ITEM 1: Business
North Country Financial Corporation (the "Registrant" or "Company") was incorporated under the laws of the state of Michigan on December 16, 1974. The Company changed its name from "First Manistique Corporation" to "North Country Financial Corporation" on April 14, 1998. The Registrant owns all of the outstanding stock of its banking subsidiary, North Country Bank and Trust ("Bank"). The Registrant also owns all of the outstanding stock of two nonbank subsidiaries: First Manistique Agency, an insurance agency which sells annuities as well as life and health insurance and First Rural Relending Company, a nonprofit relending company. The Bank represents the principal asset of the Registrant. The Registrant and its subsidiary bank are engaged in a single industry segment, commercial banking, broadly defined to include commercial and retail banking and trust activities along with other permitted activities closely related to banking, namely credit life and accident and health insurance.
The Registrant became a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the "Act"), on April 1, 1976, when it acquired First Northern Bank and Trust ("First Northern"). On May 1, 1986, Manistique Lakes Bank merged with First Northern, with the survivor being First Northern. The Registrant acquired all of the outstanding stock of the Bank of Stephenson on February 8, 1994, in exchange for cash and common stock. The Bank of Stephenson was operated as a separate banking subsidiary of the Registrant until September 30, 1995, when it was merged into First Northern with First Northern being the survivor. First Northern acquired a substantial portion of the banking assets and assumed a substantial portion of the banking liabilities of Newberry State Bank on December 8, 1994, in exchange for cash. First Northern acquired the fixed assists and assumed the deposits of the Rudyard Branch of First of America Bank on September 15, 1995, in exchange for cash. The Registrant acquired all of the outstanding stock of South Range State Bank ("South Range") on January 31, 1996, in exchange for cash and notes. On August 12, 1996, First Northern and South Range changed their names to North Country Bank and Trust and North Country Bank, respectively. The Registrant acquired all of the outstanding stock of UP Financial Inc., the parent holding company of First National Bank of Ontonagon ("Ontonagon"). Upon completion of the latter acquisition, Ontonagon was merged into North Country Bank with North Country Bank being the survivor. North Country Bank was operated as a separate banking subsidiary of the Registrant until March 10, 1998, when it was merged into North Country Bank and Trust with North Country Bank and Trust being the survivor.
The Bank is engaged in the general commercial banking business, providing a full range of loan and deposit products. These banking services include customary retail and commercial banking services, including checking and savings accounts, time deposits, interest bearing transaction accounts, safe deposit facilities, real estate mortgage lending, commercial lending, commercial and governmental lease financing, direct and indirect consumer financing, and trust services.
The principal source of revenue for the Registrant is interest and fees on loans and investments. The sources of income for the three most recent years are as follows:
The Bank's primary market areas are the areas within a radius of 30 miles from its various offices, primarily in the Upper Peninsula of Michigan. The Bank also has branch offices in Traverse City and in Gaylord in Michigan's Lower Peninsula. North Country Bank and Trust is headquartered in Manistique, Michigan. The executive offices and mailing address are located at 130 South Cedar Street, Manistique, Michigan 49854. North Country Bank and Trust maintains offices in Schoolcraft, Delta, Machinac, Luce, Alger, Menominee, Dickinson, Marquette, Baraga, Chippewa, Houghton, Iron, Gogebic, Ontonagon, Otsego and Grand Traverse Counties. North Country Bank and Trust operates 30 branch
offices, provides drive-in convenience at 21 branch locations, and has automatic teller machines operating at 16 locations. North Country Bank and Trust has no foreign offices.
As of December 31, 1998, the North Country Bank and Trust employs approximately 161 full-time employees.
Banking is a highly competitive business. The Bank competes primarily with financial institutions in its market areas for loans and deposits. In its market, namely the Upper Peninsula of Michigan, the Bank maintains the second largest deposit base, or approximately 15% of the deposit market share. There are approximately 20 banking and savings institutions and 31 credit unions with offices in the Upper Peninsula of Michigan.
In addition to other banks, the Bank also competes for loans and deposits with savings and loan associations, credit unions, investment firms, and large national retailers, and competes for deposits with money market funds. In order to successfully compete, management has developed a sales and service culture, stresses and rewards quality customer service, and designs products to meet the needs of the customer. The Bank also utilizes its ability to sell loans in the secondary market.
The Bank makes mortgage, commercial, and installment loans to customers primarily in the Upper Peninsula of Michigan. Fees may be charged for these services. Historically, the Bank has predominantly sold its secondary market conforming residential mortgage loans. The Bank also finances commercial and governmental leases throughout the country. The leases are originated by unrelated entities and the Bank reviews the credit quality of each lease before entering into a financing agreement.
The Registrant is a party to financial instruments with off-balance sheet risk in the normal course of business to meet financial needs of its customers. These financial instruments include commitments to make loans, unused lines of credit, and standby letters of credit. The Registrant's exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual amount of those instruments. The Registrant follows the same credit policy to make such commitments as it uses for on-balance-sheet items.
The Registrant had the following fixed and variable rate commitments outstanding at December 31 (in thousands):
Fixed rates on unused lines of credit ranged from 9% to 18% at December 31, 1998.
Since many commitments to make loans expire without being used, the amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management's credit evaluation of the borrower and may include real estate, vehicles, business assets, deposits, and other items.
The Bank supports the growth of the service industry, with its year round resort and related businesses, gaming, forestry, restaurants, farming, fishing, and many other activities important to growth in the Upper and Lower Peninsula. The economy of the market areas of the Bank is affected by summer and winter tourism activities and, accordingly, the Bank experiences seasonal consumer and commercial deposit growth, with substantial growth increases from May to September.
There are no material concentrations of credit to, nor have other material portions of the Bank's deposits been received from, a single person, industry, or group.
In 1993, North Country Bank and Trust joined the Federal Home Loan Bank of Indianapolis. The Federal Home Loan Bank of Indianapolis provides an additional source of liquidity and long-term funds. Membership in the Federal Home Loan Bank also provides access to additional advantageous lending programs. The Community Investment Program makes advances to be used for funding community-oriented mortgage lending, and the Affordable Housing Program grants advances to fund lending for long-term low and moderate income owner occupied and affordable rental housing at subsidized interest rates.
The Bank regularly assesses its ability to raise funds through the issuance of certificates of deposit in denominations of $100,000 or more in the local and regional market area and has established conservative guidelines for the total funding to be provided by these deposits. The Bank is also using the Internet to attract certifictes of deposits in denominations of $100,000 or more. These large denomination deposits were slightly more than 6% of total deposits at December 31, 1998. The Bank also uses federal funds purchased from correspondent banks and the Federal Reserve Bank to respond to deposit fluctuations and temporary loan demands.
As of December 31, 1998, the Bank had no material risks attendant to foreign sources. See "Interest Rate and Foreign Exchange Risk Management" section in Management's Discussion and Analysis for details on the Registrant's foreign account activity. Compliance with federal, state, and local statutes and/or ordinances relating to the protection of the environment is not expected to have a material effect upon the Bank's capital expenditures, earnings, or competitive position.
SUPERVISION AND REGULATION
The following is a summary of certain statutes and regulations affecting the Company and the Bank. This summary is qualified in its entirety by such statutes and regulations. A change in applicable laws or regulations may have a material effect on the Company, the Bank and the business of the Company and the Bank.
General
Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), the FDIC, the Commissioner of the Michigan Financial Institutions Bureau ("Commissioner"), the Internal Revenue Service, and state taxing authorities. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds, the depositors of the Bank, and the public, rather than shareholders of the Bank or the Company.
Federal law and regulations establish supervisory standards applicable to the lending activities of the Bank, including internal controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by real property.
The Company
General. The Company is a bank holding company and, as such, is registered with, and subject to regulation by, the Federal Reserve Board under the Bank Holding Company Act, as amended (the "BHCA"). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.
In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not do so absent such policy. In addition, if the Commissioner deems the Bank's capital to be impaired, the Commissioner may require the Bank to restore its capital by a special assessment upon the Company as the Bank's sole shareholder. If the Company were to fail to pay any such assessment, the directors of the Bank would be required, under Michigan law, to sell the shares of the Bank's stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank's capital.
Investments and Activities. In general, any direct or indirect acquisition by the Company of any voting shares of any bank which would result in the Company's direct or indirect ownership or control of more than 5% of any class of voting shares of such bank, and any merger or consolidation of the Company with another bank company, will require the prior written approval of the Federal Reserve Board under the BHCA. In acting on such applications, the Federal Reserve Board must consider various statutory factors, including among others, the effect of the proposed transaction on competition in relevant geographic and product markets, and each party's financial condition, managerial resources, and record of performance under the Community Reinvestment Act. Effective September 29, 1995, bank holding companies may acquire banks located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain conditions, including limitations on the aggregate amount of deposits that may be held by the acquiring company and all of its insured depository institution affiliates.
The merger or consolidation of an existing bank subsidiary of the Company with another bank, or the acquisition by such a subsidiary of assets of another bank, or the assumption of liability by such a subsidiary to pay any deposits in another bank, will require the prior written approval of the responsible Federal depository institution regulatory agency under the Bank Merger Act, based upon a consideration of statutory factors similar to those outlined above with respect to the BHCA. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the BHCA and/or the Commissioner under the Michigan Banking Code, may be required.
With certain limited exceptions, the BHCA prohibits any bank company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling banks unless the proposed non-banking activity is one that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under current Federal Reserve Board regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. As a result of recent amendments to the BHCA, well- capitalized and well-managed bank holding companies may engage de novo in certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve Board, provided that written notice of the new activity is given to the Federal Reserve Board within 10 business days after the activity is commenced. If a bank company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank company.
In evaluating a proposal to engage (either de novo or through the acquisition of a going concern) in a non-banking activity, the Federal Reserve Board will consider various factors, including among others the financial and managerial resources of the bank company, and the relative public benefits and adverse effects which may be expected to result from the performance of the activity by an affiliate of the bank company. The Federal Reserve Board may apply different standards to activities proposed to be commenced de novo and activities commenced by acquisition, in whole or in part, of a going concern.
Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve Board's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of shareholders' equity) to total assets of 3% for the most highly rated companies, with minimum requirements of 4% to 5% for all others. The risk- based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital.
The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, Federal Reserve Board regulations provide that additional capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. The Federal Reserve Board has not advised the Company of any specific minimum Tier 1 Capital leverage ratio applicable to it.
Dividends. The Company is a corporation separate and distinct from the Bank. Most of the Company's revenues are received by it in the form of dividends paid by the Bank. Thus, the Company's ability to pay dividends to its shareholders is indirectly limited by statutory restrictions on the Bank's ability to pay dividends. See "SUPERVISION AND REGULATION - The Bank - Dividends." Further, the Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the Federal Reserve Board expressed its view that a bank company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which can only be funded in ways that weakened the bank company's financial health, such as by borrowing. Additionally, the Federal Reserve Board possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Similar enforcement powers over the Bank are possessed by the FDIC. The "prompt corrective action" provisions of federal law and regulation authorizes the Federal Reserve Board to restrict the payment of dividends by the Company for an insured bank which fails to meet specified capital levels.
