,205 12.12 - 31.14 25.29 7.20 years ==============
At December 31, 1998, all outstanding options are exercisable. 16 42 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. EMPLOYEE BENEFIT PLANS (CONTINUED) The Corporation has a 401(k) Profit Sharing Plan and Trust which covers substantially all employees with at least six months of service who have attained age twenty and one-half. Participating employees may annually contribute up to 12% of their pre-tax compensation. The Corporation's annual contribution consists of a discretionary matching percentage, limited to 1% of employee compensation, and an additional discretionary amount, which is determined annually by the Board of Directors. The Corporation's contributions for 1998, 1997 and 1996, were $193, $180 and $164, respectively. 10. INCOME TAXES The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------------------------ Current: Federal $1,341 $1,157 $ 718 State 255 231 168 ------------------------------------------------------ 1,596 1,388 886 ------------------------------------------------------ Deferred (benefit): Federal (73) 36 (124) State (55) 15 (32) ------------------------------------------------------- (128) 51 (156) ------------------------------------------------------- $1,468 $1,439 $ 730 ======================================================
The provision for income taxes differs from that computed at the federal statutory corporate tax rate as follows:
YEAR ENDED DECEMBER 31 1998 1997 1996 ----------------------------------------- Income tax at statutory rate $1,419 $1,309 $694 Increase (reduction) resulting from: Tax-exempt interest income (76) (21) (49) State income taxes, net of federal tax benefit 132 163 89 Other (7) (12) (4) ----------------------------------------- $1,468 $1,439 $730 =========================================
17 43 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 10. INCOME TAXES (CONTINUED) The components of deferred tax assets and liabilities are as follows:
DECEMBER 31 1998 1997 --------------------------- Deferred tax assets: Allowance for loan losses $ 692 $ 594 Unrealized loss on securities 59 - Net operating loss carryforwards 546 509 Other assets 91 83 --------------------------- Total deferred tax assets 1,388 1,186 Valuation allowance (557) (509) --------------------------- 831 677 Deferred tax liabilities: Unrealized gain on securities - 9 Depreciation 298 293 Other liabilities 35 39 --------------------------- Total deferred tax liabilities 333 341 --------------------------- Net deferred tax asset $ 498 $ 336 ===========================
At December 31, 1998, the Corporation and its subsidiaries, which file separate state income tax returns, have state net operating loss carryforwards of approximately $10,462 which expire at various dates through 2013. Due to the unlikelihood of realizing these benefits, a valuation allowance of $546 has been established to offset the deferred tax assets relating to these carryforwards. Lincoln Community qualified under provisions of the Internal Revenue Code, which previously permitted it to deduct from taxable income an allowance for bad debts that differs from the provision for such losses charged to income for financial reporting purposes. At December 31, 1998, retained earnings included approximately $3,606 for which no provision for income taxes has been made. Income taxes of approximately $1,414 would be imposed if Lincoln Community Bank were to use these retained earnings for any other purpose other than to absorb bad debt losses. 18 44 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. LOANS TO RELATED PARTIES In the ordinary course of business, loans are granted to related parties, which include management personnel, directors and entities in which such persons are principal stockholders. Activity in loans to related parties is as follows:
Balance at December 31, 1996 $ 16,984 Loans originated 13,852 Repayments (8,021) ---------------- Balance at December 31, 1997 22,815 Loans originated 16,155 Repayments (16,249) ================ Balance at December 31, 1998 $ 22,721 ================
12. COMMITMENTS AND CONTINGENT LIABILITIES Off-balance-sheet financial instruments whose contracts represent credit and/or interest rate risk at December 31, 1998 and 1997, are as follows:
DECEMBER 31 1998 1997 ------------------------------------ Commitments to originate mortgage loans (expiring within three months): Fixed rates $ 4,172 $ 3,008 Adjustable rates 3,541 1,018 Unused lines of credit: Commercial business 29,957 24,384 Home equity (adjustable rate) 1,279 1,278 Credit cards (fixed rate) 3,148 2,599 Standby letters of credit 2,941 1,975
Loan commitments and line-of-credit loans are made to accommodate the financial needs of the Banks' customers. Standby letters of credit commit the Banks to make payments on behalf of customers when certain specified future events occur. These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Banks' normal credit policies. Collateral is obtained based on management's credit assessment of the customer. 19 45 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Except for the above-noted commitments to originate loans in the normal course of business, the Corporation and the Banks have not undertaken the use of off-balance-sheet derivative financial instruments for any purpose. 13. FAIR VALUES OF FINANCIAL INSTRUMENTS Statement No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial 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. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Corporation. The Corporation does not routinely measure the market value of financial instruments because such measurements represent point-in-time estimates of value. It is generally not the intent of the Corporation to liquidate and therefore realize the difference between market value and carrying value and even if it were, there is no assurance that the estimated market values could be realized. Thus, the information presented is not particularly relevant to predicting the Corporation's future earnings or cash flows. The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS The carrying amounts for cash and cash equivalents approximate those assets' fair values. INVESTMENT AND MORTGAGE-RELATED SECURITIES Fair values for investment and mortgage-related 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. 20 46 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 13. