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FBMI > SEC Filings for FBMI > Form 10-K on 11-Mar-2014All Recent SEC Filings

Show all filings for FIRSTBANK CORP

Form 10-K for FIRSTBANK CORP


11-Mar-2014

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The purpose of this section of the annual report is to provide a narrative discussion about Firstbank Corporation's financial condition and results of operations. Please refer to the consolidated financial statements and the selected financial data presented in this report in addition to the following discussion and analysis. We also encourage you to read our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission.

RESULTS OF OPERATIONS

Highlights

Firstbank Corporation ("We" or "the Company") had net income of $12.2 million for 2013 compared with $10.5 million in 2012, an increase of $1.7 million, or 16%. After payment of dividends on preferred stock, net income available to common shareholders was $11.8 million for 2013 compared with $9.3 million in 2012, an increase of $2.5 million or 27%. Core banking activities continued to provide a solid basis for earnings as net interest income was relatively constant, down $2.4 million from 2012. Lower loan loss provisioning was a key to the improved earnings, declining $5.9 million from a year ago to $1.8 million in 2013.

In June we redeemed the remaining $17 million outstanding preferred stock, at par from private investors.

In August, we announced our intention to merge the Company with Mercantile Bank Corporation in Grand Rapids. Shareholders from both companies voted on the combination, and overwhelmingly approved the merger transaction in December. We are actively planning for the merger as we await final regulatory approval to complete the transaction. As a result of activities associated with the planned merger, we incurred $871,000 of expenses during 2013.

Gain on the sale of mortgage loans at $4.4 million in 2013 continued to support earnings, although at a reduced level from $6.5 million in the prior year.

We achieved a return on average assets of 0.82%, 0.70%, and 0.38% for 2013, 2012, and 2011, respectively. Total average assets decreased $13 million in 2013, after having increased $10 million in 2012, and $1 million in 2011. Basic and diluted earnings per share were $1.46 and $1.45 in 2013 compared with, $1.17 and $1.16 in 2012, and $0.50 for both measures in 2011. Return on equity was 8.66% in 2013, 7.00% in 2012, and 3.75% in 2011.

Net Interest Income

Our core business is earning interest on loans and securities while paying interest on deposits and borrowings. In response to an economic recession in the United States, the Federal Reserve maintained overnight interest rates at historically low levels of 0.00% to 0.25% for a fifth consecutive year. While these low short term rates allow us to lower the rates we pay on certain deposit products, it also reduces the rates we are able to earn on variable rate loan products and rates charged on renewing fixed rate loans. The net interest spread, the difference between the interest rates charged on earning assets and the rate paid on interest bearing liabilities, was relatively stable throughout the year, although lower than the previous year, averaging 3.72%. We ended 2012 with a 3.77% net interest spread in the fourth quarter of 2012. As a result, our net interest margin decreased, ending the year with a net interest margin of 3.84% compared with 3.99% in 2012, and 4.06% in 2011. During 2013, our average loan to average deposit ratio was 79%, lower than the 80% in 2012 and 82% in 2011. The decreasing ratio is a result of both our efforts in attracting core deposits and declining loan balances. We maintain capital and funding capacity as well as a desire to expand lending; however, demand for quality loans in our local economies remains very soft at this time.

Net interest income decreased in 2013 by $2.4 million as our lower net interest margin and a slightly lower level of average earning assets combined to lower net interest income. Average interest earning assets decreased $1.4 million from 2012 levels. The decrease in average interest earning assets was largely a result of higher average balances in the investment portfolio, which rose by $10 million, $27 million decrease in average interest bearing deposits, and a $1.5 million decrease in average loan balances. A critical task of management is to price assets and liabilities so that the spread between the interest earned on assets and the interest paid on liabilities is maximized while maintaining acceptable levels of risk. While interest rates on earning assets and interest bearing liabilities are subject to market forces, in general and in the short run, we can exert more control over deposit rates than earning asset rates. However, competitive forces and the need to retain and grow deposits as a funding source place limitations on the degree of control over deposit rates. Average interest bearing liabilities decreased $29 million during the year, and the average rate paid on these liabilities fell by 19 basis points resulting in a decrease to interest expense of $2.2 million.

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The following table presents a summary of net interest income for 2013, 2012, and 2011.

