Item 1. Business
General
Pinnacle Financial Services, Inc. ("Pinnacle") is a registered bank holding company that was organized under the laws of the State of Michigan in 1986 in connection with the June 30, 1986 reorganization of Pinnacle Bank, a Michigan state banking corporation then known as "Peoples State Bank of St. Joseph" ("Pinnacle Bank"), into a wholly-owned subsidiary of Pinnacle. Pinnacle's principal executive offices are located at 830 Pleasant Street, St. Joseph, Michigan 49085, and its telephone number is (616) 983-6311.
Pinnacle Bank, which is headquartered in St. Joseph, Michigan, currently operates through 14 branch offices located throughout southwestern Michigan, 30 branch offices located throughout northwestern Indiana, and 2 loan production offices located in Merrillville and Indianapolis, Indiana.
Through Pinnacle Bank, Pinnacle offers financial service products which include domestic banking services such as consumer, commercial and real estate loans, personal and business checking accounts, savings accounts, time deposits, safe deposit services, cash management services, and transmission of funds, as well as trust and other fiduciary services, full-service brokerage services and insurance products. Commercial customers include retailers, commercial developers, professionals, and small manufacturers. Retail customers cover a broad spectrum with focus on providing personalized, high quality and comprehensive service in order to develop and maintain long-term, multiple account relationships with customers.
Pinnacle's market, which is adjacent to metropolitan Chicago, Illinois and is bisected by Interstate 94 (the primary highway between Chicago and Detroit), currently consists of northern Indiana and southwestern Michigan. The region's location has facilitated the development of a diverse economy based primarily on manufacturing, service and agriculture. The region's proximity to Chicago and the southeastern expansion of metropolitan Chicago into Lake County, Indiana, have led to significant commercial and residential development and a strong second-home housing market. The region's popularity as a year-round recreational area also has led to tourism-driven economic growth.
Pinnacle had $2.1 billion in total assets as of December 31, 1997. Pinnacle returned 0.48% on average assets for the year ended December 31, 1997. This compares to 0.83% and 1.15% for each of the years in the two year period ended December 31, 1996. For the year ended December 31, 1997, Pinnacle's return on average equity was 5.83%. Annual returns on average equity since 1993 have ranged from 5.83% to 13.87%.
Pinnacle believes its success is in part attributable to a growth strategy that, since the beginning of 1993, has (i) increased assets by more than 86% (with total assets growing to $2.1 billion by December 31, 1997), and (ii) increased loans by more than 94% (with total loans growing to approximately $1.5 billion at December 31, 1997). Pinnacle's loan to deposit ratio was approximately 105.3% at December 31, 1997. Pinnacle's growth has been generated internally through customer retention and cross-selling programs and externally through acquisitions. Since 1988, Pinnacle has consummated seven acquisitions, four of which involved thrifts.
Merger Agreement with CNB Bancshares, Inc.
Pinnacle has entered into an Agreement and Plan of Merger dated as of October 14, 1997 (the "CNB Merger Agreement"), with CNB Bancshares, Inc., an Indiana corporation ("CNB"), pursuant to and subject to the terms and conditions of which Pinnacle would be merged with and into CNB. The CNB Merger Agreement is subject to, among other conditions, approval by the respective shareholders of Pinnacle and CNB. As an inducement for CNB to enter into the CNB
Merger Agreement, Pinnacle entered into a Stock Option Agreement dated as of October 14, 1997, pursuant to which Pinnacle granted to CNB the right to purchase from Pinnacle, under the terms and conditions provided therein, at a purchase price of $37.00 per share, up to 2,000,000 shares of Pinnacle Common Stock (subject to adjustment in certain circumstances), which constituted approximately 16.2% of the issued and outstanding shares of Pinnacle Common Stock as of the date of the CNB Merger Agreement, without giving effect to the exercise of said purchase option.
Strategies to Achieve Growth
Acquisitions. In recent years, Pinnacle's growth has occurred primarily through mergers and acquisitions. Since its formation as a bank holding company in 1986, Pinnacle has successfully integrated seven significant acquisitions. In February 1988, Pinnacle acquired $37 million in assets and assumed certain liabilities of First State Bank of White Cloud, which thereafter became a branch office of Pinnacle Bank. In December 1990, the majority of the assets of Pinnacle's White Cloud branch office were sold to, and the liabilities associated with that branch office were assumed by, another unaffiliated bank. In February 1990, the Resolution Trust Corporation transferred to Pinnacle $84 million in assets and certain liabilities of the insolvent Peoples Savings Association of St. Joseph, Michigan. In December 1992, Pinnacle acquired all of the outstanding stock of Harbor Country Banking Company of Three Oaks, Michigan, an $82 million state bank.
On December 1, 1995, Pinnacle acquired all of the outstanding capital stock of Maco Bancorp, Inc., a Delaware corporation and a registered savings and loan holding company ("Maco"), through the merger of Maco with and into Pinnacle (the "Maco Acquisition"). As a result of the Maco Acquisition, Pinnacle became the sole stockholder of First Federal Savings Bank of Indiana, a federal savings bank that was renamed "Pinnacle Bank" in 1996 and was merged with and into Pinnacle Bank effective December 31, 1996, and Mr. Cyrus A. Ansary, sole shareholder of Maco, became the largest single Pinnacle stockholder. Mr. Ansary currently holds approximately 9.4% of the shares of Pinnacle Common Stock outstanding.
Effective as of August 1, 1997, Indiana Federal Corporation, a Delaware corporation ("IFC"), and CB Bancorp, Inc., a Delaware corporation ("CB"), were merged with and into Pinnacle, with Pinnacle being the surviving corporation. Coincident with those mergers, Indiana Federal Bank for Savings, a subsidiary of IFC with assets of $835 million, and Community Bank, A Federal Savings Bank, a subsidiary of CB with assets of $288 million, were merged with and into Pinnacle Bank, with Pinnacle Bank being the surviving corporation.
As a result of these acquisitions and growth generated by its own operations, Pinnacle's assets increased from $231 million at the beginning of 1990 to $2.1 billion at December 31, 1997.
On October 14, 1997, Pinnacle entered into the CNB Merger Agreement. The CNB Merger Agreement contemplates the merger of Pinnacle with and into CNB, with CNB being the surviving entity. The transaction is expected to qualify as "pooling-of-interests" for accounting and financial reporting purposes. Consummation of the transaction is subject to shareholder approval.
Customer Development. Pinnacle believes that it can increase profitability by expanding the number and types of accounts and relationships with its existing customers. To achieve that goal, Pinnacle is continuing to explore technologies that facilitate cross-selling of financial products to existing customers and deliver services more efficiently. In 1995 Pinnacle initiated a telephone marketing program utilizing personnel trained to survey customer satisfaction and needs and to cross-sell additional products offered by it.
Customer Retention. Pinnacle focuses on providing personalized, high quality and comprehensive service in order to develop and maintain long-term, multiple account relationships with customers. Through its subsidiaries, Pinnacle offers a wide range of banking services, including consumer, commercial and real estate loans, personal and business checking accounts, savings accounts, time deposits, safe deposit services, cash management services, and transmission of funds, as well as trust and other fiduciary services, and full-service brokerage services and insurance products. To facilitate the retention of customers, Pinnacle has designed and implemented a system of quality controls and initiatives known as its "Quality in the Banking Environment" program.
Pinnacle utilizes alternative delivery systems that include electronic funds transfer systems (such as direct deposit of payroll services and ATMs) and telephone banking systems. Pinnacle is also expanding its delivery of financial services in non-traditional settings. Pinnacle Bank has also established full-service branch offices in supermarkets located in Stevensville, Michigan, and Portage and Valparaiso, Indiana.
Pinnacle has attempted to increase customer convenience, and thereby increase customer loyalty, through, among other things, enhanced financial services, extended banking hours, and the development of products targeted to the needs of particular segments of its customer base. For example, some of Pinnacle's branch offices now offer Saturday lobby hours. Pinnacle has also developed a low-cost basic checking service, private banking services, commercial cash management services, and special products targeted to the senior citizen market. Finally, Pinnacle now offers its customers full-service brokerage services that include a wide range of investment opportunities and a combination of research and financial planning that are suited to individual customer needs.
Lending Practices
Loan Portfolio. In accordance with its loan policies, Pinnacle strives to maintain a diversified loan portfolio. The following table presents loans outstanding according to loan category at December 31 of each year.
The following table presents loans outstanding at December 31, 1997, which, based on remaining scheduled repayments of principal, are due in the period indicated.
The following table sets forth at December 31, 1997, the dollar amount of gross loans receivable contractually due after December 31, 1998, and whether such loans have fixed interest rates or adjustable interest rates.
The following table presents information concerning certain nonperforming loans at December 31 of each year.
- ------------------------ (1) Loans are generally placed on a nonaccrual basis when, in the opinion of management, collection of principal or interest payments is unlikely. Income on such loans is then recognized only to the extent that cash is received and where future collection is likely. If nonaccrual loans had been maintained current in accordance with their original terms, additional interest income of $840,000, $1,100,000, $449,000, $207,000, and $149,000 would have been recorded during the years ended December 31, 1997, 1996, 1995, 1994, and 1993, respectively.
Pinnacle closely monitors other loans of concern, which are loans now current (i.e., not included in non-accrual and past-due loan disclosures above) but where doubts exist as to the ability of the borrower to comply with present loan repayment terms. These loans totaled approximately $21.5 million at December 31, 1997 and approximately $11.1 million at December 31, 1996. The classification of these loans, however, does not mean that Pinnacle's management expects losses on these loans. Such classification relates to specific concerns relating to each individual borrower and does not relate to any concentrated risk elements common to all the loans. The increase in such loans during 1995 is attributable to the Maco Acquisiton. Pinnacle has no loans for which the terms have been renegotiated to less than market rates due to weakening of a borrower's financial condition.
Pinnacle's loans outstanding to borrowers in foreign countries as of December 31, 1997, 1996 and 1995 did not exceed 1% of its total assets. As of December 31, 1997, 1996 and 1995 Pinnacle had no concentrations of loans to individual borrowers that exceeded 10% of total loans.
COMMERCIAL LOANS. Through 15 experienced lending officers, Pinnacle provides cash management services and secured and unsecured loans for business purposes to individuals, companies and governmental units primarily within southwestern Michigan and northern Indiana.
Pinnacle originates commercial loans for general business purposes, including working capital requirements, inventory and accounts receivable financing, and fixed asset financing for various equipment and plant expansions. Pinnacle's commercial customers include, among others, professionals, durable-goods manufacturers, service-related companies and retail establishments.
Pinnacle also originates mortgage loans for the acquisition and refinancing of commercial real estate properties. The majority of Pinnacle's commercial real estate loans are secured by first liens on office buildings, small retail establishments and small manufacturing facilities located in its primary market area.
Although conditions vary from loan to loan, commercial loans for working capital purposes are typically written for less than one year and renewals are reviewed on an annual basis. Loans provided for non-real estate fixed assets generally have terms between four and six years and are fully amortizing over the period. Commercial real estate loans are generally written with a three to five year term with payments typically amortizing over 15 years. In addition to a first lien on the
collateral asset, Pinnacle seeks to secure its loans by obtaining a security interest in all of the other assets of the borrower's business, an assignment of rents, if applicable, and personal guaranties. Commercial real estate loans generally have interest rates which are set at a regional national bank's prime rate plus a margin and which adjust each time the designated prime rate adjusts. Pinnacle also encourages commercial real estate borrowers to open or maintain a deposit account at Pinnacle to facilitate the automatic withdrawal of the loan payment based on the terms of the loan.
Pinnacle evaluates all aspects of commercial loan transactions in order to mitigate risk to the extent possible. In underwriting these loans, consideration is given to the stability of the borrower's cash flow and operating history, future operating projections, comparable financial ratios for like businesses, and collateral asset evaluations. The underwriting analysis also includes credit checks and a review of the financial condition of the borrower and guarantor, if applicable. A narrative appraisal report is prepared by an appraiser who is either a member of the Appraisal Institute or state-certified and commissioned by Pinnacle to substantiate property values for substantially all commercial real estate loan transactions.
Commercial real estate lending entails more risks than single-family residential lending because such loans typically involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower's business. These risks can also be significantly affected by supply and demand conditions in the local market for retail establishments, offices or other commercial space. Pinnacle attempts to minimize its risk exposure by limiting such lending to proven business owners, and considering properties with an existing operating performance which can be analyzed, and continually monitoring the financial condition of the borrower and the operation and physical condition of the collateral.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LOANS. Pinnacle originates loans secured by first lien mortgages on completed one- to four-family residences in its market area for retention in its portfolio, if the loan has an adjustable rate of interest, and for sale in the secondary market, if the loan has a fixed rate of interest. Pinnacle originates fixed-rate and adjustable-rate residential mortgage loans with terms of up to 30 years; although a large number of the loans held in its portfolio have maturities that are less than the contractual terms due to prepayments, due-on-sale clauses and bi-weekly payments.