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) ACCRUED INTEREST INCOME AND EXPENSE The fair value of accrued interest income and expense approximates the respective book value. LOANS RECEIVABLE For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for residential mortgage loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values for commercial real estate loans, rental property mortgage loans, commercial business loans and consumer and other 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. FEDERAL HOME LOAN BANK STOCK FHLB stock is carried at cost which is its redeemable value since the market for this stock is restricted. DEPOSITS The fair values disclosed for noninterest-bearing checking accounts, negotiable order of withdrawal accounts, passbook accounts and savings deposits and money market investment accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed term certificate accounts approximate their fair values at the reporting date. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. BORROWINGS The fair values of the Corporation's borrowings are estimated using discounted cash flow analyses, based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements. 21 47 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 13. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) OFF-BALANCE-SHEET INSTRUMENTS Fair values for the Corporation's off-balance-sheet instruments (lending commitments and standby letters of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties' credit standing and discounted cash flow analyses. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and is not material at December 31, 1998 or 1997. The carrying amounts and fair values of the Corporation's financial instruments consist of the following:
DECEMBER 31, 1998 DECEMBER 31, 1997 ------------------------------- ------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------------------------- ------------------------------- Cash and cash equivalents $ 28,628 $ 28,628 $ 15,358 $ 15,358 Securities available-for-sale: Investment securities 15,721 15,721 12,649 12,649 Mortgage-related securities 22,850 22,850 28,169 28,169 Loans receivable 254,160 254,964 229,331 229,779 Accrued interest receivable 1,674 1,674 1,553 1,553 Federal Home Loan Bank stock 1,057 1,057 1,050 1,050 Deposits 289,230 289,357 264,669 264,624 Accrued interest payable 421 421 332 332 Borrowings 13,260 13,260 1,500 1,500
22 48 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES PARENT COMPANY ONLY FINANCIAL INFORMATION
DECEMBER 31 STATEMENTS OF FINANCIAL CONDITION 1998 1997 ------------------------------------ ASSETS Cash and cash equivalents $ 30 $ 212 Investment in subsidiaries 28,213 26,307 Premises and equipment 2,915 2,989 Other assets 1,086 959 ------------------------------------ Total assets $32,244 $30,467 ==================================== LIABILITIES Other liabilities $ 987 $ 971 Borrowings 260 - ------------------------------------ Total liabilities 1,247 971 STOCKHOLDERS' EQUITY Common stock 1,508 904 Additional paid-in capital 10,820 11,008 Unrealized gain (loss) on available for sale securities (88) 19 Retained earnings 19,391 17,574 Less treasury stock (634) (9) ------------------------------------ Total stockholders' equity 30,997 29,496 ------------------------------------ Total liabilities and stockholders' equity $32,244 $30,467 ====================================
23 49 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------ STATEMENTS OF INCOME Income: Interest on loans, including fees $ - $ - $ 26 Interest on investments - - 25 Dividends from subsidiaries 4,783 1,943 1,876 Other 1,227 280 244 ------------------------------------ 6,010 2,223 2,171 Expenses: Salaries and employee benefits 1,511 1,268 847 Occupancy 476 391 281 Interest 12 16 3 Other 517 547 544 ------------------------------------ 2,516 2,222 1,675 ------------------------------------ Income before income tax benefit and equity in undistributed net income of subsidiaries 3,494 1 496 Income tax benefit 448 670 478 ------------------------------------ Income before equity in undistributed net income of subsidiaries 3,942 671 974 Equity in undistributed net income of subsidiaries (1,236) 1,738 336 ------------------------------------ Net income $ 2,706 $2,409 $1,310 ====================================
24 50 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. AND SUBSIDIARIES PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
YEAR ENDED DECEMBER 31 1998 1997 1996 ------------------------------------- CONDENSED STATEMENTS OF CASH FLOWS OPERATING ACTIVITIES Net income $2,706 $ 2,409 $ 1,310 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries 1,236 (1,738) (336) Provision for depreciation 153 116 80 Other (110) (593) 266 -------------------------------------- Net cash provided by operating activities 3,985 194 1,320 INVESTING ACTIVITIES Sales of mortgage-backed securities - - 693 Proceeds from repayments of mortgage-related securities - - 27 Proceeds from sales of furniture and equipment - 250 - Purchases of furniture and equipment (79) (1,400) (226) ------------------------------------- Net cash provided (used) by investing activities (79) (1,150) 494 FINANCING ACTIVITIES Net increase in notes payable 260 - - Capital contribution to subsidiary (3,250) - - Payment of cash dividends (889) (703) (691) Purchase of treasury stock (845) (251) (946) Proceeds from the sale of treasury stock 110 1,256 186 Proceeds from issuing additional common stock 394 60 - Proceeds from dividend reimbursement plan 132 123 - ------------------------------------- Net cash provided (used) by financing activities (4,088) 485 (1,451) ------------------------------------- Increase (decrease) in cash and cash equivalents (182) (471) 363 Cash and cash equivalents at beginning of year 212 683 320 ------------------------------------- Cash and cash equivalents at end of year $ 30 $ 212 $ 683 =====================================
25 51 Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 15. PENDING ACQUISITION On March 9, 1999, the Corporation entered into a definitive agreement to acquire Pyramid Bancorp., Inc. (PBI) by exchanging nine shares of the Corporation's stock for each outstanding common share of PBI. Upon closing, PBI will be merged into the Corporation. The transaction is expected to close in the second quarter of 1999, and will be accounted for as a pooling of interests. At December 31, 1998, PBI had total assets and shareholder's equity of $106,909 and $8,441, respectively. 26 EX-27 2 FINANCIAL DATA SCHEDULE
9 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 9946 10095 8587 0 38571 0 0 254117 2302 334503 289230 13260 1016 0 1508 0 0 29489 334503 20032 2664 519 23215 10449 10589 12626 250 217 10532 4174 4174 0 0 2706 1.81 1.78 7.96 1021 0 0 0 2093 48 7 2302 2302 0 0
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