In addition to the restrictions on dividends imposed by the Federal Reserve Board, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if after the distribution a corporation, such as the Company, can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution. The Company is authorized to issue preferred stock but it has no current plans to issue any such preferred stock.
The Bank
General. The Bank is a Michigan banking corporation and its deposit accounts are insured by the Bank Insurance Fund (the "BIF") of the FDIC. As a BIF-insured Michigan chartered bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Commissioner, as the chartering authority for Michigan banks, and the FDIC, as administrator of the BIF. These agencies and the federal and state laws applicable to the Bank and its operations, extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their respective levels of capital and results of supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.
The Federal Deposit Insurance Act ("FDIA") requires the FDIC to establish assessment rates at levels which will maintain the Deposit Insurance Fund at a mandated reserve ratio of not less than 1.25% of estimated insured deposits. Accordingly, the FDIC established the schedule of BIF insurance assessments for the first semi-annual assessment period of 1998, ranging from 0% of deposits for institutions in the lowest risk category to .27% of deposits for institutions in the highest risk category.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution or its directors have engaged or are engaging in unsafe or unsound practices, or have violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC, or if the institution is in an unsafe or unsound condition to continue operations. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital.
Commissioner Assessments. Michigan banks are required to pay supervisory fees to the Commissioner to fund the operations of the Commissioner. The amount of supervisory fees paid by a bank is based upon the bank's total assets, as reported to the Commissioner.
FICO Assessments. Pursuant to federal legislation enacted September 30, 1996, the Bank, as a member of the BIF, is subject to assessments to cover the payments on outstanding obligations of the Financing Corporation ("FICO"). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the FDIC's Savings Association Insurance Fund (the "SAIF") which insures the deposits of thrift institutions. Until January 1, 2000, the FICO assessments made against BIF members may not exceed 20% of the amount of FICO assessments made against SAIF members. Currently, SAIF members pay FICO assessments at a rate equal to approximately 0.063% of deposits while BIF members pay FICO assessments at a rate equal to approximately 0.013% of deposits. Between January 1, 2000 and the maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. It is estimated that FICO assessments during this period will be less than 0.025% of deposits
Capital Requirements. The FDIC has established the following minimum capital standards for state-chartered, FDIC-insured non-member banks, such as the Bank: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders' equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, FDIC regulations provide that higher capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities or securities trading activities. As a condition to regulatory approval of the Bank's formation, the Bank was required to have an initial capitalization sufficient to provide a ratio of Tier 1 capital to total estimated assets of at least 8% at the end of the third year of operation.
Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized." Federal regulations define these capital categories as follows:
As of December 31, 1998, each of the Bank's ratios exceeded minimum requirements for the well capitalized category.
Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.
In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution, following receipt of a less-than-satisfactory rating on its most recent examination report, to correct the deficiency.
Dividends. Under Michigan law, the Bank is restricted as to the maximum amount of dividends it may pay on its common stock. The Bank may not pay dividends except out of net profits after deducting its losses and bad debts. A Michigan state bank may not declare or pay a dividend unless the bank will have a surplus amounting to at least 20% of its capital after the payment of the dividend. If the Bank has a surplus less than the amount of its capital, it may not declare or pay any dividend until an amount equal to at least 10% of net profits for the preceding one-half year (in the case of quarterly or semi-annual dividends) or full-year (in the case of annual dividends) has been transferred to surplus. A Michigan state bank may, with the approval of the Commissioner, by vote of shareholders owning 2/3 of the stock eligible to vote increase its capital stock by a declaration of a stock dividend, provided that after the increase the bank's surplus equals at least 20% of its capital stock, as increased. The Bank may not declare or pay any dividend until the cumulative dividends on preferred stock (should any such stock be issued and outstanding) have been paid in full. The Bank's Articles of Incorporation do not authorize the issuance of preferred stock and there are no current plans to seek such authorization.
Federal law generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its company if the depository institution would thereafter be undercapitalized. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, the FDIC may prohibit the payment of dividends by the Bank, if such payment is determined, by reason of the financial condition of the Bank, to be an unsafe and unsound banking practice.
Insider Transactions. The Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company or its subsidiaries, on investments in the stock or other securities of the Company or its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company,
and to "related interests" of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines to promote the safety and soundness of federally insured depository institutions. These guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings. In general, the guidelines prescribe the goals to be achieved in each area, and each institution will be responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. The preamble to the guidelines states that the agencies expect to require a compliance plan from an institution whose failure to meet one or more of the standards is of such severity that it could threaten the safe and sound operation of the institution. Failure to submit an acceptable compliance plan, or failure to adhere to a compliance plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action.
State Bank Activities. Under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by FDIC regulations, also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the FDIC in accordance with federal law. These restrictions are not currently expected to have a material impact on the operations of the Bank.
Consumer Protection Laws. The Bank's business includes making a variety of types of loans to individuals. In making these loans, the Bank is subject to State usury and regulatory laws and to various federal statutes, such as the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the Home Mortgage Disclosure Act, and the regulations promulgated thereunder, which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, the Bank is subject to extensive regulation under State and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank and its directors and officers.
Branching Authority. Michigan banks, such as the Bank, have the authority under Michigan law to establish branches anywhere in the State of Michigan, subject to receipt of all required regulatory approvals (including the approval of the Commissioner and the FDIC).
Effective June 1, 1997 (or earlier if expressly authorized by applicable state law), the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") allows banks to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by IBBEA only if specifically authorized by state law. The legislation allowed individual states to "opt-out" of interstate branching authority by enacting appropriate legislation prior to June 1, 1997.
Michigan did not opt out of IBBEA, and now permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the
Commissioner, (i) the acquisition of all or substantially all of the assets of a Michigan-chartered bank by an FDIC- insured bank, savings bank, or savings and loan association located in another state, (ii) the acquisition by a Michigan- chartered bank of all or substantially all of the assets of an FDIC-insured bank, savings bank or savings and loan association located in another state, (iii) the consolidation of one or more Michigan-chartered banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, with the resulting organization chartered by Michigan, (iv) the establishment by a foreign bank, which has not previously designated any other state as its home state under the International Banking Act of 1978, of branches located in Michigan, and (v) the establishment or acquisition of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting Michigan-chartered banks to establish branches in such jurisdiction. Further, the Michigan Banking Code permits, upon written notice to the Commissioner, (i) the acquisition by a Michigan-chartered bank of one or more branches (not comprising all or substantially all of the assets) of an FDIC-insured bank, savings bank or savings and loan association located in another state, the District of Columbia, or a U.S. territory or protectorate, (ii) the establishment by Michigan-chartered banks of branches located in other states, the District of Columbia, or U.S. territories or protectorates, and (iii) the consolidation of one or more Michigan-chartered banks and FDIC-insured banks, savings banks or savings and loan associations located in other states, with the resulting organization chartered by one of such other states.
SELECTED STATISTICAL INFORMATION
The following statistical information is presented in response to the Securities and Exchange Commission's "Guide 3 Statistical Disclosures by Bank Holding Companies."
I. A&B Distribution of Assets, Liabilities, and Stockholders' Equity
The following table details the key components of net interest income, the average daily balance sheet for each year--including the components of earning assets and supporting liabilities--the related interest income on a fully tax equivalent basis and interest expense, as well as the average rates earned and paid on these assets and liabilities. The following table sets forth average consolidated balance sheet data and average yield and rate data on a tax equivalent basis for the years ended December 31:
(1) For purposes of these computations, non-accruing loans are included in the daily average loan amounts outstanding. (2) The amount of interest income on nontaxable investment securities and loans has been adjusted to its fully tax equivalent. (3) Interest income on loans includes loan fees.
I.C Interest Income and Expense Volume and Rate Change
An analysis of the changes in net interest income from period-to-period is presented in the following table. The analysis highlights the relative effect of the changes in interest income and expense due to changes in the average balances of earning assets and interest-bearing liabilities and changes in interest rates.
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
(2) The amount of interest income on nontaxable loans and investment securities has been adjusted to its fully taxable equivalent.
II.A. Investment Portfolio
The following table presents the carrying value of investment securities at each respective year end.
II.B. Relative Maturities and Weighted Average Interest Rates
The following table presents the maturity schedule of securities held and the weighted average yield of those securities, as of December 31, 1998. Mortgaged backed securities are included with other securities stratified by maturity dates. Registrant holds no securities with one issuer in which the aggregate carrying value of the securities exceeds ten percent of stockholders' equity.
(1) Weighted average yield includes the effect of tax-equivalent adjustments using a 34% tax rate.
III.A. Type of Loans
The following table sets forth the major categories of loans outstanding for each category at December 31 for each year indicated (in thousands).
Included in the above totals are approximately $4.1 million of loans to Canadian obligors.
To the extent the Company utilizes lease financing for its customers, the leases are accounted for as loans.
III.B. Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table presents the remaining maturity of total loans outstanding for the categories shown at December 31, 1998, based on scheduled principal repayments. The amounts due after one year are classified according to the sensitivity to changes in interest rates.
III.C. Risk Elements
The following table presents a summary of non-performing assets.
III.D. Other Interest Bearing Assets.
None
IV.A. Summary of Loan Loss Experience.
Additional information relative to the allowance for loan losses is presented in the following table. This table summarizes loan balances at the end of each period and daily average balances, changes in the allowance for loan losses arising from loans charged off, recoveries on loans previously charged off by loan category, and additions to the allowance for loan losses through provisions charged to expense. Factors which influence management's judgment in determining the provision for loan losses each period include establishing specified loss allowances for selected loans (including large loans, nonaccrual loans, and problem and delinquent loans) and consideration of historical loss information and local economic conditions.
IV.B. Allocation of Allowance for Loan Losses
The allocation of the allowance for loan losses for the years ended December 31 is shown on the following table.
V. Deposits.
The following table represents the maturities of time certificates of deposits and other time deposits of $100,000 or more.
Approximately $6.4 million of total deposits are from Canadian customers.
VI. Return on Equity and Assets
The various ratios are disclosed in Item 6, "Selected financial Data."
VII. Short-Term Borrowings
The Company's short-term borrowings consist only of federal funds purchased. Following are the balances of federal funds purchased as of December 31 of each year shown.
ITEM 2:
ITEM 2: Properties
The Registrant conducts business from 30 banking and administrative offices. Of these, 21 are owned in fee simple covering approximately 95,000 square feet, and nine are leased covering approximately 15,000 square feet. The Registrant's headquarters, which were remodeled in 1996, are located at 130 South Cedar Street, Manistique, Michigan 49854. This facility is used for centralized support services and corporate administration. Other owned and leased properties are banking branches. All of the facilities are believed to be in good condition and adequate to meet the Registrant's present needs.
ITEM 3:
ITEM 3: Legal Proceedings
As the date hereof, there were no material pending legal proceedings, other than routine litigation incidental to the business of banking to which the Registrant or any of its subsidiaries is a party of or which any of its properties is the subject.