The adjustable-rate mortgages currently offered by Pinnacle have interest rates which adjust commencing on the first, third or fifth anniversary of the loan, and are based upon an index tied to the weekly average yield on U.S. Treasury securities (adjusted to a constant comparable maturity), as made available by the Federal Reserve Board, plus a margin.
When Pinnacle sells the residential loans it has originated, it may either retain or sell the rights to service those loans and to receive the related fees. Pinnacle currently receives servicing fees ranging generally from 0.25% to 0.375% per annum on its mortgage loan servicing portfolio. While the aggregation of a servicing portfolio can create a substantial continuing source of income, there is an active market for mortgage loan servicing rights (which are generally valued in relation to the present value of the cash flow generated by the servicing rights). Subject to market conditions, Pinnacle currently plans to increase the size of its mortgage loan servicing portfolio by retaining some servicing rights associated with wholesale residential loan purchases, making bulk purchases of servicing rights and increasing retained servicing rights on residential loans it originates.
MORTGAGE REPURCHASE PROGRAM. Pinnacle has entered into agreements with mortgage companies in which Pinnacle purchases, at its discretion, mortgage loans from mortgage companies at par, net of certain fees, and later sells them back to the mortgage companies at the same amount and without recourse provisions. Pinnacle records interest income on the loans during the funding period and records fee income (recorded as noninterst income) received from the mortgage company for each loan when resold. The interest income recorded is based on a rate of interest tied to the prime rate (as established from time to time) during the funding period, and not the rates based on individual loans. Such loans are reveiwed, prior to purchase, for evidence that the loans are of secondary market quality or meet internal underwriting guidelines. An assignment of the mortgage to Pinnacle is required. In additon, Pinnacle either takes possession of the original note and forwards such note to the end investor or Pinnacle receives a certified copy of the note and subsequently receives acknowledgment from the end investor of receiving the original note.
CONSUMER LOANS. Pinnacle originates consumer loans, which are primarily for personal, family or household purposes, in order to provide a wide range of financial services to its customers. Consumer loans made by Pinnacle include home equity lines of credit, home improvement loans, and loans to finance the purchase of new and used automobiles and boats. Pinnacle makes unsecured consumer loans on a case-by-case basis based upon a detailed review of the applicant's credit history. Pinnacle has begun purchasing home equity loans from correspondents located outside of its southwestern Michigan and northern Indiana market areas. Pinnacle also purchases retail installment loans from certain automobile dealerships in its market areas.
Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans and, except for the home equity lines of credit, usually involve more credit risk than mortgage loans because of the type and nature of the collateral. These loans are generally repaid on a monthly repayment schedule with the source of repayment tied to the borrower's periodic income. In addition, consumer lending collections are dependent on the borrower's continuing financial stability, and are thus likely to be adversely affected by job loss, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. Pinnacle believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and that consumer loans are important to its efforts to serve the credit needs of the communities and customers that it serves. Pinnacle's consumer loan lending territory approximates the markets served by its retail branches. Consumer loan customers are typically individuals who have a pre-existing banking relationship with Pinnacle.
ALLOWANCE FOR LOAN LOSSES. An allowance for loan losses is maintained at a level that management of Pinnacle considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Allowances for loan losses are based on estimated net realizable value, unless it is probable that loans will be foreclosed, in which case allowances for loan losses are based on fair value. The allowance is reviewed by management on a monthly basis and its evaluation is based upon examination of the portfolio, past loss experience, the level and trends of classified assets, the current level of the allowance as it relates to non-performing loans, the current level of provisions for loan losses and how such levels relate to total loans receivable, net, non-performing loans and recent and projected charge-offs, current economic conditions, the results of the most recent regulatory examinations and other relevant factors. While management of Pinnacle uses its best efforts to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations.
LOAN LOSS EXPERIENCE. The following table summarizes the loan loss experience and provides a breakdown of the allowance for loan losses at December 31, of each year.
The allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the above categories of loans at the dates indicated. The allowance is based on management's periodic evaluation of the loan portfolio and reflects an amount that, in management's opinion, is adequate to absorb losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior loan loss experience, the composition of the loan portfolio and management's evaluation of the probability of collection of specific loans.
INVESTMENT ACTIVITIES
GENERAL. Financial institutions such as Pinnacle have authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various Federal agencies and of state and municipal governments, certificates of deposit at federally-insured banks and savings and loan associations, certain bankers' acceptances and Federal funds. Subject to various restrictions, Pinnacle may also invest a portion of its assets in commercial paper, corporate debt securities and mutual funds (so long as the assets of such mutual funds conform to the investments that financial institutions such as Pinnacle are otherwise authorized to make directly).
Pinnacle's investment securities are comprised of securities held-to-maturity and securities available-for-sale. Securities which management believes could be sold prior to maturity in order to manage interest rate risk, prepayments,
liquidity risk, or other corporate purposes are classified as securities available-for-sale and are carried at fair value with unrealized gains and losses, net of applicable income taxes, reported as a component of stockholders' equity. Securities, other than the foregoing, which management has the ability and positive intent to hold until maturity, are classified as securities held-to-maturity and are accounted for using historical amortized cost. Pinnacle has no trading account securities.
INVESTMENT PORTFOLIO. At December 31, 1997 and 1995, Pinnacle did not have any securities held-to-maturity. The following table presents the amortized cost basis of securities held-to-maturity as of December 31, 1996.
On December 1, 1995, securities held-to-maturity including those securities acquired from First Federal were reclassified to available-for-sale pursuant to the FASB issuance of "A Guide to Implementation of Statement 115" that allowed entities to reassess the appropriateness of the reclassification of all securities.
On August 1, 1997, securities held-to-maturity were reclassified to available-for-sale upon consummation of the CB merger to conform to Pinnacle's classification of investment securities. At the date of transfer, the securities has amortized cost and net unrealized gain of $14.0 million and $200,000, respectively.
The following table presents the carrying value of securities available-for-sale at the dates indicated.
The following table summarizes the maturities of securities available-for-sale at the date indicated and the weighted yield of such securities:
SOURCES OF FUNDS
GENERAL. Pinnacle's principal source of funds for use in lending and for other general business purposes has traditionally come from deposits obtained through the branch offices of its subsidiary. Pinnacle also derives funds from the proceeds from operations, the sale of residential mortgage loans in the secondary market, and the amortization and prepayments of outstanding loans and mortgage-related securities. Pinnacle also borrows from the Federal Home Loan Bank of Indianapolis.
DEPOSITS. Pinnacle's current deposit products include savings accounts, checking accounts, money market deposit accounts and certificates of deposit ranging in terms from 14 days to ten years. Pinnacle's deposits are obtained primarily from residents in southwestern Michigan and northern Indiana. Pinnacle attracts deposit accounts by offering a variety of accounts, competitive interest rates, and convenient branch office locations and service hours. Pinnacle primarily utilizes direct mail, newspaper and radio advertising to attract new customers and deposits, but Pinnacle does not solicit brokered deposits.
The following table presents a breakdown by category of the average amount of deposits (all in domestic offices) and the average rate paid for the periods indicated.
Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1997 are summarized as follows:
BORROWINGS. Pinnacle borrows from time to time for short-term funding purposes. At December 31, 1997, total borrowings by Pinnacle were $483.9 million. Pinnacle has entered into an agreement which enables it to borrow funds from the Federal Home Loan Bank of Indianapolis that are collateralized by a blanket agreement on all unpledged assets equal to the amount of current assets. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities, and are generally available to fund loans held for sale and to meet seasonal and other withdrawals of deposit accounts. At December 31, 1997, Pinnacle had $414.4 million of advances from the Federal Home Loan Bank of Indianapolis and $69.5 million of securities sold under repurchase agreements, and other borrowings.
TRUST SERVICES
Pinnacle's trust operations had 522 trust accounts under management as of December 31, 1997. Pinnacle's trust operations provide a full complement of asset management services for individuals and corporations, and are currently emphasizing investment management for individuals and employee benefit plan management. Since its formation in 1987, Pinnacle's trust operations have experienced strong growth as assets under management grew to approximately $182.8 million as of December 31, 1997. The growth of Pinnacle's trust operations is attributable to concerted marketing efforts by Pinnacle, and the addition of 176 trust accounts from Indiana Federal Bank for Savings, representing approximately $32.3 million in assets. Its trust operations competes for business primarily with other banks and brokerage companies in its market area.
COMPETITION
The banking business is highly competitive. Pinnacle competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions, mortgage banking companies, securities brokerage companies, insurance
companies, and money market mutual funds operating in Michigan, Indiana and elsewhere. Many of these competitors have substantially greater resources and lending limits than Pinnacle and offer certain services that Pinnacle does not currently provide. In addition, non-depository institutions are generally not subject to the extensive regulation applicable to Pinnacle.
EMPLOYEES
Pinnacle does not have any employees that are not also full-time employees of Pinnacle Bank or subsidiaries of Pinnacle Bank because virtually all of Pinnacle's activities are conducted through Pinnacle Bank and its subsidiaries. Pinnacle Bank had 643 full-time employees and 87 part-time employees at December 31, 1997. None of Pinnacle's employees are represented by a collective bargaining agent. Pinnacle believes that it enjoys good relations with its personnel.
REGULATION
GENERAL. Financial institutions such as bank holding companies, banks, savings and loan holding companies, and thrifts are extensively regulated under both federal and state law. Such regulations apply to, among other things, acquisitions, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits and the safety and soundness of banking practices. The policies and regulations of financial institution regulatory authorities have had significant effect on the operating results of financial institutions in the past and are expected to have significant effects in the future. Such policies and regulations, which generally are intended to protect depositors and not stockholders, may be influenced by many factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and fiscal policies of the United States government. Regulation of the financial institutions industry is undergoing continuous change and the ultimate effect of such changes cannot be predicted. Periodically, legislation is considered and adopted which has resulted in, or that could result in, further regulation or deregulation of financial institutions. In addition to the relaxation or elimination of geographic restrictions on banks and bank holding companies, a number of regulatory and legislative initiatives have the potential for eliminating many of the product line barriers presently separating the services offered by commercial banks from those offered by nonbanking institutions, including mutual funds, securities brokerage firms and investment banking firms. No assurance can be given as to whether any additional legislation will be adopted or as to the effect such legislation would have on the business of Pinnacle and its subsidiaries.
As a bank holding company, Pinnacle is subject to regulation under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and its examination and reporting requirements and is subject to the supervision of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). Banking laws and regulations restrict transactions by insured banks owned by a bank holding company, including loans to and certain purchases from the parent holding company, non-bank and bank subsidiaries of the parent holding company, principal stockholders, officers, directors and their affiliates, and investments by the subsidiary banks in the shares or securities of the parent holding company (or of any other non-bank or bank affiliates), and acceptance of such shares or securities as collateral security for loans to any borrower. The regulators also review other payments, such as management fees, made by subsidiary banks or affiliated companies.
Under the BHCA, a bank holding company is prohibited, with certain limited exceptions, from engaging in activities other than those of banking or of managing or controlling banks and from acquiring or retaining direct or indirect ownership or control of voting shares or assets of any company which is not a bank or bank holding company, other than subsidiaries furnishing services to or performing services for its subsidiaries, and other subsidiaries engaged in activities which the Federal Reserve Board determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
Pinnacle Bank is subject to regulation and examination by the Financial Institutions Bureau of the State of Michigan (the "Michigan Financial Institutions Bureau"). As an institution whose deposits are insured by the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF") of the Federal Deposit Insurance Corporation (the "FDIC"), Pinnacle Bank is also subject to regulation and examination by the FDIC.
PAYMENT OF DIVIDENDS. Pinnacle is a legal entity separate and distinct from its subsidiaries. Substantially all of Pinnacle's revenues result from dividends paid to it by Pinnacle Bank and from earnings on investments. There are statutory and regulatory requirements applicable to the payment of dividends by Pinnacle Bank as well as by Pinnacle to its stockholders. Under Michigan law, Pinnacle Bank may not declare a cash dividend or a dividend in kind except out of net profits then on hand after deducting all losses and bad debts, and then only if it will have a surplus amounting to not less than 20% of its capital after the payment of the dividend. Moreover, Pinnacle Bank may not declare or pay any cash dividend or dividend in kind until the cumulative dividends on its preferred stock, if any, have been paid in full. Further, if the surplus of Pinnacle Bank is at any time less than the amount of its capital, before the declaration of a cash dividend or dividend in kind, it must transfer to surplus not less than 10% of its net profits for the preceding half-year (in the case of quarterly or semi-annual dividends) or the preceding two consecutive half-year periods (in the case of annual dividends). Under the foregoing dividend restrictions, Pinnacle Bank, without obtaining governmental approvals, could declare aggregate dividends in 1997 of approximately $33.2 million from retained net profits of the preceding two years, plus an amount approximately equal to the net profits (as measured under current regulations), if any, earned for the period from January 1, 1997 through the date of declaration less dividends previously paid in 1997. During 1997, Pinnacle Bank paid $9.5 million in dividends.