Summary of Consolidated Net Interest Income

                             Year Ended December 31, 2013                  Year Ended December 31, 2012                  Year Ended December 31, 2011
(In Thousands of          Average                       Average         Average                       Average         Average                       Average
Dollars)                  Balance        Interest        Rate           Balance        Interest        Rate           Balance        Interest        Rate

Average Assets
Interest Earning
Assets:
Taxable securities     $     258,074     $   3,799          1.47 %   $     293,554     $   4,512          1.54 %   $     264,657     $   4,808          1.82 %
Tax exempt
securities(1)                100,618         2,595          2.58 %          54,796         1,774          3.24 %          40,273         1,719          4.27 %
Total Securities             358,692         6,394          1.78 %         348,350         6,286          1.80 %         304,930         6,527          2.14 %

Loans(1) (2)                 961,536        52,708          5.48 %         963,027        57,086          5.93 %         981,976        61,545          6.27 %
Federal funds sold               123             1          0.32 %             626             1          0.16 %             642             1          0.16 %
Interest bearing
deposits                      60,793           176          0.29 %          70,516           209          0.30 %          76,591           253          0.33 %
Total Earning Assets       1,381,144        59,279          4.29 %       1,382,519        63,582          4.60 %       1,364,139        68,326          5.01 %

Nonaccrual loans              11,940                                        19,097                                        22,623
Less allowance for
loan loss                    (20,638 )                                     (21,814 )                                     (21,650 )
Cash and due from
banks                         26,266                                        27,645                                        26,867
Other non-earning
assets                        88,558                                        92,568                                        97,758
Total Assets           $   1,487,270                                 $   1,500,015                                 $   1,489,737

Average Liabilities
Interest Bearing
Liabilities:
Demand                 $     354,877           662          0.19 %   $     344,363           801          0.23 %   $     319,053         1,306          0.41 %
Savings                      275,539           518          0.19 %         259,330           579          0.22 %         235,422         1,032          0.44 %
Time                         347,038         3,711          1.07 %         400,397         5,246          1.31 %         470,314         8,554          1.82 %
Total Deposits               977,454         4,891          0.50 %       1,004,090         6,626          0.66 %       1,024,789        10,892          1.06 %

Federal funds
purchased and
repurchase
agreements                    46,694            85          0.18 %          47,659            87          0.18 %          43,848            83          0.19 %
FHLB advances and
notes payable                 21,280           547          2.57 %          22,831           625          2.74 %          24,078           802          3.33 %
Subordinated
debentures                    36,084           658          1.82 %          36,084         1,068          2.96 %          36,084         1,197          3.32 %
Total Interest
Bearing
Liabilities                1,081,512         6,181          0.57 %       1,110,664         8,406          0.76 %       1,128,799        12,974          1.15 %

Demand Deposits              255,189                                       226,061                                       199,849
Total Funds                1,336,701                                     1,336,725                                     1,328,648

Other Non-Interest
Bearing
Liabilities                    9,364                                        12,755                                        11,024
Total Liabilities          1,346,065                                     1,349,480                                     1,339,672

Average
Shareholders' Equity         141,205                                       150,535                                       150,065
Total Liabilities
and Shareholders'
Equity                 $   1,487,270                                 $   1,500,015                                 $   1,489,737

Net Interest
Income(1)                                $  53,098                                     $  55,176                                     $  55,352

Rate Spread(1)                                              3.72 %                                        3.84 %                                        3.86 %

Net Interest Margin
(percent of Average
earning assets) (1)                                         3.84 %                                        3.99 %                                        4.06 %

(1) Presented on a fully taxable equivalent basis using a federal income tax rate of 35% for all periods presented.

Interest income includes amortization of loan fees of $1.9 million, $2.0
(2) million, and $1.8 million for 2013, 2012, and 2011, respectively. Uncollected interest on nonaccrual loans is not included

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The table below provides an analysis of the changes in interest income and interest expense due to volume and rate:

                                              2012/2013                                                 2011/2012

                                   Change in Interest Due to: (1)                             Change in Interest Due to: (1)

                         Average Volume        Average Rate       Net Change       Average Volume         Average Rate       Net Change
                                                                   (In Thousands of Dollars)

Interest Income:
Securities
Taxable Securities(2)   $           (537 )     $         (76 )   $       (613 )   $            393       $         (770 )   $       (377 )
Tax-exempt Securities              1,212                (491 )            721                  530                 (475 )             55
Total Securities                     675                (567 )            108                  923               (1,245 )           (322 )

Loans(2)                             (88 )            (4,290 )         (4,378 )             (1,171 )             (3,288 )         (4,459 )
Federal Funds Sold                    (1 )                 1                0
Interest Bearing
Deposits                             (28 )                (5 )            (33 )                  0                   37               37