ITEM 4:
ITEM 4: Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of fiscal 1998 to a vote of the Registrant's stockholders.
ADDITIONAL ITEM - EXECUTIVE OFFICERS
The foregoing officers serve at the pleasure of the Board of Directors and are appointed by the Board annually. There are no arrangements or understandings between any officer and any other person pursuant to which the officer was elected.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions in this Report on Form 10-K and the documents incorporated herein by reference which are not statements of historical fact (including statements in the future tense and those which include terms such as "believe," "will," "expect," and "anticipate") contain forward-looking statements that involve risks and uncertainties. The Company's actual future results could materially differ from those discussed. Factors that could cause or contribute to such differences include, but are not limited to, acceptance of new products and services, the Company's future lending and collection experience, the effects of acquisitions, competition from other institutions, changes in the banking industry and its regulation, needs for technological change, and other factors including those discussed in Item 1 above in this Report and in the Management's Discussion and Analysis in Item 7, as well as those discussed elsewhere in this Report and the documents incorporated herein by reference.
PART II
ITEM 5:
ITEM 5: Market for Registrant's Common Stock and Related Security Holder Matters
There is no active market for the Registrant's common stock and there is no published information with respect to its market price. There are occasional direct sales by shareholders of which the Registrant's common stock has sold at a premium to book value. From January 1, 1997, through December 31, 1998, there were, so far as the Registrant's management knows, approximately 178 sales of shares of the Registrant's common stock, involving a total of approximately 183,265 shares. The price was reported to management in most of these transactions, and management has no way of confirming the prices which were reported. During this period, the highest price known to be paid was $23.00 per share in the last quarter of 1998, and the lowest price was $11.00 in the first quarter of 1997. To the knowledge of management, the last sale of common stock occurred on March 17, 1999, at a price of $25.00. As of March 1, 1999, there were 1,816 shareholders of record of the Registrant's common stock.
The following table sets forth the range of high and low sales prices of the Registrant's common stock during 1997 and 1998, based on information made available to management. Although management is not aware of any transactions at higher or lower prices, there may have been transactions at prices outside the ranges listed in the table. All share prices reflect the 3-for-1 stock split effective August 25, 1998.
The holders of the Registrant's common stock are entitled to dividends when, as and if declared by the Board of Directors of the Registrant out of funds legally available for that purpose. Dividends have been paid on a quarterly basis. In determining dividends, the Board of Directors considers the earnings, capital requirements and financial condition of the Registrant and its subsidiary bank, along with other relevant factors. The Registrant's principal source of funds for cash dividends is the dividends paid by the subsidiary bank. The ability of the Registrant and the subsidiary bank to pay dividends is subject to regulatory restrictions and requirements.
The following table presents cash dividends paid by quarter for 1998 and 1997 (as adjusted to reflect the 3-for-1 stock split effective August 25, 1998):
ITEM 6:
ITEM 6: Selected Financial Data
ITEM 7:
ITEM 7: Management's Discussion and Analysis of Financial Condition and Results of Operations
Incorporated by reference to the Management's Discussion and Analysis in the Company's 1998 Annual Report to Shareholders and contained in Exhibit 13 to this Report on Form 10-K.
ITEM 7A:
ITEM 7A: Quantitative and Qualitative Disclosures About Market Risk
The Company's primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and foreign exchange risk. The Company has limited agricultural-related loan assets and therefore has minimal significant exposure to changes in commodity prices. Any impact that changes in foreign exchanges rates and commodity prices would have on interest rates are assumed to be insignificant.
Interest rate risk is the exposure of the Company's financial condition to adverse movements in interest rates. The Company derives its income primarily from the excess of interest collected on its interest-earning assets over the interest paid on its interest-bearing liabilities. The rates of interest the Company earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, the Company is exposed to lower profitability if it cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excess levels of interest rate risk could pose a significant threat to the Company's earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to the Company's safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. The Company's interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk the Company assesses the existing and potential future effects of changes in interest rates on its financial condition, including capital adequacy, earnings, liquidity and asset equity.
The table below measures current maturity levels of interest-earning assets and interest-bearing liabilities, along with average stated rates and estimated fair values at December 31, 1998:
In addition to changes in interest rates, the level of future net interest income is also dependent on a number of variables, including: the growth, composition and levels of loans, deposits, and other earning assets and interest-bearing liabilities economic and competitive conditions; potential changes in lending, investing and deposit strategies; customer preferences; and other factors.
ITEM 8:
ITEM 8: Financial Statements
Incorporated by reference to the Registrant's Consolidated Financial Statements for the years ended December 31, 1998, 1997 and 1996 in the Company's 1998 Annual Report to Shareholders and contained in Exhibit 13 to this Report on Form 10-K.
ITEM 9:
ITEM 9: Changes in and Disagreements With Accountants and Financial Disclosure
There have been no disagreements with Accountants.
PART III
ITEM 10:
ITEM 10: Directors and Executive Officers of the Registrant
The information set forth on page 2, under the caption "Information About Directors and Director Nominees" of the Registrant's definitive Proxy Statement dated March 1, 1999, is hereby incorporated by reference.
ITEM 11:
ITEM 11: Executive Compensation
Information relating to compensation of the Registrant's executive officers and directors is contained on pages 3 - 7, under the captions "Remuneration of Directors" and "Compensation of Executive Officers," in the Registrant's definitive Proxy Statement dated March 1, 1999, and is incorporated herein by reference.
ITEM 12:
ITEM 12: Security Ownership of Certain Beneficial Owners and Management
Information relating to security ownership of certain beneficial owners and management is contained on page 8, under the caption "Ownership of Common Stock" in the Registrant's definitive Proxy Statement dated March 1, 1999, and is incorporated herein by reference.
ITEM 13:
ITEM 13: Certain Relationships and Related Transactions
Information relating to certain relationships and related transactions is contained on page 7, under the caption "Indebtedness of and Transactions With Management" in the Registrant's definitive Proxy Statement dated March 1, 1999, and is incorporated herein by reference.
PART IV
ITEM 14
ITEM 14 - Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) Financial Statements.
1. The following documents are filed as part of Item 8 of this report:
Report of Independent Auditors Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Income for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Changes in Shareholders 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
2. Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable, and therefore have been omitted.
3. The following exhibits are filed as part of this report: Reference is made to the exhibit index which follows the signature page of this report.
The Registrant will furnish a copy of any exhibits listed on the Exhibit Index to any shareholder of the Registrant without charge upon written request of Sherry L. Littlejohn, First Manistique Corporation, 130 South Cedar Street, P.O. Box 369, Manistique, Michigan 49854.
(b) Reports on Form 8-K
During the last quarter of the period covered by this report, the Registrant filed no Current Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March 19, 1999.
NORTH COUNTRY FINANCIAL CORPORATION
/s/ Ronald G. Ford Ronald G. Ford Chairman and Chief Executive Officer (Principal Executive Officer)
/s/ Sherry L. Littlejohn Sherry L. Littlejohn Executive Vice President, Chief Operating Officer and Treasurer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 19, 1999, by the following persons on behalf of the Registrant and in the capacities indicated. Each director of the Registrant, whose signature appears below, hereby appoints Ronald G. Ford and Michael C. Henricksen, and each of them severally, as his attorney-in-fact, to sign in his name and on his behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K.
Signature
/s/ Stanley J. Gerou II Stanley J. Gerou II - Director C. Ronald Dufina - Director
/s/ Thomas G. King Thomas G. King - Director Michael C. Henricksen - Director
/s/ John Lindroth /s/ John P. Miller John Lindroth - Director John P. Miller - Director
/s/ Ronald G. Ford Charles B. Beaulieu - Director Ronald G. Ford - Director
/s/ Sherry Littlejohn Bernard A. Bouschor - Director Sherry Littlejohn - Director
EXHIBIT INDEX Number Exhibit
3(a) Amendment to Restated Articles of Incorporation. Previously filed as an Exhibit to the Registrant's Registration statement on Form S-2 (Registration No. 333-06017). Here incorporated by reference.
3(b) Restated Articles of Incorporation. Previously filed as an exhibit to Registrant's Report on Form 10-K for the year ended December 31, 1995. Here incorporated by reference.
3(c) Amended and Restated Bylaws. Previously filed as an exhibit to the Registrant's Report on Form 10-K for the year ended December 31, 1995. Here incorporated by reference.
4(a) Dividend Reinvestment Plan. Previously filed as an exhibit to the Registrant's Registration Statement on Form (Registration No. 033-61533). Here incorporated by reference.
4(b) A specimen stock certificate of the Registrant's Common Stock filed as exhibit to Registrant's Registration Statement on Form S-2 (Registration No. 333-06017). Here incorporated by reference.
10(a) Stock Option Plan. Previously filed in the Registrant's definitive proxy statement for its annual meeting of shareholders held April 21, 1994. Here incorporated by reference.
10(b) North Country Financial Corporation Executive and Board Member Restricted Stock Plan. Previously filed in the Registrant's definitive proxy statement for its annual meeting of shareholders held April 18, 1995. Here incorporated by reference.
10(c) Employment Contract between North Country Bank and Trust and Ronald G. Ford. Previously filed as an exhibit to Registrant's Report on Form 10-K for the year ended December 31, 1995. Here incorporated by reference.
10(d) Amendment to Employment Contract between North Country Bank and Trust and Ronald G. Ford. Previously filed as an exhibit to Registrant's Report on Form 10-K for the year ended December 31, 1996. Here incorporated by reference.
10(e) Deferred Compensation, Deferred Stock, and Current Stock Purchase Plan for Nonemployee Directors. Previously filed in the Registrant's definitive proxy statement for its annual meeting of shareholders held April 23, 1996. Here incorporated by reference.
10(f) North Country Financial Corporation Stock Compensation Plan. Previously filed as an exhibit to the Registrant's definitive proxy statement for its annual meeting of shareholders to be held April 15, 1997. Here incorporated by reference.
10(g) North Country Financial Corporation 1997 Directors' Stock Option Plan. Previously filed as an exhibit to Registrant's definitive proxy statement for its annual meeting of shareholders held April 15, 1997. Here incorporated by reference.
13 1998 Annual Report to Shareholders. This exhibit, except for those portions expressly incorporated by reference in this filing, is furnished for the information of the Securities and Exchange Commission and is not deemed "filed" as part of this filing.
21 Subsidiaries of the Registrant. Filed herewith.
23. Consent of Independent Public Accountants.
27 Financial Data Schedule - year ended December 31, 1998. Filed herewith.
EXHIBIT 13
North
Country
Financial
Corporation
Annual
Report
Mission Statement
NORTH COUNTRY FINANCIAL CORPORATION NORTH COUNTRY BANK AND TRUST FIRST NORTHERN SERVICES CORPORATION FIRST MANISTIQUE AGENCY CORPORATION FIRST RURAL RELENDING CORPORATION NCB REAL ESTATE COMPANY
MISSION STATEMENT
NORTH COUNTRY BANK AND TRUST OR PRECEDENT HAS BEEN AN INDEPENDENT BANK SINCE 1934. OUR MISSION IS TO SERVE OUR TRADING AREA WITH QUALITY FINANCIAL SERVICES AND PRODUCTS. TO PROVIDE FOR PROFITABILITY WHICH WILL ENHANCE THE LIFESTYLES OF OUR CUSTOMERS, SHAREHOLDERS AND EMPLOYEES. TO CONTINUE TO GROW, AND MAINTAIN EXCELLENCE AND PROVIDE OUR TRADING AREA WITH INNOVATIVE BANKING SERVICES.