The payment of dividends by Pinnacle and its subsidiary may also be affected or limited by other factors, such as the requirements to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank or thrift under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank or thrift, could include the payment of dividends), such authority may require, after notice and hearing, that such bank or thrift cease and desist from such practice or prohibit the payment of future dividends. The Federal Reserve Board has indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board and the FDIC have issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
CERTAIN TRANSACTIONS WITH AFFILIATES. There are legal restrictions on the extent to which a bank holding company such as Pinnacle and its nonbank subsidiaries can borrow or otherwise obtain credit from its bank subsidiaries (e.g., Pinnacle Bank). The "covered transactions" that an insured bank such as Pinnacle Bank and its subsidiaries are permitted to engage in with their nonbank affiliates are limited to the following amounts: (i) in the case of any one such affiliate, the aggregate amount of "covered transactions" of the insured bank and its subsidiaries cannot exceed 10% of the capital stock and the surplus of the insured bank; and (ii) in the case of all affiliates, the aggregate amount of "covered transactions" of the insured bank and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured bank. "Covered transactions" are defined by statute to include a loan or extension of credit to the affiliate, a purchase of securities issued by an affiliate, a purchase of assets from the affiliate (unless otherwise exempted by the Federal Reserve Board), the acceptance of securities issued by the affiliate as collateral for a loan and the issuance of a guarantee, acceptance, or letter of credit for the benefit of an affiliate. Covered transactions must also be collateralized. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
CAPITAL. Bank regulators continue to indicate a desire to raise capital requirements applicable to financial institutions beyond their current levels. The Federal Reserve Board, FDIC, and state bank regulators require banks and holding companies to maintain minimum ratios of primary and total capital to total assets. Regulatory authorities may increase such minimum requirements for all banks and bank holding companies or for specified banks or bank holding companies. Increases in the minimum required ratios could adversely affect Pinnacle and Pinnacle Bank, including their ability to pay dividends.
The Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies. Under these guidelines, the ratio of total capital ("Total Capital") to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) must meet a minimum of 8.00%. At least half of Total Capital must be composed of common stockholders' equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less goodwill and certain other intangible assets ("Tier 1 Capital"). The remainder may consist of
subordinated debt, other preferred stock and a limited amount of loan loss reserves. At December 31, 1997, Pinnacle's ratio of Tier 1 capital to risk-weighted assets was 13.24%.
In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies which provide for a minimum leverage ratio of Tier 1 Capital to total assets, less goodwill and certain other intangible assets (the "Tier 1 Capital leverage ratio"), of 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies are required to maintain a minimum Tier 1 Capital leverage ratio of 3% plus an additional cushion of 100 to 200 basis points. Pinnacle's Tier 1 Capital leverage ratio at December 31, 1997 was 7.31%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "tangible Tier 1 Capital leverage ratio" (deducting all intangibles) in evaluating proposals for expansion or new activities.
Pinnacle Bank is subject to similar capital requirements adopted by the FDIC. At December 31, 1997, Pinnacle Bank had a Tier 1 Capital ratio and a Total Capital ratio in excess of the minimum requirement, and a Tier 1 Capital to risk-weighted assets ratio of 10.96%. No regulatory agency has advised Pinnacle Bank of any specific applicable minimum Tier 1 Capital leverage ratio. Failure to meet capital guidelines could subject an insured bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC and a prohibition on the acceptance of brokered deposits.
In December, 1992, the Federal Reserve Board approved a final rule altering the method of computation of Tier 1 Capital of bank holding companies. Subject to certain exceptions, in calculating Tier 1 Capital under the revised rule, bank holding companies would be required to deduct all intangible assets other than purchased mortgage servicing rights and purchased credit card relationships, each valued at least quarterly at the lesser of 90% of their fair market value or 100% of their book value, in an aggregate amount not exceeding 50% of Tier 1 Capital, with a separate sublimit of 25% of Tier 1 capital for purchased credit card relationships.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires federal bank regulatory agencies biannually to review risk-based capital standards to ensure that they adequately address interest rate risk, concentration of credit risk and risks from non-traditional activities. On December 31, 1992, capital adequacy regulations adopted by the FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency (the "Comptroller") that incorporated (i) interest rate risk into the calculation of risk-based capital and (ii) concentration of credit risk and risk from non-traditional activities into bank capital requirements became effective.
Failure to meet the capital guidelines described above could subject an insured financial institution to a variety of sanctions, including asset growth restrictions and termination of deposit insurance by the FDIC.
SUPPORT OF SUBSIDIARY BANKS. Under Federal Reserve Board policy, Pinnacle is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each of such subsidiaries. This support may be required at times when, absent such Federal Reserve Board policy, Pinnacle would not otherwise be required to provide it. Any capital loans by a bank holding company to any subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory
assistance. This right of recovery by the FDIC generally is superior to any claim of the stockholders of the depository institution that is liable or of any affiliate of such institution. Pinnacle's subsidiary bank is subject to such provisions of FIRREA and such right of recovery by the FDIC.
Under Michigan law, if the capital of a Michigan-chartered bank is impaired by losses or otherwise, the Michigan Financial Institutions Bureau is authorized to require payment of the deficiency by assessment upon the bank's stockholders, pro rata, and to the extent necessary, if any such assessment is not paid by any stockholder after three months notice, to cause the sale of the stock of such stockholder to make good the deficiency.
FDIC INSURANCE ASSESSMENTS. The deposits of Pinnacle Bank are currently insured to a maximum of $100,000 per depositor, subject to certain aggregation rules. The FDIC establishes rates for the payment of premiums by federally insured banks and thrifts, such as Pinnacle Bank, for deposit insurance. Separate insurance funds (the BIF and the SAIF) are maintained for commercial banks and thrifts, with insurance premiums from the industry used to offset losses from insurance payouts when banks and thrifts fail. Due to the high rate of failures in recent years, the FDIC has adopted a risk-based deposit insurance premium system for all insured depository institutions, including Pinnacle Bank, which requires that a depository institution pay to BIF from $.04 to $.31 per $100, or to SAIF from $.04 to $.31 per $100, of insured deposits depending on its capital levels and risk profile, as determined by its primary federal regulator on a semiannual basis. Under its risk-based assessment system, the FDIC may place a member in one of nine assessment risk categories based on certain capital and supervisory measures. The capital measures are "well capitalized," "adequately capitalized" and "under capitalized." Within each capital group a member may be assigned to one of three supervisory subgroups: "healthy," "supervisory concern" and "substantial supervisory concern."
A financial institution is "well capitalized" if it has a Total Capital to risk based assets of 10% or greater, a Tier 1 Capital ratio of 6% or greater, and a leverage ratio of 5% or greater. A financial institution is "adequately capitalized" if it does not meet the standards for "well capitalized" but has a Total Capital to risk based assets of 8% or greater, a Tier 1 Capital ratio of 4% or greater, and a leverage ratio of 4% or greater. A financial institution is "less than adequately capitalized" if it does not meet the standards for "adequately capitalized."
A "healthy" financial institution is one that is financially sound with only a few minor weaknesses. A financial institution raising "supervisory concern" is one with weaknesses which, if not corrected, could result in significant deterioration of the institution and increased risk to the BIF or SAIF. A financial institution raising "substantial supervisory concern" is one that poses a substantial probability of loss to the BIF or SAIF unless effective corrective action is taken.
The risk-related adjusted assessment schedule adopted by the FDIC with respect to deposits insured by the BIF is as follows:
The risk-related adjusted assessment schedule recently adopted by the FDIC with respect to deposits insured by the SAIF is as follows:
The FDIC's adoption of risk-based insurance assessment schedules did not result in a significant increase in the insurance assessment costs of Pinnacle. As of December 31, 1997, Pinnacle Bank was classified as "well capitalized" and "healthy."
Legislation was enacted during 1996 that resulted in, among other things, the assessment of a one-time charge (the "Special Assessment") against financial institutions with deposits insured by SAIF. The amount of the charge equaled approximately .657% of the deposits of a financial institution held on March 31, 1995 and subject to the SAIF premium. The Special Assessment was due on September 30, 1996 and payable no later than November 27, 1996. As a result of the Special Assessment, Pinnacle paid an assessment of $5.9 million on approximately $901.5 million of deposits held by it on March 31, 1995 and insured by SAIF.
The FDIC determined not to levy any premium on healthy banks for 1997. As a "well capitalized" and "healthy" institution, Pinnacle Bank did not pay (or accrue) any premiums for FDIC coverage during 1997. BIF insured financial institutions will, however, begin servicing Financing Corp. ("FICO") bonds, which were funded by SAIF insured financial institutions. The FICO bonds were issued in the late 1980s in connection with government efforts to bail out the thrift industry. Beginning in 1997, interest payments for FICO bonds will be borne by all FDIC insured institutions. FICO bond servicing will require BIF members to pay 1.3 cents for every $100 in insured deposits, and SAIF members to pay 6.48 cents for each $100 in insured deposits. The servicing payments were collected electronically by the FDIC beginning January 2, 1997. Pinnacle paid $681,000 for such servicing payments in 1997. The rates are expected to remain in effect through 1999, after which banks and thrifts are expected to pay the same rates.
REGULATION OF PROPOSED ACQUISITIONS. With certain limited exceptions, the BHCA prohibits bank holding companies, such as Pinnacle, from acquiring direct or indirect ownership or control of voting shares or assets of any company other than a bank, unless the company involved is engaged solely in one or more activities which 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. Any such acquisition will require, except in certain limited cases, the prior approval of the Federal Reserve Board.
In evaluating an application for its approval of such an acquisition, the Federal Reserve Board will consider whether the performance by an affiliate of Pinnacle of the activity can reasonably be expected to produce benefits to the public (such as greater convenience, increased competition, or gains in efficiency) that outweigh possible adverse effects (such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices). 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. The Federal Reserve Board's consideration will also include an evaluation of the financial and managerial resources of Pinnacle, including its existing subsidiaries, and of any entity to be acquired, and the effect of the proposed transaction on those resources. This required regulatory approval is subject to public notice and comment procedures, and adverse public comments received, or adverse considerations raised by regulatory agencies, may delay or prevent consummation of such an acquisition.
FIRREA amended the BHCA in 1989 to permit the Federal Reserve Board to approve an application by any bank holding company to acquire and operate a thrift as a non-bank subsidiary of such bank holding company. A bank holding company such as Pinnacle may apply to the Federal Reserve Board for permission to acquire and operate a thrift engaged only in deposit-taking, lending and other activities that the Federal Reserve Board has determined to be permissible for bank holding companies, in accordance with the procedures and standards described in the preceding paragraph.
RECENT LEGISLATION. In September 1994, the Riegle Community Development and Regulatory Improvement Act (the "Community Development Act") was enacted. The Community Development Act consists of (i) Subtitle A, the "Community Development and Financial Institutions Act," which establishes the "Community Development Financial Institutions Fund" to promote economic revitalization and community development through investment in "Community Development Financial Institutions," and (ii) Subtitle B, "The Home Ownership and Equity Protection Act of 1994," which seeks to increase the protections afforded to individuals most at risk from abusive lending practices, particularly high-interest mortgages secured by the borrowers' homes.
The Community Development Act provides a number of initiatives to lessen the regulatory burden placed upon depository institutions and also affects a number of the consumer compliance laws by allowing streamlined disclosures for radio advertising of consumer leases, providing consumers with information necessary to challenge an "adverse characterization" due to a credit reporting agency report and by clarifying the disclosure requirements under the Real Estate Settlement Procedures Act regarding the transfer of serviced mortgaged loans.
The Community Development Act also reforms currency transaction reports to increase their usefulness to the Federal Government and to various law enforcement agencies in combating money laundering. The measure also calls for improvement in the identification of money laundering schemes, better controls over negotiable instruments drawn on foreign banks by making them subject to reporting, and uniform licensing and registration of check cashing and money transmitting businesses, which are often used to facilitate illegal currency transactions.
In September 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") was also enacted. The Interstate Act facilitates the interstate expansion and consolidation of banking organizations by permitting (i) beginning one year after enactment of the legislation, bank holding companies that are adequately capitalized and managed to acquire banks located in states outside their home states regardless of whether such acquisitions are authorized under the law of the host state, (ii) the interstate merger of banks after June 1, 1997, subject to the right of individual states to "opt in" or "opt out" of this authority prior to such date, (iii) banks to establish new branches on an interstate basis provided that such action is specifically authorized by the law of the host state, (iv) foreign banks to establish, with approval of the appropriate regulators in the United States, branches outside their home states to the same extent that national or state banks located in such state would be authorized to do so and (v) beginning September 29, 1995, banks to receive deposits, renew time deposits, close loans, service loans and receive payments on loans and other obligations as agent for any bank or thrift affiliate, whether the affiliate is located in the same or different state.