Total Interest Income
on Earning Assets                    558              (4,861 )         (4,303 )               (248 )             (4,496 )         (4,744 )


Interest Expense:
Deposits
Interest Paying
Demand                                24                (163 )           (139 )                 97                 (602 )           (505 )
Savings                               35                 (96 )            (61 )                 96                 (549 )           (453 )
Time                                (645 )              (890 )         (1,535 )             (1,148 )             (2,160 )         (3,308 )
Total Deposits                      (586 )            (1,149 )         (1,735 )               (955 )             (3,311 )         (4,266 )


Federal Funds
Purchased and
Securities
Sold under Agreements
to Repurchase                         (2 )                 0               (2 )                  7                   (3 )              4
FHLB and Other Notes
Payable                              (41 )               (38 )            (79 )                (40 )               (137 )           (177 )
Subordinated
Debentures                             0                (410 )           (410 )                  0                 (129 )           (129 )

Total Interest
Expense on
Liabilities                         (629 )            (1,597 )         (2,226 )               (988 )             (3,580 )         (4,568 )

Net Interest Income     $          1,187       $      (3,264 )   $     (2,077 )   $            740       $         (916 )   $       (176 )

Changes in volume/rate have been allocated between the volume and rate
(1) variances on the basis of the ratio that the volume and rate variances bear to each other.
(2) Interest is presented on a fully taxable equivalent basis using a federal income tax rate of 35%.

In 2013, the average rate realized on earning assets was 4.29%, a decrease of 31 basis points from the 2012 results of 4.60%, and 72 basis points lower than the 5.01% realized in 2011. In 2008, in reaction to a weakening economy and a credit crisis in the financial markets, the Federal Reserve aggressively lowered rates by 2.25% between January and April bringing the prime rate down to 5.00%. After a six month pause in the rate reduction strategy, the Federal Reserve then lowered rates by another 1.75% in the fourth quarter with the prime rate settling at 3.25% at year end 2008, where it has remained through the end of 2013. Current language from the Federal Reserve indicates their intention to maintain this level of rates sometime into 2015. In addition, the Federal Reserve has also been purchasing longer term bonds in the open market in an effort to keep longer term rates low.

Average loans outstanding decreased $1.5 million in 2013 when compared with 2012. As of December 31, 2013, approximately 19% of the loan portfolio was comprised of variable rate instruments, compared with 22% as of the end of 2012. The remaining 81% of the loan portfolio is made up of fixed rate loans that do not re-price until maturity. Of the fixed rate loans approximately $90 million, or 11%, mature within twelve months and are subject to rate adjustments at maturity. At year end 2013, 87% of our variable rate commercial loan portfolio was protected by a floor compared with 92% at the end of 2012.

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During 2012 and 2013 maturing securities in the investment portfolio were replaced with securities of comparable quality bearing generally lower yields. As a result, maturing securities ran off from the investment portfolio at higher rates than comparable current offerings, decreasing the overall investment portfolio tax equivalent yield from 2.14% in 2011 to 1.80% in 2012 and 1.78% in 2013.

Average total interest bearing deposits for the year decreased $27 million. The average rate paid on interest bearing liabilities was 0.57% in 2013, compared to 0.76% in 2012, and 1.15% in 2011. Deposit rates decreased during 2012 and 2013 with the soft economy. Average rates paid on time deposits decreased 24 basis points in 2013 compared with 2012 and 75 basis points compared with 2011, as new and renewing deposits re-priced to lower rates. Rates on checking and savings deposits also decreased in 2013, falling four basis points and three basis points, respectively. These same rates were 22 basis points and 26 basis points lower in 2013 than they had been in 2011.

Brokered CDs are more sensitive to changes in the interest rate than CDs offered in local markets and have been issued with original maturities ranging from three months to two years. The average balance of brokered CDs in 2013 was $17 million, compared with $18 million in 2012 and $15 million in 2011. These CDs carried an average interest rate of 0.62% in 2013 compared with 0.69% in 2012, and 0.88% in 2011.

We fund a portion of our loan portfolio with borrowings from the Federal Home Loan Bank (FHLB). During 2013, the average outstanding balance of FHLB advances decreased $1.6 million and year-end balance decreased $2.7 million when compared with 2012 balances. While FHLB borrowings are one method of funding loans when core deposits are not available, the cost is typically higher than our core deposit costs. As core deposit funding has increased and loan demand decreased, we have been able to reduce our reliance on this source of funding. The 2013 average rate paid for Federal Home Loan Bank advances and notes payable was 2.57%, 17 basis points lower than 2012's rate of 2.74%. Subsequent to year end we prepaid approximately $6.8 million in FHLB Advances, incurring a prepayment penalty of $1.3 million.