AS AN INDEPENDENT COMMUNITY BANK, WE WILL STRIVE TO FOSTER ECONOMIC VITALITY AND CIVIC WELL BEING IN THE COMMUNITIES WE SERVE. IT IS OUR BELIEF THAT A STRONG COMMUNITY IS A PREREQUISITE TO A STRONG BANK. BASED ON OUR BELIEF THAT AS A "COMMUNITY" BANK WE BEST SERVE OUR SHAREHOLDERS, CUSTOMERS AND COMMUNITIES, IT IS OUR INTENTION TO MAINTAIN THE INDEPENDENCE OF NORTH COUNTRY BANK AND TRUST.
To Our Shareholders............................................................1
Comparative Highlights.........................................................2
Five Year Comparisons..........................................................3
Report of Independent Auditors.................................................6
Consolidated Balance Sheets....................................................7
Consolidated Statements of Income..............................................8
Consolidated Statements of Changes in Shareholders' Equity.....................9
Consolidated Statements of Cash Flows.........................................10
Notes to Consolidated Financial Statements....................................13
Selected Financial Data.......................................................43
Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................44
Directors.....................................................................56
To Our Shareholders
Dear Shareholder:
Growth is a proud tradition of North Country Financial Corporation. For another consecutive year, assets, deposits, net loans, shareholders' equity, book value per share, net income and dividends paid to our shareholders have all increased.
The market value of your North Country Financial Corporation stock has increased almost 32.95% during the last year. The continued appreciation of your stock brings us one step closer to our long-term goal of 18% return on beginning equity.
We continue to be a leader in the financial industry in Northern Michigan. Internally, we have continued to improve the efficiency of our consolidated loan administration and credit departments. To provide more effective customer service, we have improved our central call center and have provided our call center professionals with superior training to assist any customer. Personal bankers and relationship bankers are in place at each office to give customers personalized service for all their financial needs.
Externally, we have expanded our current business operations once again in 1998 to include two new branches, located in Escanaba and Gaylord. Our market presence will be further expanded early in 1999 with the addition of two new branch acquisitions in the lower peninsula. In addition to branch expansion, we continue to seek new business opportunities that will result in increased market share, value added services for our customers, and increased shareholder value.
On March 10, 1998, North Country Bank and North Country Bank and Trust merged. All offices across the Upper Peninsula were named North Country Bank and Trust. Our shareholders voted in 1998 to change the corporation name to North Country Financial to more closely identify the corporation with its bank subsidiary North Country Bank and Trust. This was particularly important as we continue to expand our market area.
On behalf of the Board of Directors, we express our appreciation to you, our shareholders, for your continued confidence. Together we can achieve the extraordinary.
_______________________ __________________________ _________________ Ronald G. Ford Michael C. Henricksen Thomas G. King President and C.E.O. Chairman Vice-Chairman
1.
Comparative Highlights
DIVIDEND SUMMARY (Cash Dividend paid per Common Share)
The above summary should be read in connection with the related consolidated financial statements and notes included elsewhere in this report.
BUSINESS OF THE CORPORATION
North Country Financial Corporation is a registered bank holding company formed under the Bank Holding Company Act of 1956, as amended. The principal assets of the Corporation are its ownership of all the outstanding capital stock of North Country Bank and Trust, Manistique, Michigan, First Manistique Agency Corporation, First Northern Services Corporation, First Rural Relending Corporation and NCB Real Estate Company. The subsidiary bank is engaged in the commercial banking business and provides a full range of banking services. First Manistique Agency is engaged in the selling of insurance. First Northern Services operates a real estate appraisal business. First Rural Relending is a non profit lending corporation. NCB Real Estate Company owns several properties used by North Country Bank & Trust.
FORM 10-K
A copy of the Annual Report to the Securities and Exchange Commission on Form 10-K is available without charge by writing Shirley Young, North Country Financial Corporation, P.O. Box 369, Manistique, Michigan 49854.
MARKET SUMMARY
The common stock of North Country Financial Corporation has been traded in private sales since October 1976. The Corporation has approximately 1,786 shareholders of record, as of January 22, 1999.
2.
Five Year Comparisons ASSETS Total assets on a consolidated basis increased by 11.85% in [GRAPHIC OMITTED] 1998 to a record $471,380,858. Total assets have increased over $218,000,000 since the end of 1994, an increase of 86% in four years.
LOANS Total net loans increased 10.54% to $405,608,135 in 1998. Loan demand is strong and our primary lending objective [GRAPHIC OMITTED] continues to be one of selecting the highest quality credits. Total loan losses have remained at an acceptable level, and we continue to maintain a loan loss allowance above regulatory guidelines. The allowance for loan losses totaled $6,112,334 at the end of 1998, an increase of over $500,000 over 1997. We expect strong loan demand to continue, with the majority being commercial and business loans, which represent 67.8% of the loan portfolio.
DEPOSITS Total deposits increased by 12.32% to $404,961,333. In 1998, [GRAPHIC OMITTED] we paid our depositors interest of more than $16,500,000 which goes back into our regional economy.
3.
Five Year Comparisons
INVESTMENT SECURITIES Our portfolio of debt and equity securities decreased 15.22% [GRAPHIC OMITTED] during 1998 to $8,565,282. This decrease is based on our strategy to employ more of our resources in the loan portfolio in order to maximize the earnings on our assets and the return to the shareholder.
SHAREHOLDERS' EQUITY During 1998, $2,877,292 was added to shareholders' equity, [GRAPHIC OMITTED] increasing total equity by 7.86%. In addition, cash dividends of $0.17 per share, or $1,251,224, were paid to our shareholders, an increase of 5.86% over 1997. Book value per share increased to $5.54 compared to $5.13 at the end of 1997.
NET INCOME Net income for 1998 was $4,561,190. Basic earnings per share [GRAPHIC OMITTED] increased to $0.65 in 1998 from $0.58 in 1997, a 12.07% increase.
4.
Report of Independent Auditors
INDEPENDENT AUDITOR'S REPORT TO THE SHAREHOLDERS OF THE NORTH COUNTRY FINANCIAL CORPORATION MANISTIQUE, MICHIGAN
5.
Report of Independent Auditors
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Shareholders North Country Financial Corporation Manistique, Michigan
We have audited the accompanying consolidated balance sheets of North Country Financial Corporation and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. 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. The consolidated statements of income, changes in shareholders' equity and cash flows for the year ended December 31, 1996, were audited by other auditors whose report dated February 14, 1997, expressed an unqualified opinion on those statements.
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 1998 and 1997 financial statements referred to above present fairly, in all material respects, the financial position of North Country Financial Corporation and Subsidiaries at December 31, 1998 and December 31, 1997, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
/s/ Wipfli Ullrich Bertelson LLP Wipfli Ullrich Bertelson LLP
January 29, 1999 Appleton, Wisconsin
6.
Consolidated Balance Sheets
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997
See accompanying notes to consolidated financial statements.
7.
Consolidated Statements of Income
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1998, 1997 and 1996
See accompanying notes to consolidated financial statements.
8.
Consolidated Statements of Changes in Shareholders' Equity
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years Ended December 31, 1998, 1997 and 1996
See accompanying notes to consolidated financial statements.
9.
Consolidated Statements of Cash Flows
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1998, 1997 and 1996
10.
Consolidated Statements of Cash Flows (Continued)
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1998, 1997 and 1996
11.
Consolidated Statements of Cash Flows (Continued)
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1998, 1997 and 1996
See accompanying notes to consolidated financial statements.
12.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of North Country Financial Corporation (the "Corporation") and Subsidiaries conform to generally accepted accounting principles and prevailing practices within the banking industry. Significant accounting policies are summarized below.
Principles of Consolidation
The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, North Country Bank & Trust (the "Bank"), Rural Relending, and other minor subsidiaries, after elimination of intercompany transactions and accounts. During 1998, North Country Bank, a wholly-owned subsidiary of the Corporation, was merged into the Bank.
Nature of Operations
The Corporation's and the Bank's revenues, operating income, and assets are primarily from the banking industry. Rural Relending is in the business of generating loans for commercial entities. Loan customers are mainly located in Michigan's Upper Peninsula. In addition, a significant portion of its commercial loan portfolio consists of leases to commercial and government entities which are secured by equipment and vehicles. These leases are dispersed geographically throughout the country.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, non-interest-bearing deposits in correspondent banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
13.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Investment Securities
The Corporation's investment securities are classified in two categories and accounted for as follows:
Securities available for sale - Securities available for sale consist of investment securities not classified as securities held to maturity. These securities are stated at fair value. Unrealized holding gains and losses, net of tax, on securities available for sale are reported as accumulated other comprehensive income within shareholders' equity until realized.
Securities held to maturity - Investment securities for which the Corporation has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized in interest income using the interest method over the period to maturity.
Gains and losses on the sale of securities are determined using the specific-identification method.
Loans Held for Sale
Loans held for sale represent originations of fixed-rate, first mortgage loans recorded at cost. The loans are sold at fair value shortly after origination based on an agreement with an outside mortgage company.
Interest Income and Fees on Loans
Interest on loans is accrued and credited to income based on the principal amount outstanding. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed. Loan-origination fees are credited to income when received, as capitalization of the fees and related costs would not have a material effect on the overall consolidated financial statements.
Allowance for Loan Losses
The allowance for loan losses includes specific allowances related to commercial loans which have been judged to be impaired. A loan is impaired when, based on current information, it is probable that the Corporation will not collect all amounts due in accordance with the contractual terms of the loan agreement. These specific allowances are based on discounted cash flows of expected future payments using the loan's initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.
14.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Corporation continues to maintain a general allowance for loan losses for loans not considered impaired. The allowance for loan losses is maintained at a level which management believes is adequate to provide for possible loan losses. Management periodically evaluates the adequacy of the allowance using the Corporation's past loan loss experience, known and inherent risks in the portfolio, composition of the portfolio, current economic conditions, and other factors. This evaluation is inherently subjective since it requires material estimates that may be susceptible to significant change.
Other Real Estate
Other real estate is carried at the lower of cost or fair value, less estimated sales costs.
Premises and Equipment
Premises and equipment are stated at cost. Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income. Depreciation is computed on the straight-line method and is based on the estimated useful lives of the assets.
Acquisition Intangibles
The Corporation's intangible assets include the value of ongoing customer relationships (core deposits) and the excess of cost over the fair value of net assets acquired (goodwill) arising from the purchase of a financial institution and the acquisition of certain assets and the assumption of certain liabilities of other financial institutions. Core deposit intangibles are amortized to income over a 10-year period on an accelerated basis, and goodwill is amortized on a straight-line basis over periods ranging from 15 to 25 years.