The Federal Deposit Insurance Corporation Improvement Act of 1991 substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and revised several other federal banking statutes. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets each such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to meet any critical capital level set forth in regulations. The critical capital level is defined as a ratio of tangible equity to total assets of two percent or less. An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position under certain circumstances.
Among other things, FDICIA requires the federal bank regulatory authorities to take "prompt corrective action" in respect of any depository institution which does not meet specified minimum capital requirements. The scope and degree of regulatory intervention is linked to the extent of the shortfall of the depository institution's capital from required minimum standards. In the case of a depository institution which is "critically undercapitalized" (a term defined to include institutions which still have a positive net worth), the federal bank regulatory authorities are generally required to appoint a conservator or receiver. FDICIA also requires the holding company of any undercapitalized depository institution to guarantee, in part, such depository institution's capital plan in order for such plan to be acceptable. FDICIA also prohibits a depository institution that is not well-capitalized from accepting brokered deposits and paying deposit interest rates which significantly exceed the prevailing rate in its own market or the national rate (as determined by the FDIC) for similar deposits. Implementing regulations for these provisions of FDICIA have not yet been adopted by the federal bank regulatory authorities.
FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized.
MORTGAGE REGULATION. In the origination of mortgage loans, Pinnacle and its subsidiaries are subject to various federal statutes, such as the Equal Credit Opportunity Act, Fair Credit Reporting Act, Truth in Lending Act, Real Estate Settlement
Procedures Act, and Home Mortgage Disclosure Act, and the regulations promulgated thereunder, which prohibit discrimination and specify disclosures to be made to borrowers regarding credit and settlement costs.
As sellers and servicers of mortgage loans, Pinnacle and its subsidiaries are participants in the secondary mortgage market with some or all of the following: private institutional investors, Federal National Mortgage Association ("FNMA"), Government National Mortgage Association, Federal Home Loan Mortgage Corporation ("FHLMC"), Veterans' Administration and Federal Housing Authority. In its dealings with these agencies, Pinnacle and its subsidiaries are subject to various eligibility requirements prescribed by the agencies, including but not limited to net worth, quality control, bonding, financial reporting and compliance reporting requirements. The mortgage loans which Pinnacle and its subsidiaries originate are subject to agency-prescribed procedures, including (without limitation) inspection and appraisal of properties, maximum loan-to-value ratios,and obtaining credit reports on prospective borrowers. On some types of loans, the agencies prescribe maximum loan amounts, interest rates and fees. When selling mortgage loans to FNMA and FHLMC, a seller must represent and warrant that all such mortgage loans conform to the requirements of FNMA and FHLMC. If the mortgage loans sold are found to be nonconforming mortgage loans, FNMA or FHLMC may require the seller to repurchase the nonconforming mortgage loans. Additionally, FNMA and FHLMC may require a seller/servicer to indemnify them against all losses arising from the seller/servicer's failure to perform its contractual obligations under the applicable selling or servicing contract.
FORWARD-LOOKING STATEMENTS
From time to time, Pinnacle may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, new products, and similar matters. Such information is often subject to risks and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, Pinnacle notes that a variety of factors could cause its actual results and experience to differ materially from the anticipated results or other expectations expressed in its forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business include those discussed elsewhere herein (such as competition and regulation); future economic conditions in the regional and national markets in which the companies compete; financial market conditions; inflation; changing competition; the ability to carry out business plans; the ability to enter new markets successfully and capitalize on growth opportunities; adverse changes in applicable law, regulations or rules governing financial institutions and environmental, tax or accounting matters; and the following:
INTEREST RATE SENSITIVITY. Prevailing economic conditions, particularly changes in market interest rates, may significantly affect the operations of financial institutions such as Pinnacle and Pinnacle Bank because the earnings of a financial institution depend primarily on its net interest income, which is the difference between the income earned on its loans and investments and the interest paid on its deposits and borrowings. Changes in interest rates also can affect the value of a financial institution's interest-earning assets, which are comprised of fixed- and adjustable-rate instruments. Generally, the value of fixed-rate instruments fluctuates inversely with changes in interest rates. Changes in interest rates also can affect the average life of, and demand for, loans and mortgage-related securities. A financial institution is subject to reinvestment risk to the extent that it is not able to reinvest such prepayments at rates which are comparable to the rates on the maturing loans or securities.
LOCAL ECONOMIC CONDITIONS. The success of Pinnacle is dependent to a certain extent upon the general economic conditions in the geographic markets served by it and its subsidiaries. No assurance can be given that favorable economic conditions will exist in such markets.
ITEM 2.
ITEM 2. PROPERTIES
Pinnacle owns or leases all of the properties in which its various offices are located. Pinnacle owns its main office in St. Joseph, Michigan. Pinnacle has 14 additional branch offices in Michigan and 30 branch offices in Indiana. Pinnacle also owns 43 automated teller machines, of which 31 are housed within its banking offices and 12 are independently located. At December 31, 1997 and 1996, the properties and equipment of Pinnacle had an aggregate net book value of $29.3 million and $26.1 million, respectively.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Pinnacle from time to time is subject to pending and threatened legal action and proceedings arising in the normal course of business. Any such litigation currently pending is incidental to such business and, based on information currently available to management, management believes the outcome of such actions or proceedings will not have a material adverse effect on the operations or financial condition of Pinnacle. See also Note 18 to the consolidated financial statement of Pinnacle Financial Services, Inc.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of Pinnacle's shareholders during the fourth quarter of 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Shares of common stock, no par value per share, of Pinnacle ("Pinnacle Common Stock") are traded in the over-the-counter market and listed for quotation on the Nasdaq National Market under the symbol "PNFI." Although transactions in Pinnacle Common Stock, have been, and are expected to continue to be, facilitated by market-makers, there can be no assurance that an established or liquid trading market will continue.
The following table sets forth, for the periods indicated, the high and low sale prices per share of the Pinnacle Common Stock as reported by the Nasdaq National Market. The information with respect to such Nasdaq National Market quotations was obtained from the National Association of Securities Dealers, Inc.
As of March 20, 1998, there were 2,063 registered holders of shares of Pinnacle Common Stock.
The holders of Pinnacle Common Stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors of Pinnacle out of funds legally available therefor. Pinnacle (or its predecessor) has paid cash dividends at least annually since the 1930's and on a regular quarterly basis since April 1979. The table below presents the cash dividends declared, as retroactively adjusted for the effect of stock dividends, for the periods indicated.
Any future dividends will depend upon, among other things, the earnings, cash position and capital needs of Pinnacle and the future financial results and requirements and contractual restrictions applicable to Pinnacle or its subsidiaries. Under the terms of the Agreement and Plan of Merger dated as of October 14, 1997, between CNB and Pinnacle, in the case of dividends payable until June 30, 1998, Pinnacle may declare and pay its regular quarterly dividend on the Pinnacle Common Stock in an amount not to exceed $0.235 per share, at approximately the same times during each quarter during such period which it has historically declared and paid such dividends, and in the case of dividends payable on or after July 1, 1998, Pinnacle may declare and pay its regular quarterly dividend on the Pinnacle Common Stock in an aggregate amount equal to the aggregate amount that Pinnacle shareholders would have received on their shares of CNB Common Stock received in the merger with CNB had the effective time of the merger with CNB been immediately before the record date or dates for the payment of each such dividend, at approximately the same times during each quarter during such period which it has historically declared and paid such dividends. The ability of Pinnacle to fund its operations and to pay dividends on its common stock will be dependent upon its receipt of dividends from its subsidiaries. The ability of those subsidiaries to pay dividends is subject to regulatory restrictions.
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ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain consolidated historical financial data of Pinnacle for each of the years in the five year period ended December 31, 1997. All information is presented in accordance with generally accepted accounting principles, except for selected regulatory data, which are presented in accordance with regulatory accounting practices. All information has been restated to reflect the combination of the historical financial results of Pinnacle, IFC and CB and their respective recorded assets and liabilities have been restated at their historical cost as if the combining companies had been consolidated for all periods presented.
Selected Financial Data Five Year Summary of Operations
- ------------------------ (1) Efficiency ratio is equal to noninterest expense less amortization of intangible expenses less one time restructuring charge divided by net interest income plus noninterest income less gain or loss on security transactions.
(2) Per share data has been restated to reflect all stock dividends and stock splits. Pinnacle's last stock split was in 1993.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion provides information regarding Pinnacle's financial condition and results of operations for each of the years ended December 31, 1997, 1996 and 1995. This discussion should be read in conjunction with the consolidated financial statements of Pinnacle, and the notes thereto, which appear elsewhere herein.
OVERVIEW AND FINANCIAL CONDITION
For the year ended December 31, 1997, net income was $10.2 million or basic earnings per share of $.83 as compared to net income of $16.1 million or basic earnings per share of $1.33 for the year ended December 31, 1996 and $16.2 million or basic earnings per share of $1.60 per share for the year ended December 31, 1995. The decrease from 1996 to 1997 was largely the result of the restructuring charges of $8.2 million after tax and the $6.0 million after tax ($10.0 million pre-tax) increase in the provision for loan losses in connection with conforming loan loss reserve methodologies as a result of the acquisitions of IFC and CB in the third quarter of 1997, offset by the one-time SAIF charge in the third quarter of 1996 of $3.6 million after tax. On a diluted basis, earnings per share was $.83 for the year ended December 31, 1997 as compared to $1.32 for the year ended December 31, 1996. All per share income has been restated in accordance with the Financial Accounting Standards Board's Statement No. 128 "Earnings per Share" which requires the presentation of basic and diluted income per share in lieu of primary income per share amounts previously reported by Pinnacle. Net income without the restructuring charges of $8.4 million after tax would have been $18.6 million or basic earnings per share of $1.52 for the year ended December 31, 1997 as compared to $1.64 for the year ended December 31, 1996 without the $3.6 million after tax SAIF charge in 1996, a decrease of 6.1%.
During the fourth quarter of 1997 and continuing in the first quarter of 1998, Pinnacle devoted substantial attention to reconciling amounts and resolving related items generated through the data processing conversion of Community Bank and Indiana Federal Bank for Savings that were a result of the CB and IFC mergers. Net income was reduced in the fourth quarter of 1997 through a charge to earnings of $1,341,000 to reserve for such items. Pinnacle continues to work on clearing the reconciling items identified. Pinnacle does not expect the ultimate resolution of the items to have a further significant impact on the financial results of Pinnacle.
Due to the timing of the Maco Bancorp, Inc. acquisition, which was consummated on December 1, 1995, and because of the application of purchase accounting (which includes the earnings and assets of Maco from the date of the Maco Acquisition), results for the year ended December 31, 1996 are not necessarily comparable to results for years ended on or before December 31, 1995.
Since 1995, average earning assets have equaled or exceeded 93.0% of total average assets. The following table summarizes the components of Pinnacle's total assets, total loans, total deposits and stockholders' equity at the dates indicated.
OVERVIEW AND FINANCIAL HIGHLIGHTS
Net loans at December 31, 1997 were approximately $1.5 billion, which was $92.5 million greater that net loans at December 31, 1996. The increase was primarily attributable to commercial loan growth of $70.0 million or 16.6%, an increase in Pinnacle's Mortgage Loan Reverse Repurchase Program of $84.4 million or 88.6% offset by a decrease of $62.6 million in real estate loans as management placed greater emphasis on commercial loans to adjust the loan mix in the portfolio. Net loans at December 31, 1996 were approximately $1.4 billion, which was $205.6 million greater than net loans at December 31, 1995 of $1.2 billion. The substantial growth in net loans from December 31, 1995 to December 31, 1996, was primarily related to Pinnacle's new presence in the northern Indiana market and the moderate growth of the their southwestern Michigan market. The remaining increase is attributable to a $15.2 million increase in Pinnacle's Mortgage Loan Reverse Repurchase Program and due to Pinnacle Bank's regular banking activities.
Total assets decreased by $19.8 million at December 31, 1997 to $2.1 billion as compared to December 31, 1996. The company's focus was mainly on changing the asset mix, primarily in the loan portfolio while holding total assets constant. However, average assets increased by $208.4 million for the year ended December 31, 1997 to $2.1 billion as compared to $1.9 billion for the year ended December 31, 1996, an increase of 10.7%. Total assets increased by $294 million or 16%, from $1.8 billion, at December 31, 1995 to $2.1 billion at December 31, 1996. The growth was primarily the result of strong loan demand which was funded by strong deposit growth and increases in Federal Home Loan Bank advances and securities sold under repurchase agreements and other borrowings. Total deposits at December 31, 1997 were $1.4 billion, a decrease of $45.6 million or 3.1% as compared to $1.5 billion at December 31, 1996. The decrease was due primarily to a corresponding decrease in non-interest bearing demand deposits of $22.0 million from $121.2 million at December 31, 1996 to $99.3 million at December 31, 1997. Total deposits at December 31, 1996 increased by 7.7% or $105.4 million when compard to the balance at December 31, 1995 of $1.4 million. The growth in deposits was primarily in noninterest bearing demand deposits which increased $23.3 million or 23.8% and time deposits which increased $65.8 million or 9.3%.