In July of 2007, we issued $15.5 million in subordinated debentures to fund a portion of the ICNB acquisition. That issuance was split evenly between debentures that carry a fixed rate of 6.566% for five years, and variable interest rate debentures that carry a rate of 90 day LIBOR plus 1.35%. During 2012 the fixed rate debentures converted to variable rate debentures that carry a rate of 90 day LIBOR plus 1.35%. In January of 2006, we issued $10.3 million in subordinated debentures that carried a fixed rate of 6.049% for five years. During 2011 this issuance converted to a variable interest rate of 90 day LIBOR plus 1.27%. In October of 2004, we issued $10.3 million in subordinated debentures, at a variable interest rate of 90 day LIBOR plus 1.99%. The average rate paid on all subordinated debentures during 2013 was 1.82% compared with 2.96% and 3.32% in 2012 and 2011, respectively. All of the variable rate debentures re-price quarterly.

We utilize short term borrowing, made up of Federal Funds Purchased and Repurchase Agreements as a source of liquidity and to balance our daily cash needs. Average short term borrowed funds decreased by $1 million when 2013 is compared with 2012.

The 2013 interest rate spread of 3.72% is 12 basis points lower than the 2012 spread of 3.84%, and 14 basis points lower than the 2011 spread of 3.86%. Tax equivalent net interest income decreased $2.1 million in 2013 as a decrease in total average earning assets of $1.4 million and a 15 basis point decline in the net interest margin decreased earnings. The net interest margin of 3.84% for 2013 was 15 basis points below 2012 and 22 basis points lower than 2011. The decrease in the rate spread in 2013 was the result of rates on average earning assets decreasing 31 basis points while the average cost of interest bearing liabilities decreased 19 basis points. The 15 basis point decrease in the net interest margin was attributable to these same metrics. Average earning assets represented 93% of total average assets in 2013 compared with 92% in 2012 and 91% in 2011.

Provision for Loan Losses

In accordance with accounting standards, we allocate a portion of the allowance to loans that we determine to be impaired. We analyze other loans and current market conditions on a pool basis in order to arrive at the appropriate allowance for loan losses. If a loan for which allocations had been established pays off, or the risk of loss is otherwise reduced, we reverse those specific allocations. The methodology described above resulted in a provision for loan losses in 2013 of $1.8 million, compared with $7.7 million in 2012, and $13.3 million in 2011. These provision charges, which exceed pre-recession levels, were incurred as struggling borrowers resulted in new problem loans for which either allocated reserves were established for probable losses, or loans were charged off during the year.

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During 2013, we had recoveries of previously charged off loans totaling $871,000, and favorable outcomes on certain previously identified problem loans, reducing the amount of provision expense needed, while deterioration of certain loans to problem status and charge offs of $6.0 million increased the amount of provision expense needed. In 2012, we had recoveries of previously charged off loans totaling $1.1 million and favorable outcomes on certain previously identified problem loans, reducing the amount of provision expense needed, while deterioration of certain loans to problem status and charge offs of $8.4 million increased the amount of provision expense needed.

At December 31, 2013, the allowance for loan losses as a percent of total loans was 1.82% compared to 2.21% and 2.14% at December 31, 2012, and December 31, 2011, respectively. Total nonperforming loans (including performing restructured loans) were 3.12% of ending loans at December 31, 2013, compared to 3.78% and 4.27% at the two previous year ends. The decrease in the ratio in 2013 was due to a decrease in nonaccrual loans of $6 million. Loans 90 days past due and restructured loans were unchanged from the prior year end. All loans reported as restructured are current or less than 90 days past due and conforming to the agreed upon restructured terms of the loan. The decrease in the nonperforming ratio in 2012 was due to a decrease in nonaccrual loans of $7 million, a reduction in 90 day past due loans of $0.4 million, which were partially offset by an increase in restructured loans of $2 million.

Net charged off loans totaled $5.2 million in 2013 compared to $7.4 million in 2012, and $13.7 million in 2011. Net charged off loans as a percent of average loans were 0.53% in 2013, 0.75% in 2012, and 1.37% in 2011. Charge offs of $932,000 in 2013 had specific reserves established in a prior year, while in 2012 and 2011, $1.7 million and $3.9 million, respectively, of specific allowance allocations had been set aside at the end of the prior year. Provision expense did not need to be increased to cover those previously identified losses.