Advertising Costs
Advertising costs are expensed as incurred.
Earnings Per Common Share
Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits through the date of issue of the financial statements.
15.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income (deficit). Other comprehensive income (deficit) includes unrealized gains and losses on securities available for sale which are recognized as a separate component of equity, accumulated other comprehensive income (deficit). The accounting standard that requires reporting comprehensive income first applies for 1998, with prior information restated to be comparable.
Income Taxes
Deferred income taxes have been provided under the liability method. Deferred tax assets and liabilities are determined based upon the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences are expected to reverse. Deferred tax expense (benefit) is the result of changes in the deferred tax asset and liability.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Corporation has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable.
Future Accounting Change
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The statement is effective for fiscal years beginning after June 15, 1999. Management, at this time, cannot determine the effect adoption of this statement may have on the consolidated financial statements of the Corporation as the accounting for derivatives is dependent on the amount and nature of derivatives in place at the time of adoption.
16.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Reclassifications
Certain amounts in the 1997 and 1996 consolidated financial statements have been reclassified to conform to the 1998 presentation.
17.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - CHANGES IN ACCOUNTING PRINCIPLES
Effective January 1, 1998, the Corporation adopted SFAS No. 130, "Reporting Comprehensive Income," which was issued in June 1997. In accordance with this statement, the Corporation reports those items defined as comprehensive income in the statement of changes in shareholders' equity. The adoption of SFAS No. 130 did not have an impact on the Corporation's financial position or results of operations.
Effective January 1, 1998, the Corporation adopted SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information," which was issued in June 1997. This statement establishes new standards for reporting information about operating segments in annual and interim financial statements. The standard also requires descriptive information about the way operating segments are determined, the products and services provided by the segments, and the nature of differences between reportable segment measurements and those used for the consolidated enterprise. The disclosure requirements had no impact on the Corporation's financial position or results of operations.
NOTE 3 - ACQUISITIONS
During the period of 1996 through 1998, the Corporation completed two acquisitions. The acquisitions have been accounted for under the purchase method of accounting. Accordingly, the assets, liabilities, and results of operations are included in the Corporation's consolidated financial statements as of and subsequent to the respective acquisition dates. Following is a summary of the acquisitions. Note 9 provides information regarding acquisition intangibles and the amortization thereof. Additional information regarding assets acquired and liabilities assumed is presented on the accompanying consolidated statements of cash flows.
18.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - RESTRICTIONS ON CASH AND CASH EQUIVALENTS
Cash and cash equivalents in the amount of $6,643,000 are restricted at December 31, 1998, to meet the reserve requirements of the Federal Reserve System.
NOTE 5 - INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities available for sale as of December 31 are as follows:
19.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - INVESTMENT SECURITIES (CONTINUED)
Included in other assets are equity securities totaling $3,145,222 and $3,044,300 at December 31, 1998 and 1997, respectively. Equity securities are reported at the lower of cost or market.
Following is a summary of the proceeds from sales of investment securities available for sale, as well as gross gains and losses for the years ended December 31:
20.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - INVESTMENT SECURITIES (CONTINUED)
The amortized cost and estimated fair value of investment securities available for sale at December 31, 1998, by contractual maturity, are shown below. Contractual maturities will differ from expected maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The carrying value of securities pledged to secure public deposits, treasury deposits, and repurchase agreements was $1,002,800 and $3,595,938 as of December 31, 1998 and 1997, respectively.
NOTE 6 - LOANS
The composition of loans at December 31 follows:
21.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LOANS (CONTINUED)
An analysis of the allowance for loan losses for the years ended December 31 follows:
Information regarding impaired loans follows:
The subsidiary bank in the ordinary course of banking business grants loans to the Corporation's executive officers and directors including their families and firms in which they are principal owners. Activity in such loans during 1998 is summarized below.
Substantially all loans to executive officers and directors were made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others and did not involve more than the normal risk of collectibility or present other unfavorable features.
22.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - PREMISES AND EQUIPMENT
Details of premises and equipment at December 31 follow:
Depreciation and amortization of premises and equipment charged to operating expenses amounted to $1,381,015 in 1998, $1,222,939 in 1997 and $1,436,612 in 1996.
NOTE 8 - OTHER REAL ESTATE
Included in other assets is other real estate totaling $449,537 and $397,861 at December 31, 1998 and 1997, respectively. There is no allowance for losses on other real estate. Other real estate expenses totaled $87,139, $104,408 and $9,489 for 1998, 1997, and 1996, respectively.
NOTE 9 - ACQUISITION INTANGIBLES
Intangible assets, which were acquired through acquisitions, consist of the following as of December 31 (net of amortization):
Amortization expense related to the acquisition intangibles was $789,663, $719,071 and $593,220 for the years ended December 31, 1998, 1997, and 1996, respectively.
23.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - DEPOSITS
The distribution of deposits at December 31 is as follows:
Time deposits of $100,000 or more were $25,619,255 and $26,827,133 at December 31, 1998 and 1997, respectively. Interest expense on time deposits of $100,000 or more was $1,543,612, $1,606,273 and $1,085,714 for the years ended December 31, 1998, 1997, and 1996, respectively.
NOTE 11 - SHORT-TERM BORROWINGS
Short-term borrowings consist of federal funds purchased of $1,195,000 at December 31, 1997. There were no short-term borrowings at December 31, 1998.
NOTE 12 - OTHER BORROWINGS
Other borrowings consist of the following at December 31:
24.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - OTHER BORROWINGS (CONTINUED)
Maturities of other borrowings outstanding at December 31, 1998, are as follows:
The Federal Home Loan Bank borrowings are collateralized by a blanket collateral agreement on the Bank's residential mortgage loans, U.S. Government and agency securities, and by the Federal Home Loan Bank stock owned by the Bank. Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of December 31, 1998. The Farmers Home Administration borrowing is collateralized by loans totaling $1,693,308, originated and held by the Corporation's wholly owned subsidiary, Rural Relending, and guaranteed by the Corporation.
25.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - INCOME TAXES
The components of the federal income tax provision for the years ended December 31 follow:
Included in the total provision for income taxes are expenses (credits) of $15,131, $(20,455) and $(2,686) for the years ended December 31, 1998, 1997, and 1996, respectively, related to security transactions.
Deferred income taxes are provided for the temporary differences between the financial reporting and tax bases of the Corporation's assets and liabilities. The major components of net deferred tax assets at December 31 are as follows:
A summary of the source of differences between income taxes at the federal statutory rate and the provision for income taxes for the years ended December 31 follows:
26.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - RETIREMENT PLAN
The Corporation has established a 401(k) profit-sharing plan. Employees who have completed one year of service and attained the age of 18 are eligible to participate in the plan. Eligible employees can elect to have a portion, not to exceed 15%, of their annual compensation paid into the plan. In addition, the Corporation may make discretionary contributions into the plan. Retirement plan contribution expense charged to operations totaled $200,267, $105,267 and $120,126 for 1998, 1997, and 1996, respectively.
NOTE 15 - DEFERRED COMPENSATION PLANS
As an incentive to retain key members of management and directors, the Corporation has two deferred compensation plans.
Benefits under one of the plans is based on the number of years the key members have served the Corporation. A liability is recorded on a present value basis and discounted using current market rates. The liability may change depending upon changes in long-term interest rates. The liability at December 31, 1998 and 1997, for vested benefits under this plan, was $1,098,267 and $841,236, respectively. The Corporation maintains life insurance policies on the plan participants. Death benefits received from the life insurance policies will be used to offset the obligations under the plan. The cash surrender value of these policies was $899,087 and $781,040 at December 31, 1998 and 1997, respectively.
The Corporation sponsors a deferred stock compensation plan for directors. Directors are allowed to defer their director's fees under the plan. The deferred compensation is computed as stock equivalents as the compensation is earned. Directors receive the deferred compensation in the form of common stock upon retirement. The liability relating to this plan was $219,100 and $141,700 at December 31, 1998 and 1997, respectively.
Deferred compensation expense for the plans was $316,041, $175,000 and $105,950 for 1998, 1997, and 1996, respectively.
27.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - SHAREHOLDERS' EQUITY
Earnings per share are based upon the weighted average number of shares outstanding, restated to reflect the three-for-one stock splits on August 25, 1998 and April 29, 1996. The following shows the computation of the basic and diluted earnings per share for the years ended December 31:
Effective August 25, 1998 and April 29, 1996, the Board of Directors of the Corporation approved three-for-one stock splits. All references to the number of shares of common stock in the consolidated financial statements and footnotes thereto have been restated for these stock splits.
28.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - SHAREHOLDERS' EQUITY (CONTINUED)
The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's 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 Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 1998, the Corporation meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized the subsidiary bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and 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 subsidiary bank's category.
29.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - SHAREHOLDERS' EQUITY (CONTINUED)
The Corporation's actual and required capital amounts and ratios as of December 31 are as follows:
30.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - SHAREHOLDERS' EQUITY (CONTINUED)
The Bank is restricted by banking regulations from making dividend distributions above prescribed amounts. At December 31, 1998, the Bank could have paid $9,829,000 of additional dividends to the Corporation without prior regulatory approval.
NOTE 17 - STOCK OPTION PLANS
The Corporation adopted two stock option plans in 1997, one for officers and employees and one for nonemployee directors. A total of 600,000 shares were made available for grant under these plans. The Corporation also sponsors an additional employee and director stock option plan. A total of 148,500 shares were made available for grant under this plan.
Options under all of the plans are granted at the discretion of a committee of the Corporation's Board of Directors. Options to purchase shares of the Corporation's stock are granted at a price equal to the market price of the stock at the date of grant. The committee, within guidelines of no less than six months and no greater than ten years, as established under the plans, determines the vesting of the options when they are granted.
The fair value of each option granted is estimated on the grant date using the Black-Scholes methodology. The following assumptions were made in estimating fair value for options granted for the years ended December 31:
The weighted average fair value of options granted as of their grant date, using the assumptions shown above, was computed at $0.39 per share for options granted in 1998 and $0.37 per share for options granted in 1997. No options were granted in 1996.
31.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - STOCK OPTION PLANS (CONTINUED)
No compensation cost has been recognized for the plans. Had compensation cost been determined on the basis of fair value, net income and earnings per share would have been reduced for the years ended December 31, as follows:
Following is a summary of stock option transactions for the years ended December 31:
32.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - STOCK OPTION PLANS (CONTINUED)
Options granted during 1998 were granted at prices of $19.00 and $20.33. Options granted in 1997 were granted at a price of $15.00. Under these plans, options expire ten years after the date of grant.
Following is a summary of the options outstanding at December 31, 1998:
NOTE 18 - OTHER COMPREHENSIVE INCOME (DEFICIT)
Other comprehensive income (deficit) components and related taxes were as follows:
33.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - SEGMENT INFORMATION
North Country Financial Corporation, through the branch network of its subsidiary, North Country Bank & Trust, provides a broad range of financial services to individuals and companies in northern Michigan. These services include demand, time and savings deposits; lending and lease financing; credit card servicing; ATM processing and cash management. While the Corporation's chief decision makers monitor the revenue streams of the various Corporation products and services, operations are managed and financial performance is evaluated on a Corporation-wide basis. Accordingly, all of the Corporation's banking operations are considered by management to be aggregated in one reportable operating segment.