Federal Home Loan Bank advances, securities sold under repurchase agreements and other borrowings were approximately $483.9 million at December 31, 1997, an increase of $12.4 million or 2.6% from December 31, 1996 levels. Federal Home Loan Bank advances, securities sold under repurchase agreements and other borrowings were approximately $471.4 million at December 31, 1996, an increase of $185.1 million, or 64.6%, from December 31, 1995 levels. The increase was used primarily to fund strong loan growth and to match fund specific investment security purchases with similar adjustable rate features and maturities.
A majority of Pinnacle's revenue is generated by its average earning assets. For 1997, average earning assets totaled $2.0 billion, an increase of $202.4 million, or 11.2% , over 1996, which helped increase net interest income by $7.3 million. The growth in average loans of $161.8 million accounted for most of the average earning asset growth in 1997. The net interest margin was stable for the year-ended December 31, 1997 at 3.75% as compared to 3.77% for the year-ended December 31, 1996. The Maco Acquisition on December 1, 1995 and the Mortgage Loan Reverse Repurchase Program
provided the increase in average earning assets of $496 million for 1996 from $1.3 billion in 1995 to $1.8 billion in 1996. The increase in average earning assets was offset by a reduction in net interest margin to 3.77% in 1996 as compared to 4.01% in 1995. This reduction was primarily the result of the Maco Acquisition which experienced a lower net interest margin as compared to Pinnacle's margin before the acquisition.
Stockholder's equity was approximately $181.0 million at December 31, 1997 as compared to $170.3 million at December 31, 1996, resulting in an increase of $10.7 million or 6.3%. The increase was attributable to net income of $10.2 million for the year ended December 31, 1997 offset by cash dividends of $9.5 million in 1997. Common stock issued upon exercise of stock options added $9.1 million to stockholders equity in 1997. Stockholders' equity increased approximately $5.8 million or 3.5% at December 31, 1996, as compared to $164.5 million at December 31, 1995. Retained earnings generated primarily through net income added $7.4 million while net unrealized gains decreased to $45,000 at December 31, 1996 resulting in a reduction of $1.9 million. Additional paid in capital increased $706,000. The return on average assets for the year ended December 31, 1997 was .48% as compared to .83% for the year ended December 31, 1996. Without the restructuring and SAIF charges, return on average assets would have been .87% and 1.02%, respectively, for the years ended December 31, 1997 and 1996. The return on average equity for the year ended December 31, 1997 was 5.83% as compared to 9.83% for the year ended December 31, 1996. Without the restructuring and SAIF charges, return on average equity would have been 10.61% and 12.05%, respectively, for the years ended December 31, 1997 and 1996.
RESULTS OF OPERATIONS
NET INCOME. For the year ended December 31, 1997, net income was $10.2 million or basic earnings per share of $.83 as compared to net income of $16.1 million or basic earnings per share of $1.33. The decrease was largely the result of the restructuring charges of $8.4 million after tax and the $6.0 million after tax ($10.0 million pre-tax) increase in the provision for loan losses in connection with conforming loan loss reserve methodologies as a result of the acquisitions of IFC and CB in the third quarter of 1997, offset by the one-time SAIF charge in the third quarter of 1996 of $3.6 million after tax. On a diluted basis, earnings per share was $.85 for the year ended December 31, 1997 as compared to $1.32 for the year ended December 31, 1996. All per share income has been restated in accordance with the Financial Standards Board's Statement No. 128 "Earnings per Share" whcih requires the presentation of basic and diluted earnings per share in lieu of primary income per share previously reported by Pinnacle. Net income without the restructuring charges of $8.4 million after tax would have been $18.6 million or basic earnings per share of $1.52 for the year ended December 31, 1997 as compared to $1.64 for the year ended December 31, 1996 without the $3.6 million after tax SAIF charges in 1996, a decrease of 7.3%.
NET INTEREST INCOME. Net interest income is Pinnacle's primary source of earnings and represents the excess of interest earned on earning assets over interest expense associated with the deposits and other funding sources used to finance those assets. Net interest income is influenced primarily by changes in the volume and mix of earning assets and sources of funding and market rates of interest. Other external factors, such as the strength of credit demands by customers, liquidity and maturity preferences of deposit customers, and governmental monetary policy, also can have a significant impact on earnings.
SUMMARY OF CONSOLIDATED NET INTEREST INCOME
The following table sets forth certain information with respect to Pinnacle's consolidated net income for each of the years ended December 31, 1997, 1996 and 1995.
- ------------------------ (1) Income from state and political subdivisions securities and loans are stated on a tax equivalent basis.
(2) For purposes of these computations, nonaccrual loans and unearned income are included in the daily average loan amounts outstanding.
(3) Net interest rate margin is equal to total interest income less total interest expense divided by total average earning assets.
The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have effected Pinnacle's interest income and expense during the periods indicated. For each category of interest-earnings assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), (iii) changes in volume and rate combined (change in rate multiplied by change in volume), and (iv) total change in rate and volume.
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(1) Income from state and political subdivisions securities and loans are stated on a tax equivalent basis.
Net interest income on a tax equivalent basis was approximately $75.6 million for the year ended December 31, 1997 as compared to $68.3 million for 1996, an increase of $7.3 million. The increase was from the $202.4 million increase in average earning assets for the year ended December 31, 1997 which contributed $6.1 million to the increase in net interest
income. Net interest income on a tax-equivalent basis was approximately $68.3 million for the year ended December 31, 1996, as compared to $52.8 million for the year ended December 31, 1995. The substantial increase in net interest income during 1996 over the same period in 1995 was due primarily to the increase in average earning assets associated with the Maco Acquisition and the Mortgage Loan Reverse Repurchase Program. An increase in average earning assets for the year ended December 31, 1996 of $496.0 million increased net interest income by $15.1 million.
Total loans as of December 31, 1997 were $1.5 billion, an increase of $92.5 million or 6.5% over total loans as of December 31, 1996 of $1.4 billion. Commercial loans at December 31, 1997 totaled $491.9 million, an increase of $70.0 million or 16.6% over the December 31, 1996 total of $421.9 million. Mortgage repurchase loans were $179.7 million at December 31, 1997 as compared to $95.3 million, an increase of $84.4 million or 88.6% as the increased level of capital and alternative funding by way of a larger company, after the merger of CB Bancorp into Pinnacle, allowed growth to accelerate in 1997. Real Estate loans decreased $62.6 million to $588.0 million at December 31, 1997 as compared to $650.6 million at December 31, 1996, as the company placed greater emphasis on other loan types to reduce the loan mix of real estate lending into commercial loans. Consumer loans were steady at $238.4 million at December 31, 1997 as compared to $238.3 million at December 31, 1996. The company decided to manage consumer loan levels through the sale of home equity loans in 1997. Total loans as of December 31, 1996 were $1.4 billion, an increase of $205.6 million or 17% over total loans as of December 31, 1995 of $1.2 billion. Commercial loans at December 31, 1996 totaled $421.9 million, an increase of $107.4 million or 34.1% over the December 31, 1995 total of $314.6 million. Consumer loans, including home equity loans, grew by 33.3% to $238.3 million at December 31, 1996 as compared to $178.7 million at December 31, 1995. Real estate loans at December 31, 1996 increased slightly by 2.8%, or $18.0 million, to $650.6 million as compared to $632.7 million at December 31, 1995 as Pinnacle primarily originated real estate loans for resale in the secondary market for fee income and sought to control the level of real estate loans to manage interest rate risk associated with these longer term assets.
Securities, federal funds sold and interest-bearing deposits with financial institutions decreased by $129.5 million at December 31, 1997 or 23.3% to total $427.2 million as compared to $556.7 million at December 31, 1996 as the company placed more emphasis on the growth in higher yielding loans. Securities, federal funds sold and interest-bearing deposits with financial institutions increased by $91.0 million or 19.4% to approximately $556.7 million at December 31, 1996 when compared to $466.1 million at December 31, 1995. The increase in this item in 1996 as compared to 1995 was attributable primarily to Pinnacle using specific adjustable rate security investments to match against short-term funding sources as a tool to manage interest rate risk.
The following table presents a breakdown by category of the average amount of deposits (all in domestic offices) and the average rate paid for the years indicated.
Total deposits decreased by $45.6 million or 3.1% to $1.4 billion at December 31, 1997. Non-interest bearing deposits decreased $22.0 million or 18.1% as lower levels of year end commercial deposits were experienced. Interest bearing demand deposits increased $43.0 million or 29.9% as the company continued to have success with its line of retail checking accounts in 1997. Total deposits increased by $105.4 million or 7.7% to $1.5 billion at December 31, 1996 from $1.4 billion at December 31, 1995. Noninterest bearing demand deposits increased $23.3 million or 23.8% as Pinnacle continued to have success with a new line of checking accounts introduced in 1995.
Time deposits decreased $62.2 million or 8.0% to $713.9 million at December 31, 1997 as compared to $776.1 million at December 31, 1996, primarily through the decrease in reliance on funding the company with higher priced brokered time deposits acquired with the acquisition of CB Bancorp on August 1, 1997. Time deposits grew by $65.8 million, or 9.3%, to $776.1 million at December 31, 1996 as compared to $710.4 million at December 31, 1995, as interest rates on time deposits remained attractive as compared to yields on products available from non-bank competitors when compared to risk. Additionally, the increase is due to management's decision to utilize the public fund and institutional deposit markets to meet Pinnacle's funding needs. Management has found these markets to be reliable and attractively priced funding sources and will continue to take advantage of these funding sources as market conditions warrant.
SHORT-TERM BORROWINGS
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(1) Based on amount outstanding at month end during each year
Federal Home Loan Bank advances, securities sold under repurchase agreements and other borrowing increased $12.4 million or 2.6% to $483.9 million at December 31, 1997 when compared to December 31, 1996. Federal Home Loan Bank advances, securities sold under repurchase agreements and other borrowings increased $185.1 million, or 64.6%, to approximately $471.4 million at December 31, 1996 when compared to the balance at December 31, 1995 of $286.4 million. The increase was primarily used to match specific adjustable rate security purchases of approximately $40 million, to the match funding of approximately $30 million in longer term 15 year fixed rate home equity loans, to purchase $30 million in fixed-rate home equity loans and to fund a $25 million leveraging stratergy in fixed-rate investment securities.
PROVISION FOR LOAN LOSSES. The provision for loan losses for the year ended December 31, 1997 was $13.3 million as compared to $2.7 million for the year ended December 31, 1996, an increase of $10.6 million as additional provisions were made to conform loan loss reserve methodologies as a result of the acquisitions of IFC and CB. Nonaccrual loans decreased to $10.8 million at December 31, 1997 as compared to $11.1 million at December 31, 1996. Total nonperforming loans to total loans decreased to 1.19% at December 31, 1997 as compared to 1.27% at December 31, 1996. Total loans past due over 90 days increased from $6.2 million at December 31, 1996 to $7.0 million at December 31, 1997. For the year ended December 31, 1996, the provision for loan losses totaled $2.7 million, as compared to $1.4 million, for the same period in 1995. Non-accrual loans increased to $11.1 million, at December 31, 1996 as compared to $10.5 million at December 31, 1995. Total nonperforming loans to total loans decreased to 1.27% as of December 31, 1996 compared to 1.14% as of December 31, 1995. Total past due loans over 90 days increased from $2.6 million in 1995 to $6.2 million in 1996.
Pinnacle's management believes these increases are attributable primarily to the Maco Acquisition and to the significant increase in loans receivable and are not due to any general decline in credit quality.
NONINTEREST INCOME. The following table reflects various components of noninterest income for each time period reported.
NONINTEREST INCOME
Noninterest income for the year ended December 31, 1997 was approximately $18.5 million, an increase of $5.7 million or 44.1% as compared to $12.9 milion for the year ended December 31, 1996. Gain on sale of loans increased $2.4 million or 234.7% as the company started selling home equity loans in 1997. Additionally, fees related to loans purchased under agreements to resell increased $446,000 or 64.7% as the company increased this line of business in 1997. Service charges on deposit accounts increased $938,000 or 21.6% primarily from higher levels of NSF fees related to retail checking accounts. Trust fees increased $123,000 or 15.6%. Other income increased $1.6 million primarily from higher wire transfer fees associated with the mortgage repurchase program, insurance income, check printing charges and increased lease income. Noninterest income for the year ended December 31, 1996 was approximately $12.9 million and approximately $9.8 million for the year ended December 31, 1995. Of this $3.0 million increase, $1.8 million was attributable to the Maco Acquisition (including $315,000, attributable to security gains from the sale of securities available-for-sale). Additionally, deposit service charges increased $688,000, or 18.8%, trust income increased $184,000, or 30.4.%, and brokerage fees increased $719,000 , or 56.9%.
NONINTEREST EXPENSE. The following table presents the major components of noninterest expense for each period reported.