Non-interest Income

Non-interest income decreased by $1.9 million when 2013 is compared with 2012. Affecting the results in 2013 were gains on the sale of mortgages, which were down $2.1 million, service charges on deposit accounts which decreased $83,000, and a decrease in other income of $304,000. Partially offsetting these items were increases in gain on sale of securities of $290,000, and increases in mortgage servicing income of $294,000. Comparing 2012 to 2011 non-interest income increased by $3.0 million. Affecting the comparison in 2012 were gains on the sale of mortgages, which were up $2.8 million, and other income which increased $652,000. Partially offsetting these items was a decrease in service charges on deposit accounts of $273,000 and a decline in mortgage servicing income of $320,000.

Gains on the sale of mortgage loans decreased $2.1 million when comparing 2013 to 2012. Steady demand for re-financing of existing mortgage loans gave way in the latter half of 2013 as rates moved higher slowing the pace of gains. Gains on the sale of mortgage loans increased $2.8 million in 2012 compared with 2011. The low interest rate environment during 2012 pushed mortgage rates to record lows during the year, spurring a high level of refinance activity. In 2011, new regulatory requirements and onerous conditions placed on the sale of loans in the secondary market resulted in lower gains on the sale of loans. By midyear 2011, rates had fallen once again to the point where refinance activity picked up and the second half of the year generated higher gains

Mortgage servicing rights, net of amortization, increased from a negative $231,000 in 2012 to a positive $63,000 in 2013 as amortization and write downs of servicing rights due to the high level of refinancing receded during the year. When a mortgage is refinanced or pre-paid, capitalized mortgage servicing rights relating to that mortgage are written off, with the write off amounts included in the amortization cost of servicing rights. Comparing 2012 to 2011, mortgage servicing rights, net of amortization, declined from $89,000 in 2011 to a negative $231,000 in 2012 as amortization and write downs of servicing rights due to the high level of refinancing negatively affected this line item. The higher level of refinance activity in 2012 compared with 2011 resulted in $605,000 more of servicing rights reversals. Income from servicing loans increased by $285,000 during 2012, partially offsetting the higher servicing rights expense.

Deposit account service charges declined $83,000 in 2013 to $4.1 million, stabilizing somewhat compared to the prior year. Deposit account service charges declined $273,000 from $4.5 million in 2011 to $4.2 million in 2012. Changing customer behavior associated with new regulations regarding overdraft charges put in place mid-year 2011 resulted in lower fees collected.

During 2013 we booked $334,000 in gains on securities transactions compared with $44,000 during 2012. These gains are ancillary income from our available for sale securities portfolio. During 2013, we liquidated a position in FHLMC preferred stock that had previously been written down and had recovered some of its value. Comparing 2012 to 2011, we recorded $44,000 in securities gains in 2012 compared with a loss on securities of $37,000 the prior year. The gains in 2012 and losses in 2011 resulted from routine securities transactions during the year.

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Other income decreased $304,000 in 2013 to $1.8 million. Within the category of other income, gains on the sale of other real estate owned decreased by $47,000, and in 2012 we recorded $178,000 non-recurring item relating to a director benefit plan. Comparing 2012 to 2011, other income increased $652,000 from $1.5 million in 2011 to $2.1 million in 2012, primarily due to higher gains on the sale of other real estate owned, which improved by $389,000, and other income increased $263,000 primarily due to a $178,000 non-recurring item relating to a director benefit plan. Gains on the sale of other real estate owned were $436,000 in 2013, $484,000 in 2012, and $95,000 in 2011.

Non-interest Expense

Total non-interest expense was $43.7 million in 2013 compared with $44.7 million in 2012 and $43.6 million in 2011. Within non-interest expense, salaries and benefits increased $601,000, merger related expenses were $871,000, while other real estate owned expenses decreased $1.1 million and other non-interest expense decreased $958,000. Comparing 2012 to 2011, salaries and benefits increased $1.4 million and other non-interest expense increased $1.7 million, while other real estate owned expense decreased $1.5 million.

Salary and employee benefits expenses increased $601,000 in 2013 from $22.7 million in 2012 to $23.3 million in 2013. Within this line item, benefits costs increased $194,000, variable compensation expense increased $128,000, and base salaries increased $279,000.

Salary and employee benefits expenses increased $1.4 million in 2012 from $21.3 million in 2011 to $22.7 million in 2012. Within this line item, benefits cost increased $131,000, variable compensation expense increased $711,000, and base salaries increased $575,000, or 3.6%. The company's improved performance resulted in higher payments under the variable compensation plan.

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