NOTE 20 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK
Financial Instruments With Off-Balance-Sheet Risk
The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets.
The Corporation's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. These commitments at December 31 are as follows:
34.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The commitments are structured to allow for 100% collateralization on all standby letters of credit.
Credit card commitments are commitments on credit cards issued by the Corporation's subsidiary and serviced by other companies. These commitments are unsecured.
Contingencies
In the normal course of business, the Corporation is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.
Concentration of Credit Risk
The Corporation's subsidiary banks grant residential, commercial, agricultural, and consumer loans throughout Michigan's Upper Peninsula. Due to the diversity of locations, the ability of debtors to honor their contracts is not tied to any particular economic sector.
35.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates, methods, and assumptions are set forth below for the Corporation's financial instruments:
Cash and cash equivalents - The carrying values approximate the fair values for these assets.
Investment securities - Fair values are based on quoted market prices where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, residential mortgage, and other consumer. The fair value of loans is calculated by discounting scheduled cash flows using discount rates reflecting the credit and interest rate risk inherent in the loan.
The methodology in determining fair value of nonaccrual loans is to average them into the blended interest rate at 0% interest. This has the effect of decreasing the carrying amount below the risk-free rate amount and therefore discounts the estimated fair value.
Impaired loans are measured at the estimated fair value of the expected future cash flows at the loan's effective interest rate or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans approximate the estimated fair values for these assets.
36.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Deposit liabilities - The fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits and savings, is equal to the amount payable on demand at the reporting date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows applying interest rates currently being offered on similar certificates.
Short-term and other borrowings - Rates currently available for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date.
Off-balance-sheet instruments - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the counterparties. Since this amount is immaterial, no amounts for fair value are presented.
The following table presents information for financial instruments at December 31:
37.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Limitations - Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and other liabilities. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
NOTE 22 - SUPPLEMENTARY INCOME STATEMENT INFORMATION
Details of other operating expenses in the consolidated statements of income are as follows for the years ended December 31:
38.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
BALANCE SHEETS December 31, 1998 and 1997
39.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF INCOME Years Ended December 31, 1998, 1997, and 1996
40.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS Years Ended December 31, 1998, 1997, and 1996
41.
Notes to Consolidated Financial Statements
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1998, 1997, and 1996
42.
Selected Financial Data
NORTH COUNTRY FINANCIAL CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA (Unaudited)
* Adjusted for 3 for 1 stock splits on May 1, 1994, April 29, 1996 and August 25, 1998
43.
Management's Discussion and Analysis of Financial Condition and Results of Operations
NORTH COUNTRY FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
HIGHLIGHTS
For North Country Financial Corporation ("the Corporation"), 1998 was a year of continued growth. The Corporation grew approximately 12 percent. During 1998, the Corporation added two new offices in Escanaba and Gaylord. Plans are currently under way to continue the expansion into new and developing market areas by adding additional branches in 1999 .
At December 31, 1998, the Corporation had total assets of $471 million, an increase of $50 million from December 31, 1997. The current year increase in assets represents 100% growth generated internally. In 1997, the acquisition of U.P. Financial had accounted for approximately 54% of the growth, with the remaining 46% being generated internally. During 1998, outstanding loan balances increased 10.52% or $39 million to $412 million. Of the total increase in loans, $37 million, or 94.87% came from an increase in the commercial, financial and agricultural loan portfolios.
The growth in 1998 continues the trend which has developed over the past four years. From 1994 through 1998, assets grew by a total of $218 million or 86%, with approximately 36% of this growth occurring due to acquisitions. During the same period, loans grew over 124%, with nearly 55% of this growth being internally generated.
Earnings have also continued to increase from 1997 to 1998. Net income was $4.6 million, $4.1 million, and $2.8 million for 1998, 1997, and 1996, respectively. Return on average shareholders' equity was 11.18%, 12.06%, and 10.12%, for 1998, 1997, and 1996, respectively. The decrease in return on average shareholders' equity is mainly attributable to the Corporation purchasing its own stock in an effort to increase shareholders' value. Basic and diluted earnings per share have continued to increase during this three-year period. Basic earnings per share were $0.65 in 1998, $0.58 in 1997, and $0.43 in 1996, an increase of 12.07% from 1997 and 51.16% from 1996. This significant increase in earnings per share is a result of growth in earnings with a small decrease in outstanding stock due to the buy back of stock. In prior years, the Corporation has issued stock for acquisitions. The consolidated operations of the Corporation in 1998 provided improved profitability through more efficient operations.
44.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Growth remains an important element of the Corporation's strategy and selective bank and branch acquisitions may continue to occur. However, management anticipates the rate of asset growth in the next few years will be somewhat slower than recently experienced. The Corporation's banking offices are currently located in Michigan's Upper Peninsula and northern Lower Peninsula, an area which covers a large geographic area and has a low population density. Because of the nature of this market area, the cost of operating the Corporation's banking network is higher than the average for banking companies the same size as the Corporation. Management's primary focus in the near future is to increase the operating efficiency of its banking network by increasing the average deposit level per branch, increasing lending capabilities in each local market, and closely monitoring and controlling operating costs.
FINANCIAL CONDITION
Loans
Loans represented 87.34% of total assets at the end of 1998, compared to 88.39% at the end of 1997. The loan to deposit ratio decreased slightly dropping from 103.32% at December 31, 1997 to 101.67% at December 31, 1998. Loans provide the most attractive earning asset yield available to the Corporation and management believes that the trained personnel and controls are in place to successfully manage a growing loan portfolio. Accordingly, management intends to continue to maintain loans at the highest level which is consistent with maintaining adequate liquidity.
Following is a summary of the Corporation's loan balances at December 31:
45.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The Corporation has five major categories of lending activities. Four categories, commercial real estate, commercial, residential real estate, and consumer, are generally with customers in Michigan, primarily in the Upper Peninsula. The fifth major lending line, commercial and governmental leasing, takes place on a nationwide basis. As shown in the table above, the amount of outstanding loans increased in the commercial loan and commercial leasing categories in 1998. Management feels these categories will continue to grow in the future, with the level of consumer lending continuing to decrease.
The Corporation finances commercial and governmental leases throughout the country. Management visits all originators twice a year to review their operations and credit controls. Management is working to diversify its sources of lease paper. Management closely reviews the credit quality of each proposed lease before entering into a financing agreement. Such reviews may include visits to major equipment vendors which produce the equipment to be leased or to the lease customers, including governmental organizations. The lease agreements are strictly financing; while the Corporation has access to the underlying equipment as collateral, there is no interest in the residual value to the equipment. As illustrated in the table above, most of the leasing activity is to state and local governmental units, including Native American organizations. Management continues to aggressively pursue leases. The makeup of the lease portfolio has remained substantially the same from 1995 through 1997. In 1998, commercial leases increased significantly as the Corporation pursued business in this lending arena. Commercial leases at December 31, 1998 were 4.9% of total loans compared to 3.0% in 1997. Interest income from certain of the governmental leases is exempt from federal income taxes.
For the year, commercial loans increased by $37.34 million or by 20.55%. The most prominent type of financing remains hospitality and tourism related industries. Tourism related financing represents $60.27 million, or 27.5%, of the commercial loan portfolio. The growth represents a continual business development by the Relationship Bankers and their ability to penetrate growth markets such as Marquette and Sault Ste. Marie. The rest of the commercial loan portfolio is diversified in such categories as gaming, forestry, and farming.
Real estate lending on 1-4 family residences makes up the second largest portion of the loan portfolio. This past year, real estate loans grew by 1.96% or by $1.87 million to $97.42 million. Approximately 79% of these loans are adjustable rate products that have an annual interest adjustment. These loans typically have a maximum adjustment of two percentage points annually and five percentage points over the life of the loan. The Corporation has increased its mortgage banking activities in 1998 to maintain adequate asset/liability risk factors. Loans made and sold to the secondary market totaled $21.42 million compared to $6.75 million in 1997. These loans are sold but servicing is retained as it provides the Corporation with a source of noninterest income and a means of maintaining customer contact.
The other large portion of the loan portfolio is consumer loans. This segment of the loan portfolio represents $23.16 million dollars of the loan portfolio. In 1998, consumer loans dropped by $3.64 million or 13.57%. This represents the direction management has taken to minimize risk associated with consumer lending. Underwriting standards have become more strict to insure that credit risk is minimized.
This past year, the Allowance for Loan/Lease Losses reached 1.48% or $6.11 million. This represents a continual effort by management to provide for any loan/lease losses that may occur. Management's direction will be to continually focus on the Allowance so that the Corporation is properly reserved for the risk associated with the loan portfolio.
46.
Management's Discussion and Analysis of Financial Condition and Results of Operations
As mentioned in previous reports, the Corporation entered into a Settlement Agreement outside of the Bankruptcy Court proceedings on November 21, 1996 with Resort Funding, Inc. ("RFI"). Since this time covenants and payments on this credit have occurred as agreed. Taking in consideration the modest interest rate (3%) for the 24 months remaining, and the fact that payments are interest only with the principal due in two years, the loan to RFI has a present value of $3,257,939 as of December 31, 1998. The Bank has allocated $423,489 of its Allowance for Loan and Lease towards this credit. The financial strength of RFI was substantially upgraded in 1997 when a creditor converted $25 million of debt into stock of RFI. This gave RFI approximately $31 million of equity, reducing 1997 year-end debt-to-equity ratio of 27:1, down to 3:1. As of December 31, 1998, RFI has maintained its repayment schedule as agreed and has shown significant improvement in the overall financial condition of the Company. Management continues to monitor the credit regularly.
The Corporation's success in maintaining credit quality is demonstrated in the following table:
Management analyzes the allowance for loan losses in detail on a monthly basis to ensure that losses inherent in the portfolio are properly recognized. In addition to the input of lending officers, management uses an external loan review contractor to examine large commercial real estate, lease, and commercial loan relationships. An internal loan review function is also in place, with a primary objective of reviewing loans below the scope established by management for the external contractor.
Investments
During 1998, the Corporation's total investments decreased $1.53 million, from $10.10 million to $8.57 million. This decrease was primarily the result of an increase in the Corporation's outstanding loans. Because of the higher yield associated with funds invested in loans (as discussed above), management's desire is to maintain a minimum balance in the investment portfolio. The amount to be maintained will be the minimum which will allow us to meet our pledging requirements. Most of the portfolio is invested in U.S. Treasury and agency securities, which have little credit risk and are highly liquid. The Corporation classifies all securities as available for sale, in order to maximize our ability to react to changing market conditions.