NONINTEREST EXPENSE
Non-interest expense for the year ended December 31, 1997 was $66.0 million, an increase of $11.1 million or 20.1% over the $54.9 million for the year ended December 31, 1996. The company incurred restructuring costs associated with the acquistion of Indiana Federal Corp. and CB Bancorp on August 1, 1997 of $11.5 million, offset by $6.0 million in charges related to the SAIF assessment in the third quarter of 1996, which accounted for $5.5 million of the increase. Salary and benefits increased $2.2 million or 10.0% for the year ended December 31, 1997 as compared to the year ended December 31, 1996, primarily related to compensation expense of the former IFC ESOP of $728,000 in 1997. Professional services expense increased $517,000 or 26.3% for the year ended December 31, 1997, primarily from consulting expenses incurred to assist in organizational design to facilitate a larger organization. Occupancy expense and equipment related expenses increased $790,000 or 10.4% as additional space and equipment upgrades were needed to facilitate growth in the combined entities. Non-interest expenses as a percent of average assets was 2.54% for the year ended December 31, 1997 as compared to 2.53% for the year ended December 31, 1996, before the one-time restructuring charges and the SAIF special assessment.
Non-interest expense for the year ended December 31, 1996 was $54.9 million as compared to $38.7 million for the same period in 1995. Of this $16.3 million or 42.1% increase in non-interest expense, approximately $11.0 million was attributable to the Maco Acquisition (including $2.0 million attributable to the one-time Special Assessment against financial institutions with deposits insured by SAIF). The balance of this increase, which was attributable primarily to the activities of Pinnacle Bank and approximately $300,000, in costs associated with changing of the name of First Federal, $3.9 million, for the Special Assessment charged against Pinnacle's thrift deposits, $4.1 million for salaries and benefits, $1.0 million for occupancy expenses and $775,000 for marketing and promotion.
INCOME TAXES. Income taxes were approximately $4.6 million for the year ended December 31, 1997 as compared to $7.4 million for the year ended December 31, 1996. The decrease was primarily the result of lower levels of earnings in 1997 as a result of the restructuring charges associated with the IFC and CB acquisitons. Income taxes were approximately $7.4 million for the year ended December 31, 1996 and approximately $6.4 million for the year ended December 31, 1995. The increase was the result of higher levels of earnings, including, in substantial part, earnings associated with the Maco Acquisition and partially offset by increasing tax credits received for investments in low and moderate income housing by Pinnacle's subsidiary, IndFed Mortgage Company.
The effective tax rates for 1997, 1996 and 1995 were 30.9%, 31.6% and 28.1%, respectively. The increase in 1996 was primarily from the non-deductibility of goodwill expenses associated with the Maco Acquisition and a higher state income tax rate associated with income in the Indiana market.
ANALYSIS OF FINANCIAL CONDITION
EARNING ASSETS. Average earning assets equaled 93.9%, 93.5% and 93.1% of total average assets for the year ended December 31, 1997, 1996 and 1995, respectively. Generally, the higher earning assets are to total assets, the greater the contribution of Pinnacle's net interest margin to profitability.
Average loans outstanding for the year ended December 31, 1997 were $1.5 billion as compared to $1.3 billion for the year ended December 31, 1996 and increase of $162,000 or 12.3%. This increase was primarily in average commercial loans and average mortgage repurchase loans offset by a decrease in average mortgage loans. Average loans outstanding for the year ended December 31, 1996 were $1.3 billion. Average loans outstanding at December 31, 1995 were $1.1 billion. The increase in this item was attributable to the Maco Acquisition which added $222.5 million in loans.
The following table presents the amortized cost of securities held-to-maturity as of December 31, 1996.
The following table presents the carrying value of securities available-for-sale at the dates indicated.
The following table sets forth certain information regarding securities available-for-sale at December 31, 1997.
- -------------------------- (1) Weighted yields on tax-exempt obligations have not been computed on a fully tax-equivalent basis.
(2) Maturities of mortgage backed securities are determined based on original maturity dates.
Average securities for the year ended December 31, 1997 was approximately $528.2 million as compared to $474.9 million for the year ended December 31, 1996, primarily in mortgage backed securities and tax-exempt obligations of state and political subdivisions. Average securities for the year ended December 31, 1996 was approximately $474.9 million as
compared to $251.9 million at December 31, 1995, as the Maco Acquisition added $185.6 million to average security balances.
Gross loan balances as of December 31, 1997 totaled $1.5 billion, an increase of $92.5 million or 6.5%. Commercial loans increased $70.0 million or 16.6% at December 31, 1997 to $491.9 million. Mortgage repurchase loans increased $84.4 million to $179.7 million at December 31, 1997 as compared to $95.3 million at December 31, 1996. Real estate loans decreased $62.6 million or 9.6% to $588.0 million at December 31, 1997. Consumer loans were approximately the same at $238.4 million on December 31, 1997 as compared to $238.3 million at December 31, 1996. Gross loan balances as of December 31, 1996 totaled $1.4 billion, an increase of $205.6 million, or 17.0% as compared to the balance at December 31, 1995 of $1.2 billion. Commercial loans increased by $107.4 million, or 34.1%, at December 31, 1996 to $421.9 million. Consumer loans (primarily in home equity loans) increased $59.6 million, or 33.3%, to $238.3 million. Real estate loans grew slightly in 1996 by $18.0 million, or 2.8%, to $650.6 million as Pinnacle originated real estate loans primarily for sale in the secondary market in order to manage interest rate risk.
The following table presents loans outstanding, according to loan category at the dates indicated.
The following table presents loans outstanding at December 31, 1997, which, based on remaining scheduled repayments of principal, are due in the period indicated.
The following table sets forth at December 31, 1997, the dollar amount of gross loans receivable contractually due after December 31, 1998, and whether such loans have fixed interest rates or adjustable interest rates.
The following table presents information concerning nonperforming loans including nonaccrual, past due, and restructured loans at the indicated dates.
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(1) Loans are generally placed on a nonaccrual basis when, in the opinion of management, collection of principal or interest payments is unlikely. Income on such loans is then recognized only to the extent that cash is received and where future collection is likely. If nonaccrual loans had been maintained current in accordance with their original terms, additional interest income of $840,000, $1,100,000, $449,000, $207,000, and $149,000 would have been recorded during the periods ended December 31, 1997, 1996, 1995,1994, and 1993 respectively.
Effective January 1, 1995, Pinnacle adopted FASB Statement No. 114, (as amended by Statement 118), "Accounting by Creditors for Impairment of a Loan". For further discussion see Note 7 to consolidated financial statements of Pinnacle's contained later in this document.
Pinnacle has no loans for which the terms have been renegotiated to less than market rates due to weakening of a borrower's financial condition.
POTENTIAL PROBLEM LOANS
In addition to the loans classified as nonaccrual or greater than 90 days delinquent and still accruing interest, there were other loans of approximately $21.5 million and $11.1 million at December 31, 1997 and 1996, respectively, where management is closely following the borrower's ability to continue to comply with loan payment terms. Current conditions do not warrant classification as nonperforming, nor is any principal loss on these loans considered likely at this time.
FOREIGN LOANS
Pinnacle's loans outstanding to borrowers in foreign countries as of December 31, 1997 and 1996 did not exceed 1% of its total assets.
LOAN CONCENTRATIONS
As of December 31, 1997, there were no concentrations of loans to individual borrowers that exceeded 10% of total loans.
The following table summarizes the loan loss experience, and provides a breakdown of the allowance for loan losses at December 31 of each year.
The allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the above categories of loans at the dates indicated. The allowance is based on management's periodic evaluation of the loan portfolio and reflects an amount that, in management's opinion, is adequate to absorb losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior loan loss experience, the composition of the loan portfolio, and management's evaluation of the collectability of specific loans.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses increased by $5.6 million or 37.7% to approximately $20.5 million at December 31, 1997 from approximately $14.9 million at December 31, 1996. The increase was largely the result of an additional $10.0 million provision for loan losses recorded in the third quarter of 1997 to conform loan loss reserve methodologies in connection with the third quarter 1997 acquisitons of IFC and CB. In completing Pinnacle's allowance for loan losses conformity review of IFC and CB, Pinnacle applied the general reserve assumptions consistent with those utilized historically by Pinnacle. The allowance for loan losses increased by $1.1 million or 7.62% to approximately $14.9 million at December 31, 1996 from approximately $13.9 million at December 31, 1995. The allowance as a percentage of total loans was 1.05%, and 1.14%, respectively, for such dates indicated. The allowance for loan losses increased primarily due to the $205.6 million increase in loans receivable during the year.
Net charge-offs for the year ended December 31, 1997 were $8.2 million or .55% of average loans outstanding as compared to $1.6 million, or .12% for the year ended December 31, 1996. The increase in net charge-offs for the year ended December 31, 1997 were primarily in the commercial real estate and commercial loan portfolio which totaled $4.6 million in 1997 as compared to $32,000 in 1996 and the mortgage loan repurchase portfolio which totaled $2.0 million for the year ended December 31, 1997 as compared to $501,000 for the year ended December 31, 1996. Pinnacle realized losses on those loans that had specific reserves established. Net charge-offs for the year ended December 31, 1996 were $1.6 million, or .12%, of average loans outstanding as compared to $1.2 million, or .12%, for the year ended December 31, 1995. Recoveries on previously charged-off loans were $735,000, in 1996 and $335,000, in 1995. At December 31, 1996 and 1995, nonaccrual loans amounted to $11.1 million, and $10.5 million, respectively. Pinnacle's management believes these increases are attributable primarily to the Maco Acquisition and to the significant increase in loans receivable and are not due to any general decline in credit quality.
Other loans of concern to Pinnacle management increased to approximately $21.5 million as of December 31, 1997. Other loans of concern to Pinnacle management increased to approximately $11.1 million as of December 31, 1996 as compared to approximately $10.5 million in 1995. In the opinion of Pinnacle's management, the allowance for loan losses is adequate and appropriately reflects the risk inherent in each of the period-end loan portfolios. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on economic conditions and borrower circumstances. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Pinnacle's allowance for loan losses. Such agencies may require Pinnacle to recognize additions to the allowance based on their judgments regarding information available to them at the time of their examination.
NONEARNING ASSETS. Premises and equipment increased $3.2 million to $29.3 million as of December 31, 1997 from $26.1 million as of December 31, 1996. The increase was primarily from investment in technology and computer based systems needed to support the consolidated operations after the acquistions of IFC and CB. Premises and equipment increased $229,000 to $26.1 million as of December 31, 1996 from $25.9 million as of December 31, 1995. Capital improvements for the year ended December 31, 1997 and 1996 totaled $6.3 and $1.7 million, respectively.
Interest receivable and other assets increased $30.2 million to $109.2 million at December 31, 1997 as compared to $79.0 million at December 31, 1996. The increase was primarily from the company's investment of $25.0 million in bank owned life insurance purchased in 1997. Other real estate decreased $618,000 to $4.5 million for the same time periods. Goodwill and other purchased intangible assets decreased $1.7 million to $16.8 million at December 31, 1997, primarily
through expense provisions in 1997. Interest receivable and other assets increased to $79.0 million from $73.9 million as of December 31, 1996 and 1995, respectively. The increase was primarily from higher levels of accrued interest associated with higher levels of earning assets. Other real estate decreased to $5.2 million from $5.9 million for the same time periods. Goodwill and other purchased intangible assets decreased $2.4 million to $18.5 million as of December 31, 1996 as compared to $20.9 million at December 31, 1995, primarily through expense provision in 1996 and through a favorable tax treatment in 1996 on the recapture of bad debt reserves for thrifts of approximately $600,000.
INTEREST-BEARING LIABILITIES. In 1997, average interest bearing liabilities increased from $1.7 billion at December 31, 1996 to $1.9 billion at December 31, 1997, an increase of $197.9 million or 11.9%. The increase was primarily from increased advances from the FHLB and securities sold under repurchase agreements and other borrowing which increased $161.4 million or 47.7%. In 1996, average interest-bearing liabilities increased from $1.2 million at December 31, 1995 to $1.7 million at December 31, 1996. The Maco Acquisition was the primary reason for the increase with the acquisition providing $393.6 million of the increase and the increase of FHLB advances, securities sold under repurchase agreements and other borrowings which increased $185.1 million or 64.6%.
OTHER LIABILITIES. At December 31, 1997, other liabilities increased $2.7 million or 18.4% to $17.5 million from $14.8 million as of December 31, 1996 which decreased $2.4 million, or 14.0% from $17.2 million as of December 31, 1995.
LIQUIDITY
Liquidity is the ability to satisfy demands for extensions of credit, deposit withdrawals, and other customer and operational needs. Traditional sources of liquidity include asset maturities and core deposit growth. Pinnacle maintains a portion of its assets in liquid form to meet anticipated withdrawal requirements and loan demand from customers. At December 31, 1997, cash and due from banks, federal funds sold, and money market instruments equaled approximately $57.2 million. Additional liquidity, is provided by the ability to borrow from the Federal Reserve Bank and Federal Home Loan Bank of Indianapolis. As of December 31, 1997, Pinnacle had borrowed $414.4 million from the Federal Home Loan Bank of Indianapolis to match longer term loans and specific securities with matching maturities.
Pinnacle identified securities totaling approximately $419.3 million and $513.5 million, respectively, as being available-for-sale at December 31, 1997 and December 31, 1996, respectively. They also identified securities totaling approximately $14.3 million as being held-to-maturity at December 31, 1996. Consequently, this portfolio, which totaled $419.3 million at December 31, 1997, is available to meet most any liquidity need of Pinnacle.
Proceeds from the sales of securities available-for-sale amounted to $205.1 million in 1997 and $146.6 million in 1996, with resulting net gains of $813,000 and $708,000, respectively. At December 31, 1997, gross unrealized holding gains and gross unrealized holding losses in Pinnacle's total security portfolio amounted to approximately $4.1 million and approximately $723,000, respectively. At December 31, 1996 gross unrealized holding gains and gross unrealized holding losses in Pinnacle's total security portfolio amounted to approximately $2.9 million and $2.8 million respectively.
The focus of liquidity management at Pinnacle is to satisfy general operating expenses, to service existing debt, and to take advantage of investment opportunities which Pinnacle's management believes will result in an improved return to stockholders.
There are statutory and regulatory requirements applicable to the payment of dividends by Pinnacle Bank as well as by Pinnacle to its stockholders. Under applicable dividend restrictions, Pinnacle Bank, without obtaining government approvals, could declare aggregate dividends in 1997 of approximately $ million from retained net profits of the preceding two years, plus an amount approximately equal to the net profits (as measured under current regulations), if any, earned for the period from January 1, 1997 through the date of declaration less dividends previously paid in 1997.
INTEREST RATE SENSITIVITY
Interest rate sensitivity is measured by analyzing the maturity and timing of interest rate changes on assets and liabilities. The "gap" is the amount by which interest-sensitive assets exceed interest-sensitive liabilities for any given period. In periods of increasing interest rates, a positive gap will generally result in increased net interest income; conversely, a negative gap will result in decreased net interest income in such periods. In periods of decreasing interest rates, a positive gap will result in decreased net interest income, and a negative gap will result in increased net interest income.
To manage Pinnacle's exposure to changes in interest rates, management of Pinnacle closely monitors its interest rate risk. An asset/liability committee consisting of senior officers meets regularly and reviews Pinnacle's interest rate risk position and makes recommendations for adjustments to the position. In addition, the Board of Directors of Pinnacle periodically reviews their asset/liability position, including simulations of the effect on Pinnacle's earnings and capital of various interest rate scenarios.
In managing its asset/liability mix, and depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, Pinnacle may place somewhat greater emphasis on maximizing its net interest margin than on matching the interest rate sensitivity of its assets and liabilities in an effort to increase its net income. Management believes that the increased net income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates which can result from such mismatch. As a result, there may be relatively more exposure to rapid increases in interest rates than some other institutions which concentrate principally on matching the duration of their assets and liabilities.
Pinnacle is managing its current negative gap position by emphasizing variable rate loans, investing in short-term securities, and encouraging longer term deposit products through pricing strategies. The following table sets forth management's estimate of the projected maturities and/or repricing of Pinnacle's assets and liabilities as of December 31, 1997. In preparing the table, management of Pinnacle has assumed that loans prepay to varying degrees based on type, maturity and rate. Certificates of deposit have been entered into the analysis based on contractual maturity.
INTEREST RATE SENSITIVITY/GAP ANALYSIS
Certain shortcomings are inherent in the above analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of, or lag behind, changes in market rates. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the analysis. Finally, in the event of rising interest rates, management may choose to increase the rates paid on deposit accounts in order to retain those accounts.
Year 2000
Many existing computer programs use only two digits to identify a year in the date field. These programs were designed without considering the impact of the upcoming change in the century. If not corrected, many computer applications and systems could fail or create erroneous results by or at the year 2000. The Company developed a plan to deal with the year 2000 problem and began a process to be year 2000 compliant. The plan provides for conversion efforts to be completed by the end of 1998. The total cost of the project cannot be estimated as of December 31, 1997. The Company is expensing all costs associated with these changes as the costs are incurred.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of Pinnacle are monetary in nature. As a result, interest rate have a more significant impact on Pinnacle's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.
EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income" ("Statement No. 130"). This Statement establishes standards for reporting and displaying comprehensive income and its components within the consolidated financial statements. Comprehensive income is defined in FASB Concepts Statement 6 as the "change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." The Statement is effective for fiscal years beginning after December 15, 1997 and is not expected to have a material impact on the Pinnacle results of operations.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements. This Statement requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. This Statement supersedes FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise." Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This Statement is effective for financial statements for periods beginning after December 15, 1997 and is not expected to have a material impact on Pinnacle.
In February 1998, the Financial Accounting Standards Board issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement revises employers' disclosures about pension and other postretirement benefit plans and standardizes the disclosure requirements to the extent practicable, requires additional information on Changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis and eliminates certain disclosures. This statement is effective for fiscal years beginning after December 15, 1997 and is not expected to have a material impact on Pinnacle.
RECENT LEGISLATION
Legislation was enacted in 1996 that resulted in, among other things, the assessment of a one-time charge against financial institutions with deposits insured by SAIF. The amount of the charge equaled approximately .657% of the deposits of a financial institution held on March 31, 1995 and subject to the SAIF premium. The Special Assessment was due on October 1, 1996 and payable no later than November 27, 1996. As a result of the Special Assessment, Pinnacle paid an assessment of $5.9 million.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Managing interest rate risk is fundamental to the financial services industry. Pinnacle's policies are designed to manage the inherently different maturity and repricing characteristics of the loan, investment security, and deposit portfolios. In doing so, Pinnacle is able to achieve a desired interest sensitivity position and to limit exposure to interest rate risk, while optimizing interest income within the constraints of prudent capital adequacy and liquidity needs. Principal maturities and repricing profiles are monitored through static gap analysis and future operating results are simulated through computer modeling.
The management of interest rate sensitivity includes monitoring the maturities and repricing opportunities of interest earning assets and interest bearing liabilities. The Corporation's interest rate sensitivity/GAP analysis as of December 31, 1997 is included in the Liquidity section of Management's Discussion and Analysis of this form 10-K. A rate sensitivity position is computed for various repricing intervals by calculating rate sensitivity gaps. Interest earning assets and interest bearing liabilities have been distributed based on their repricing opportunities. The maturities of certain investments, loans and deposits have been adjusted based on projected prepayment patterns or historical relationships to changes in market interest rates. Although rate sensitivity gaps constantly change as funds are acquired and invested, Pinnacle's negative gap of $346,426 million at one year or less at December 31, 1997, as approximately 16.4% of total assets. This, in the opinion of management, represented a relatively balanced position.
For further discussion regarding Quantitative and Qualitative Disclosure about Market Risk, see Item 7 of this Form 10-K, "Management Discussion and Analysis of Financial Condition and Results of Operations--Liquidity.''
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors Pinnacle Financial Services, Inc.
We have audited the accompanying consolidated balance sheet of Pinnacle Financial Services, Inc. and subsidiaries (the Company) as of December 31, 1997 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Financial Services, Inc. and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
We previously audited and reported on the consolidated balance sheet of Pinnacle Financial Services, Inc. and subsidiaries as of december 31, 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years ended December 31, 1996, and 1995, prior to their restatement for the 1997 pooling of interests. The contribution of Pinnacle Financial Services, Inc. and subsidiaries to total assets and net income represented 50% and 57% of the respective restated totals for the year ended December 31, 1996 and the contribution of Pinnacle Financial Services, Inc. and subsidiaries to total assets and net income represented 50% and 40% of the respective restated totals for the year ended December 31, 1995. Separate consolidated financial statements of the other companies included in the December 31, 1996 restated consolidated balance sheet and consolidated statements of income, changes in stockholders' equity, and cash flows for the years ended December 31, 1996 and 1995 were audited and reported on separately by other auditors. We also audited the combination of the accompanying consolidated balance sheet as of December 31, 1996 and consolidated statements of income, changes in stockholders' equity, and cash flows for the years ended December 31, 1996 and 1995, after restatement for the 1997 pooling of interests; in our opinion, such consolidated statements have been properly combined on the basis described in note 1 of the notes to the consolidated financial statements.
/s/ KPMG Peat Marwick LLP
Chicago, Illinois March 30, 1998
PINNACLE FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
See accompanying notes to consolidated financial statements.
PINNACLE FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
See accompanying notes to consolidated financial statements.
PINNACLE FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
See accompanying notes to consolidated financial statements.
PINNACLE FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
See accompanying notes to consolidated financial statements.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Pinnacle Financial Services, Inc. and subsidiaries conform to generally accepted accounting principles and prevailing practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that effect 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, revenues and expenses during the reporting period. Actual results could differ from those estimates.
The following are significant accounting and reporting policies of Pinnacle Financial Services, Inc. and subsidiaries.
(a) Consolidation
The consolidated Pinnacle Financial Services, Inc. entity (the "Company") was formed on August 1, 1997 through a merger transaction whereby Indiana Federal Corporation and subsidiaries ("IFC") and CB Bancorp, Inc. and subsidiaries ("CB") were merged with and into the then existing Pinnacle Financial Services, Inc. and subsidiaries ("Pinnacle"). The merger transaction was accounted for in accordance with the pooling-of-interests method of accounting for a business combination. Accordingly, the consolidated financial statements included herein reflect the combination of the historical financial results of Pinnacle, IFC and CB and their respective recorded assets and liabilities have been restated at their historical cost as if the combining companies had been consolidated for all periods presented.
As a result of the merger transaction, the consolidated financial statements include the accounts of Pinnacle Financial Services, Inc. and its wholly-owned subsidiaries, Pinnacle Bank (the "Bank"), IndFed Mortgage Company, and Pinnacle Financial Consultants. Pinnacle Bank's two wholly-owned subsidiaries are Starkeis, Inc. and Brookview Real Estate, LTD. Effective December 31, 1996, Pinnacle Bank-Indiana (formerly a wholly-owned subsidiary of Pinnacle Financial Services, Inc.) was merged with and into Pinnacle Bank-Michigan, now collectively known as Pinnacle Bank. Significant intercompany balances and transactions have been eliminated in consolidation.
Prior to the combination, CB's fiscal year ended March 31. In restating the historical consolidated financial statements included herein, the consolidated financial statements as of and for the year ended December 31, 1997 reflect transactions on a merged basis from January 1, 1997 through December 31, 1997. Additionally, CB's financial statements as of March 31, 1997 and 1996 and for each of the years in the two year period ended March 31, 1997 were combined with Pinnacle's and IFC's financial statements as of December 31, 1996 and 1995 and for each of the years in the two year period ended December 31, 1996. An adjustment of $745,000 was recorded in the consolidated statement of changes in stockholders' equity for the year ended December 31, 1997 to remove CB net income from January 1 through March 31, 1997 from retained earnings, which amount is included in December 31, 1996 retained earnings.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(b) Securities
Securities which management believes could be sold prior to maturity in order to manage interest rate risk, prepayment risk, liquidity risk, or other corporate purposes are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of applicable income taxes, reported as a component of stockholders' equity. Securities which management believes are held for resale in anticipation of short-term market movements are classified as trading securities which are stated at fair value with unrealized holding gains and losses recognized in the income statement. Securities, other than the foregoing, which management has the positive ability and intent to hold until maturity are classified as securities held-to-maturity and are accounted for using historical amortized cost. At December 31, 1997, the company had no trading or held-to-maturity securities.
Premiums and discounts on securities are amortized and accreted over the life of the related security as an adjustment to yield using the effective interest method. Gain or loss on the sale of securities is determined based on the adjusted cost of the specific security sold. A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary results in a charge to earnings thereby establishing a new cost basis for the security.
(c) Mortgage Loans Purchased Under Agreements to Resell
The Company purchases residential mortgage loans from various mortgage companies prior to sale of these loans by the mortgage companies in the secondary market. The Company held loans that were purchased under agreements to resell from approved mortgage companies as of December 31, 1997. The Company purchases such loans from mortgage companies at par, net of certain fees, and later sells them back to the mortgage companies at the same amount and without recourse provisions. As a result, no gains and losses are recorded at the resale of loans. The Company records interest income on the loans during the funding period and fee income received from the mortgage company for each loan when the loan is sold. The Company uses the stated interest rate in the agreement with each mortgage company for interest income recognition, and not the interest rates on individual loans. The Company does not retain servicing of the loans when they are resold. Purchase money and refinancing mortgage loans are generally held no more than 90 days by the Company and typically are resold within 30 days. Construction loan mortgages acquired are held for the duration of the construction loan period, which approximates one year or less.
(d) Mortgage loans Held for Sale
Loans held for sale are carried at the lower of aggregate cost or market value. Net unrealized losses are recognized in a valuation allowance by charges to income.