47.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Deposits
Deposit growth has been a key element of the Corporation's expansion strategy. Total deposits at December 31, 1998, were $404.96 million, compared to $360.55 million at the end of 1997. Additional growth has occurred at branch locations opened in 1997 and 1998. The most significant impact on the growth of deposits is in the savings, money market and interest-bearing demand deposit category. This increase is directly attributable to the newly offered "Preferred Checking" account, which as of December 31, 1998, paid interest at a rate of 5.25% on balances over $10,000. Deposits over $100,000 consist primarily of stable, governmental balances, and balances from retail customers. There were no brokered deposits at December 31, 1998, and management has no current plans to solicit such deposits.
The Corporation is constantly looking for stable sources of deposits. One innovative approach is the premium-based certificate of deposit program. Customers can elect to receive one of several products in place of cash payments for interest on term certificates. The Corporation offers firearms, golf clubs, diamond jewelry, and grandfather clocks under these programs. The most successful and long-standing of the programs is the firearm program, which is offered to sportsmen nationally. Under this program, the Corporation records the cost of the product given as a discount from the face amount of the certificate of deposit and recognizes interest expense on the effective interest method over the life of the certificate. Total certificates of deposits outstanding under this program were approximately $1.63 million and $2.61 million at December 31, 1998 and 1997, respectively.
Another nontraditional source of deposits is the Corporation's CANSAVE program. CANSAVE accounts are savings accounts denominated in Canadian dollars. These accounts are offered in the Sault Ste. Marie banking offices and had total balances of $6.4 million in U.S. dollars at December 31, 1998. Such accounts are available only to Canadian citizens who are attracted to such accounts due to very low interest rates paid by domestic Canadian banks.
Borrowings
As previously discussed, the Corporation's branching network is a relatively high cost network in comparison to peer banking companies. Accordingly, the Corporation continues to use alternative funding sources to provide funds for lending activities. Other borrowings increased in 1998 with a balance of $23.27 million at the end of 1998, compared to $19.63 million in 1997. At December 31, 1998, $20.61 million of the borrowings were from the Federal Home Loan Bank of Indianapolis. From time-to-time, alternative sources of funding can be obtained at interest rates which are competitive with, or lower than, retail deposit rates and with inconsequential administrative costs. Management anticipates that such borrowings will continue to be a significant part of the overall funding mix of the Corporation.
Liquidity
The Corporation's sources of liquidity include principal payments on loans and investments, sales of securities available for sale, sales of loans held for sale, deposits from customers, borrowings from the Federal Home Loan Bank, other bank borrowings, and the issuance of common stock. The Corporation has ready access to significant sources of liquidity on an almost immediate basis. Management anticipates no difficulty in maintaining liquidity at the levels necessary to conduct the Corporation's day-to-day business activities.
48.
Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Summary
Earnings have continued to increase from 1997 to 1998 as a direct result of the Corporation's asset growth. Net income was $4.6 million, $4.1 million, and $2.8 million for 1998, 1997, and 1996, respectively. Net income for 1998 was 11.10% greater than in 1997, while assets grew by 11.85% over the same period. Basic earnings per share were $0.65 in 1998, $0.58 in 1997, and $0.43 in 1996, an increase of 12.07% in 1998. The increase in basic earnings per share is a result of the combination of the Corporation's continued earnings growth and improvements in operations in 1998, particularly at locations acquired over the past several years, and the repurchase of Corporation stock during 1998.
Net interest income is the primary source of earnings growth, increasing to $20.68 million in 1998, from $20.07 million and $16.05 million in 1997 and 1996, respectively. The majority of this increase is attributable to the increase in volume in the lending arena coupled with a decease in overall deposit rates. Noninterest income kept pace with the asset growth in 1998, increasing 61.82% to $2.65 million. A significant increase in service fee income from demand and savings products and an increase in gains on the sales of loans and investments accounted for the growth in 1998. This is a significant improvement over 1997 where noninterest income increased only slightly in comparison to 1996. Management feels income from noninterest sources will become a more significant component of the Corporation's earnings due to the expectation that the net interest margin may begin to decrease in the future due to competitive pressures. As a result of this expectation, management instituted policies in 1997 designed to maximize fees collected for services provided to customers.
The increase in noninterest expense to $16.60 million in 1998 from $14.80 million and $11.61 million in 1997 and 1996, only slightly exceeded total asset growth. The increase in noninterest expense was 12.20% compared to total asset growth of 11.85%. In 1997, noninterest expense increased 27.47% over 1996 compared to total asset growth of 14.78%. Management continues to focus on reducing noninterest expense in an effort to improve the efficiency of the Corporation's operations.
Net Interest Income
The Corporation continues to emphasize the lending function as a primary source of interest income. The decreasing rates in the lending arena in 1998 had a significant impact on the Corporation's net interest income and net interest margin. Net interest income as a percentage of total interest income was 53.7%, 55.8%, and 55.9%, in 1998, 1997, and 1996, respectively. Net interest margin was 5.34%, 5.63%, and 5.45%, for the same periods.
Interest income from loans represented 96.85% of total interest income in 1998, compared to 96.00% in 1997, and 93.25% in 1996. The total amount of interest income and the yield on total earning assets is heavily impacted by the results from lending activities. The yield on earning assets was 9.52%, 9.86%, and 9.53% in 1998, 1997, and 1996, respectively. This decrease was directly attributable to the declining rates in the lending area, with the yield on loans decreasing from 10.10% in 1997 to 9.71% in 1998.
49.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Total interest expense was $17.82 million in 1998, compared to $15.90 million and $12.67 million in 1997 and 1996, for an increase of 12.06% since 1997 and 40.56% since 1996. While other sources of funding are beginning to become an important part of the Corporation's funding strategy, interest expense on deposits still represented 92.79% of total interest expense in 1998. The yield on interest-bearing liabilities was 4.65%, 4.73%, and 4.56% in 1998, 1997, and 1996, respectively.
While overall cost of funds decreased, reflective of the declining rate environment, the costing side of the balance sheet has not declined in proportion to that of the earning side. This is apparent in the continued decrease or shrinking of the net interest margin. In response to the declining net interest margin, the Corporation intends to continue to focus on the origination of higher yielding loan products, in addition to reviewing current rates paid on deposit products in an effort to reduce interest expense. Both of the above mentioned steps would lead to an improved interest margin and, correspondingly, improved profitability.
Provision for Loan Losses
The Corporation maintains the allowance for loan losses at a level considered adequate to cover losses inherent in the portfolio. The Corporation records a provision for loan losses necessary to maintain the allowance at that level after considering factors such as loan charge-offs and recoveries, changes in the mix of loans in the portfolio, loan growth, and other economic factors more fully described in Note 1 to the accompanying consolidated financial statements. The reduction in the provision for loan losses to $1.20 million in 1998 is a result of stable net charge-offs and overall improvement in the quality of the loan portfolio. The decrease in the provision for loan losses, to $1.40 million in 1997 from $2.42 million in 1996, was primarily a result of settlement and restructuring of loans with the Bennett Funding Group (discussed above). The allowance for loan losses decreased in 1998 to 1.48% of total loans, compared to 1.50% at December 31, 1997.
Noninterest Income
Noninterest income was $2.65 million, $1.64 million, and $1.36 million in 1998, 1997, and 1996, respectively. The principal source of noninterest income is service charges on deposit accounts. In 1998, such fees were $1.48 million, a 21.18% increase over the amount recorded in 1997. In 1998, fees on deposit accounts kept pace with overall asset growth. This is an improvement over past years since the institutions acquired had lower fee structures than the Corporation. In 1997, management put into place controls and procedures to help ensure the Corporation maximizes its fees for services rendered. The increase noted above is the realization of these changes.
Noninterest Expense
Noninterest expense has steadily increased from 1996 through 1998. The increase since 1997 in this category was 11.36% for salaries and benefits and 9.67% for occupancy expenses. These increases were less than the Corporation's asset growth, over the same period, with a downward trend for annual increases over the three-year period ending December 31, 1998. While annual increases in these expenses are expected, a primary objective of management is to hold the rate of increase in these categories below future asset growth. Management believes that significant efficiencies have been obtained with further improvements coming in the future as management continues its outsourcing of back room operations.
50.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The Corporation underwent a significant internal restructuring process in 1997 and 1998. Management not only reduced total full-time equivalents by 50, but also centralized three key departments of the Corporation's sales and service environment: the credit department, the operations department and the call center. The result is a more focused and effective team built to serve its customer's needs. As a result of this process, the Corporation will be able to provide better customer service and have more cost-effective operations. This transition has effectively reduced total operating expenses of the Corporation in comparison to asset growth.
The application of purchase accounting to acquisitions created two intangible assets, the core deposit intangible and goodwill, which are being amortized as described in the notes to the consolidated financial statements. This expense did not exist prior to the acquisitions. The amortization of acquisition intangibles was $0.80 million in 1998, compared to $0.72 million in 1997 and $0.59 million in 1996.
Federal Income Taxes
The provision for income taxes is 17.54% of income before income tax in 1998, compared to 25.47% in 1997 and 16.09% in 1996. The difference between these rates and the federal corporate income tax rate of 34% is primarily due to tax-exempt interest earned on loans and investments.
INTEREST RATE AND FOREIGN EXCHANGE RATE RISK MANAGEMENT
Management actively manages the Corporation's interest rate risk. In the relatively low interest rate environment which has been in place the last few years, borrowers have generally tried to extend the maturities and repricing periods on their loans and place deposits in demand, or very short-term accounts. Management has taken various actions to offset the imbalance which those tendencies would otherwise create. In general, management tries to write commercial and real estate loans at variable rates or, when forced to offer fixed rates due to competitive pressures, write fixed rate loans for relatively short terms. Conversely, management has attempted to offer deposit products designed to steer depositors to longer periods. Management has generally been successful, with approximately 65% of loans repricing within one year and approximately 29% of certificates of deposit maturing over one year.
Beyond general efforts to shorten loan pricing periods and extend deposit maturities, management can manage interest rate risk by the maturity periods of securities purchased, selling securities available for sale, and borrowing funds with targeted maturity periods, among others. Also, the rate of interest rate changes can impact the actions taken since the speed of change affects various borrowers and depositors differently.
51.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Presented below is the Corporation's GAP table at December 31, 1998. This table treats all money market accounts (approximately $52 million) as immediately repriceable. Management considers the GAP acceptable.
The Corporation provides foreign exchange services, makes loans to, and accepts deposits from, Canadian customers primarily at its banking office in Sault Ste. Marie, Michigan. To protect against foreign exchange risk, the Corporation monitors the volume of Canadian deposits it takes in and then invests these Canadian deposits in Canadian commercial loans. As of December 31, 1998, the Corporation had excess Canadian liabilities of approximately $6.5 million (or $4.2 million in U.S. dollars). Management anticipates this spread to decrease in early 1999 as the Canadian loans are expected to increase faster than deposits. Management feels the exposure to short-term foreign exchange risk is minimal and at an acceptable level for the Corporation.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A derivative financial instrument includes futures, forwards, interest rate swaps, option contracts and other financial instruments with similar characteristics. The Corporation currently does not enter into futures, forwards, swaps or options. However, the Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Corporation. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions.
52.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Corporation until the instrument is exercised.
The Corporation's exposure to market risk is reviewed on a regular basis by the Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximize income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. Tools used by management include the standard GAP report and a simulation model. The Corporation has no market risk sensitive instruments held for trading purposes. At December 31, 1998 and 1997, it appears the Corporation's market risk is reasonable.
CAPITAL
It is the policy of the Corporation to maintain capital at a level consistent with both safe and sound operations and proper leverage to generate an appropriate return on shareholders' equity. Capital formation has been key to the Corporation's growth. During 1998, the Corporation raised $1.19 million in capital through the issuance of common stock. Net income exceeded cash dividends by $3.31 million in 1998, $2.92 million in 1997, and $1.92 million in 1996. In addition, $373,000, $355,000, and $254,000 of the cash dividends were reinvested in the Corporation through the dividend reinvestment program in 1998, 1997, and 1996, respectively. The issuance of shares, retained income, and the dividend reinvestment program increased shareholder's equity by $2.88 million since December 31, 1997 and $7.08 million since December 31, 1996. Management believes that significant demand for the Corporation's common stock exists in its market area, and that the capital required to take advantage of expansion opportunities is available in the local market, to the extent that such capital cannot be internally generated.
As a banking company, the Corporation is required to maintain certain levels of capital under government regulation. There are several measurements of regulatory capital and the Corporation is required to meet minimum requirements under each measurement. The Federal banking regulators have also established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action in the event an institution becomes financially troubled.
Regulatory capital is not the same as shareholders' equity reported in the accompanying consolidated financial statements. Certain assets cannot be considered assets for regulatory purposes. The Corporation's acquisition intangibles are examples of such assets.
53.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Presented below is a summary of the Corporation's consolidated capital position in comparison to regulatory requirements:
ISSUED BUT NOT YET ADOPTED ACCOUNTING POLICIES
See Note 1 to the accompanying consolidated financial statements for a discussion of accounting pronouncements issued by the Financial Accounting Standards Board which the Corporation is not required to implement until periods subsequent to December 31, 1998.
IMPACT OF INFLATION AND CHANGING PRICES
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and results of operations in historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Corporation's operations. Nearly all the assets and liabilities of the Corporation are financial, unlike industrial or commercial companies. As a result, the Corporation's performance is directly impacted by changes in interest rates, which are indirectly influenced by inflationary expectations. The Corporation's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its financial liabilities tends to minimize the effect of changes in interest rates on the Corporation's performance. Changes in interest rates do not necessarily move to the same extent as changes in the price of goods and services.
NEW DEVELOPMENTS
As briefly mentioned in the Letter to the Shareholders, the Corporation continues to seek and develop new and existing business opportunities. In the coming year, the Corporation will be engaging in the following exciting new developments:
The Corporation will be completing a Trust Preferred Stock offering in the amount of $15 million. Amounts raised through this offering will be used to support capital and growth of the Corporation.
54.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The Corporation will also finalize the formation of a new company in the Denver, Colorado area known as North Country Securities, Inc. This company will primarily be involved in the offering of municipal securities and municipal lease financing.
Completion of two branch acquisitions will also be finalized in 1999. The addition of the Kaleva and Mancelona branches will increase the Corporation's deposit base by approximately $20,000,000.
Finally, the Corporation will be entering into a partnership with a newly formed banking institution located in Grand Rapids, Michigan. As a 20% shareholder in this new venture, the Corporation will benefit in the long-term growth and earnings this investment can provide.
YEAR 2000 COMPLIANCE
Because many computerized systems use only two digits to record the year in date fields (for example, the year 1998 is recorded as 98), such systems may not be able to accurately process dates ending in the year 2000 and after. The effects of the issue will vary from system to system and may adversely affect the ability of a financial institution's operations as well as its ability to prepare financial statements.
Corporation management has developed and the Board of Directors has approved a comprehensive Year 2000 Compliance Plan. The plan consists of five phases: awareness, assessment, renovation, validation and implementation. The Corporation has an internal task force to assess Year 2000 compliance by the Corporation, its vendors, and major deposit and loan customers. In addition, the Bank has been contacting commercial borrowers about Year 2000 compliance to avoid any negative impact on the quality of the loan portfolio.
To date, the Corporation has spent approximately $225,000 on Year 2000 compliance and expect to spend an additional $500,000 to complete this work.
The Corporation presently anticipates that it will complete its Year 2000 assessment and remediation by April of 1999. However, there can be no assurance that the Corporation will be successful in implementing its Year 2000 remediation plan according to the anticipated schedule. In addition, the Corporation may be adversely affected by the inability of other companies whose systems interact with the Corporation to become Year 2000 compliant.
The Bank's core processing applications are provided by a third party vendor, LASCO Development Corporation (LASCO). The Corporation receives regular correspondence from LASCO which documents the status of their Year 2000 compliance. The Corporation has been advised that LASCO software has been successfully tested for Year 2000 compliance.
Although the Corporation expects its internal systems to be Year 2000 compliant as described above, the Corporation has prepared a contingency plan that specifies what it plans to do if important internal or external systems are not Year 2000 compliant in a timely manner.
Management does not anticipate that the Corporation will incur material operating expenses or be required to invest heavily in additional computer system improvements to be Year 2000 compliant. Nevertheless, the inability of the Corporation to successfully address Year 2000 issues could result in interruptions in the Corporation's business and have a material adverse effect on the Corporation's results of operations.
55.
Officers and Directors
NORTH COUNTRY FINANCIAL CORPORATION Michael C. Henricksen, Chairman Thomas G. King, Vice Chairman Ronald G. Ford, President and Chief Executive Officer Sherry L. Littlejohn, Executive Vice President, Chief Operating Officer and Treasurer Paulette M. Demers, Secretary
NORTH COUNTRY FINANCIAL CORPORATION BOARD OF DIRECTORS
CHARLES B. BEAULIEU Owner, Beaulieu's Funeral Home
C. RONALD DUFINA Balsam Shop, Inc., Ramas, Inc., HRD, Inc., Island Leasing, Inc., Mackinac Island Hospitality, Inc.
RONALD G. FORD President and Chief Executive Officer, North Country Financial Corporation, First Manistique Agency Corporation, First Northern Services Corporation, First Rural Relending Corporation Chairman and Chief Executive Officer, North Country Bank and Trust
STANLEY J. GEROU II Owner, Days Inn & Comfort Inn (Munising), Gerou Excavating
MICHAEL C. HENRICKSEN Owner, Satellite Services
THOMAS G. KING President of Top of Lake Investment Company
JOHN D. LINDROTH President, Superior State Agency, Inc.
JOHN P. MILLER Owner, Peoples Store Co., Inc.
BERNARD A. BOUSCHOR Tribal Chairman, Sault Tribe of Chippewa Indians
SHERRY L. LITTLEJOHN President and Chief Operating Officer, North Country Bank and Trust
56.
Officers and Directors
NORTH COUNTRY BANK AND TRUST Chairman, Ronald G. Ford, President and Chief Executive Officer, North Country Financial Corporation, First Manistique Agency Corporation, First Northern Services Corporation First Rural Relending Corporation; Chief Executive Officer, North Country Bank and Trust Vice Chairman, John D. Lindroth, President, Superior State Agency, Inc. Sherry L. Littlejohn, President and Chief Operating Officer, North Country Bank and Trust Robert Arfstrom, Owner, Arfstrom Pharmacy Paul W. Arsenault, Owner, Concepts Consulting Bernard A. Bouscher, Tribal Chairman, Sault Tribe of Chippewa Indians C. Ronald DuFina, Balsam Shop, Inc., Ramas, Inc., HRD, Inc., Island Leasing, Inc., Mackinac Island Hospitality, Inc. Stanley J. Gerou II, Owner, Days Inn & Comfort Inn (Munising), Gerou Excavating Michael C. Henricksen, Owner, Satellite Services Wesley Hoffman, Attorney, (Partner in the law firm of Barstow, Selsor, Hoffman) G. David Jukuri, Owner, Century 21 Agency Thomas G. King, Owner, President of Top of Lake Investment Company John P. Miller, Owner, Peoples Store Co., Inc. Richard A. Paidl, Manager- Stephenson Marketing Association
FIRST MANISTIQUE AGENCY CORPORATION Ronald G. Ford, President & CEO Sherry L. Littlejohn, Executive Vice President & COO Paulette M. Demers, Secretary-Treasurer
FIRST NORTHERN SERVICES CORPORATION Ronald G. Ford, President & CEO Sherry L. Littlejohn, Executive Vice President & COO Paulette M. Demers, Secretary-Treasurer
FIRST RURAL RELENDING CORPORATION Ronald G. Ford, President & CEO Sherry L. Littlejohn, Executive Vice President & COO Paulette M. Demers, Secretary-Treasurer
NCB REAL ESTATE COMPANY Ronald G. Ford, President & CEO Sherry L. Littlejohn, Executive Vice President & COO Paulette M. Demers, Secretary-Treasurer
COMMUNITY BANK BOARD DIRECTORS
Sault Ste. Marie Carol Brawley Edward Graves Theodore Haapala Anthony Bosbous Timothy Lukenda
Copper Country Robert Nara Lawrence Julio Glen Tolksdorf Dell Harma John Hawley Steve Vairo 57.
FINANCIAL AFFILIATES North Country Bank and Trust Sherry L. Littlejohn, President and Chief Operating Officer 906-341-8401 or 1-800-236-2219
SHAREHOLDER INFORMATION For information or to assist with questions, please contact Shirley Young at 906-341-8401 or 1-800-236-2219
DIVIDEND REINVESTMENT PLAN Shareholders may acquire additional shares of North Country Financial Corporation stock free of service charges. For information, please contact Shirley Young 906-341-8401 or 1-800-236-2219
STOCK TRANSFER AGENT For questions regarding transfer of stock, please contact Shirley Young at 906-341-8401 or 1-800-236-2219 or Registrar & Transfer Company at 1-800-866-1340
EXECUTIVE OFFICES 130 South Cedar Street P.O. Box 369 Manistique, Michigan 49854 906-341-8401
WORLD WIDE WEB SITE http://www.ncbt.com
58.
Exhibit 21 - Subsidiaries of Registrant
North County Bank and Trust - 100% owned Incorporated as a Michigan Banking Corporation 130 South Cedar Street Manistique, MI 49854
First Manistique Agency - 100% owned Incorporated as a Michigan Corporation 130 South Cedar Street Manistique, MI 49854
First Rural Relending Company- 100% owned Incorporated as a Michigan Corporation 130 South Cedar Street Manistique, MI 49854
Exhibit 23 - Consent of Independent Public Accountants
Indepedent Auditor's Consent
We consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 33-61533) of North Country Financial Corporation (f/k/a First Manistique Corporation) of our report dated January 29, 1999, relating to the consolidated balance sheet of North Country Financial Corporation and Subsidiares as of December 31, 1998, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year then ended, which report is included in the December 31, 1998, annual report on Form 10-K of North Country Financial Corporation and to the continued reference to our firm as experts in the prospectus which is a part of the Registration Statement.
/s/Wipfli Ullrich Bertelson LLP
Wipfli Ullrich Bertelson LLP
Appleton, Wisconsin March 29, 1999
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