(e) Allowance for Loan Losses
The allowance for loan losses is increased by provisions charged to operating expense, is decreased by charge offs, net of recoveries, and is available for losses incurred on loans, including certain accrued interest receivable. The allowance for loan losses is based on management's periodic evaluation of the loan portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior loan loss experience, the composition of the loan portfolio, and management's evaluation of the collectibility of specific loans. Management believes that the allowance for loan losses is adequate to absorb potential losses in the portfolio, however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies periodically review the provision for loan losses. These agencies may require that additions be made to allowance for loan losses based upon their
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
judgment of information available to them at the time of their examination.
A loan is considered impaired when it is probable that a creditor will be unable to collect contractual principal and interest due according to the contractual terms of the loan agreement. Impaired loans are generally considered by the Company to be nonaccrual commercial and commercial real estate loans, restructured loans and commercial and commercial real estate loans for which principal and/or interest is at risk. Impairment is measured by determining the fair value of the loans based on the present value of expected cash flows, the market price of the loans, or the fair value of the underlying collateral. If the fair value of the loan is less than the recorded book value, a valuation allowance is established as a component of the allowance for loan losses.
(f) Nonperforming Assets
Nonperforming assets are comprised of loans for which the accrual of interest has been discontinued, loans contractually past due 90 days or more as to interest and/or principal and not included in nonaccrual loans, and other real estate which has been acquired primarily through foreclosure and is awaiting disposition. Loans are generally placed on a nonaccrual basis when, in the opinion of management, collection of principal or interest payments is unlikely. Income on such loans is then recognized only to the extent that cash is received and where future collection of principal is probable.
Other real estate is carried at the lower of cost or fair value, less estimated costs to sell. When the property is acquired through foreclosure, any excess of the related loan balance over estimated fair value is charged to the allowance for loan losses. Subsequent write-downs, losses upon sale, and expenses related to maintenance of properties are charged to other expense.
(g) Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation, computed on the straight-line and accelerated methods, is charged to operations over the estimated useful lives of the properties.
(h) Goodwill and Other Intangibles
Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis up to 15 years with a remaining life of approximately 10 years at December 31, 1997. At December 31, 1997 and 1996, goodwill of approximately $13,393,000 and $14,604,000, respectively, is included in other assets in the accompanying consolidated balance sheets.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Core deposit intangibles, representing the premium associated with the acquisition of certain deposit liabilities, are being amortized to operating expenses on a straight-line basis over the average lives of approximately 7 to 10 years of such deposit liabilities, with a remaining life at December 31, 1997 of approximately 4 years. At December 31, 1997 and 1996, core deposit intangibles of approximately $2,687,000 and $3,368,000, respectively, are included in other assets in the accompanying consolidated balance sheets.
The Company assesses the recoverability of its goodwill and other intangibles through review of various economic factors on a periodic basis in determining whether impairment, if any, exists.
(i) Loan Servicing Rights
The Company recognizes as a separate asset the right to service loans for others which are amortized over the estimated lives of the loans. The Company also evaluates these servicing rights for impairment based on the current fair value of those rights. Impairment is recognized through a valuation allowance established through a charge to expense. Loan servicing rights as of December 31, 1997 and 1996 totaled approximately $1,029,000 and $477,000, respectively.
(j) Trust Assets
Assets held by the Company in fiduciary or agency capacity for customers are not assets of the Company and as such are not included in the consolidated financial statements. Fee income is recognized on an accrual basis for financial reporting purposes.
(k) Employee Stock Ownership Plan
The Company has established an Employee Stock Ownership Plan (the ESOP) for the former employees of IFC and CB. The Company recognizes compensation expense for the applicable ESOP shares based on the fair value of those shares when committed to be released to employees, rather than based on their original cost in accordance with the American Institute of Certified Public Accountants & Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans (SOP93-6).
(l) Retirement Plans
Costs for the Company's defined benefit plans, which cover substantially all employees of the former Pinnacle and CB entities, are accounted for in accordance with the requirements of Statement of Financial Accounting Standards No. 87, "Employers: Accounting for Pensions". The projected unit credit method is utilized for measuring net periodic pension cost over the employees' service life. The Company's funding policy is to contribute annually an amount calculated under the minimum ERISA funding requirements.
(m) Postretirement Benefits Other Than Pensions
An accrual for postretirement benefits is charged to current earnings based upon the expected cost of providing postretirement benefits to employees during the years that the employees render services.
(n) Stock Option Plan
As of December 31, 1996, the Company adopted the disclosure requirements of Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation". The Company applies APB Opinion 25, "Accounting for Employee Benefit Plans" and related interpretations in accounting for its stock option plan.
(o) Income Taxes
Prior to the merger Pinnacle, IFC and CB and their respective subsidiaries each filed consolidated U.S. income tax returns. The consolidated tax liability is settled between companies generally as if each company had filed a separate return. For the year ended December 31, 1997, the Company and its subsidiaries will file consolidated tax returns.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes", the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
(p) Income Recognition
The Company uses the accrual basis of accounting for financial reporting purposes. Loans are stated at the principal amount outstanding, net of any unearned income. Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the yield.
(q) Statements of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold.
(r) Per Share Data
Basic net income per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during each period. The diluted net income per share calculation is adjusted for the effects of options. Average shares have been increased for the assumed conversion of outstanding options into common shares and is retroactively adjusted for stock splits and stock dividends. Cash dividends declared per share are based upon the number of shares outstanding at date of declaration, retroactively adjusted for stock splits and stock dividends.
(s) Reclassifications
Certain prior year amounts have been reclassified to conform to current year presentation.
NOTE 2 SUPERVISION AND REGULATION
The Company and its subsidiary bank are subject to supervision, regulation and periodic examination by various federal and state banking regulatory agencies including the Board of Governors of the Federal Reserve Board (the "FRB"), the Federal Deposit Insurance Corporation (the "FDIC"), and the Michigan Financial Institutions Bureau (the "FIB"). Since the Company is a bank holding company, the Company's activities are limited to the business of banking and activities closely related to banking.
The following is a summary of certain statutes and regulations affecting the Company. This summary is qualified in its entirety by such statutes and regulations, which are subject to change based on pending and future legislation and action by regulatory agencies.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BANK HOLDING COMPANIES. As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and by the FRB.
Banking laws and regulations restrict transactions by insured banks owned by a bank holding company, including loans to and certain purchases from the parent holding company, non-bank and bank subsidiaries of the parent holding company, principal stockholders, officers, directors and their affiliates, and investments by the subsidiary banks in the shares or securities of the parent holding company (or of any other non-bank or bank affiliates), and acceptance of such shares or securities as collateral security for loans to any borrower. The regulators also review other payments, such as management fees, made by subsidiary banks or affiliated companies.
Under the BHCA, a bank holding company is prohibited, with certain limited exceptions, from engaging in activities other than those of banking or of managing or controlling banks and from acquiring or retaining direct or indirect ownership or control of voting shares or assets of any company which is not a bank or bank holding company, other than subsidiaries engaged in activities which the Federal Reserve Board determines to be so closely related to banking and managing or controlling banks as to be a proper incident thereto.
BANKS. The Company's subsidiary bank is subject to regulation, supervision and periodic examination by the Michigan FIB. Additionally, as an institution whose deposits are insured by the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF") of the FDIC, Pinnacle Bank is also subject to supervision, regulation and periodic examination by the FDIC.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--- actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank'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 Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 1997, the most recent notification from the primary regulator of Pinnacle Bank categorized the 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, Tier I leverage ratios as set forth in the table. This notification occurred prior to the effective date of the pooling. There are no conditions or events since that notification that management believes have changed the institution's category.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's and the Bank's actual capital amounts and ratios are also presented in the tables for 1997 and 1996.
NOTE 3 MERGERS AND ACQUISITIONS
Effective August 1, 1997, the Company issued 4,790,736 and 1,553,144 shares of its common stock in exchange for all outstanding common stock of Indiana Federal Corporation ("IFC") and CB Bancorp, Inc. ("CB"), respectively, both of which were thrift holding companies located in Valparaiso and Michigan City, Indiana, respectively. Total assets acquired of IFC and CB were $835 million and $288 million respectively. The business combinations have been accounted for as pooling-of-interests transactions, and accordingly, the consolidated financial statements for periods prior to the combinations have been restated to include the accounts and results of operations of IFC and CB.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The results of the operations previously reported by the separate enterprises and the combined amounts presented in the accompanying consolidated financial statements are summarized below (in thousands):
On October 1, 1996, the Company , through Pinnacle Bank, purchased Starke's, Inc., a local insurance agency, through the issuance of 99,451 shares of Pinnacle common stock. The assets acquired were $1,241,000 and the transaction was accounted for using the pooling-of-interests method with no restatement of prior periods as amounts involved were not material.
On December 1, 1995, the Company acquired all of the outstanding stock of Maco Bancorp, Inc. ("Maco"), a Delaware corporation and registered savings and loan holding company headquartered in Merrillville, Indiana, for a purchase price of $41,944,000 (the "Purchase Price"). Approximately 50% of the Purchase Price was paid in cash ($20,959,000) and the balance was paid in Pinnacle common stock valued at $20,985,000. The acquisition of Maco was accounted for as a purchase. All assets (approximately $412,800,000) and all liabilities (approximately $384,200,000) of Maco and its subsidiaries (First Federal Savings Bank of Indiana, Brookview Real Estate Ltd. and First Insurance, Inc.) were adjusted to fair value as of the effective date creating goodwill in the amount of $13,350,000 which is being amortized on a straight line basis over 15 years. Premiums and discounts on the fair value adjustments amounted to approximately $3,895,000 and $830,000, respectively. The operating results of Maco have been included in the Company's financial statements since the date of acquisition.
On January 31, 1995, the Company acquired, for $8.2 million, NCB Corporation ("NCB"), a bank holding company with total assets of approximately $45.0 million with offices in Culver and Granger, Indiana. The operations of NCB are included in the Company's financial statements since the date of acquisition and reflect the application of the purchase method of accounting. Under this method of accounting, the aggregate cost to the Company of the acquisition was allocated to the assets acquired and liabilities assumed, based on their estimated fair values as of January 31, 1995, creating goodwill in the amount of $1.5 million which is being amortized on a straight line basis over 15 years.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" (Statement 107), requires that the Company disclose estimated fair values for its financial instruments in its consolidated financial statements. Fair value estimation methods and assumptions are presented below for the Company's consolidated financial statements.
The estimated fair value of the Company's financial instruments at December 31, 1997 and 1996 was as follows:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD: The carrying value of cash and due from banks and federal funds sold approximates fair value due to the short term maturity of those instruments.
INTEREST-BEARING DEPOSITS WITH FINANCIAL INSTITUTIONS AND SECURITIES: Fair values of these instruments are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of comparable assets.
MORTGAGE LOANS HELD FOR SALE: Fair value are estimated based on quoted market prices.
NET LOANS: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, and consumer, including credit card loans. Each loan category is further segmented into fixed and adjustable rate interest terms.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of performing loans, except credit card loans, is calculated by discounting scheduled cash flows through the estimated maturity using the current rates at which similar loans would be made to borrowers with similar credit ratings with the same remaining maturities. The estimate of the maturity is based on industry forecast experience with repayments for each loan classification. The fair value of variable rate loans repricing within three months and credit card loans were assumed to be at carrying value.
Fair value for nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
ACCRUED INTEREST RECEIVABLE AND ACCRUED INTEREST PAYABLE: The carrying value of accrued interest receivable and accrued interest payable approximates fair value due to the relatively short period of time to expected realization.
NONINTEREST-BEARING AND INTEREST-BEARING DEPOSITS: The fair value of deposits with no stated maturity, such as demand deposits, savings, NOW accounts and money market accounts, is equal to the amount payable on demand as of December 31, 1997 and 1996. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for similar remaining maturities.
FEDEERAL HOME LOAN BANK ADVANCES, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND OTHER BORROWINGS: The carrying amounts for securities sold under repurchase agreements and certain other borrowings approximate fair value as they mature in 90 days or less. The fair value of certain other borrowings with maturities greater than 90 days are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT: The value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties.
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 Company's entire holdings of particular financial instruments. Because no market exists for a significant portion of the Company'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.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. For example, the Company has a substantial trust department that contributes net fee income annually. The trust department is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include the mortgage servicing rights, premises and equipment, and intangible assets. 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 5 CASH AND DUE FROM BANKS
The Bank is required to maintain certain daily reserve balances on hand in accordance with Federal Reserve Board requirements. The reserve balances maintained in accordance with such requirements at December 31, 1997 and 1996, were $12,086,000 and $10,603,000, respectively.
NOTE 6 SECURITIES
The following summarizes the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities at December 31, 1997.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summarizes the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities at December 31, 1996.
The following summarizes the amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for securities held to maturity at December 31, 1996.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Maturities of investment securities classified as available-for-sale at December 31, 1997 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of securities (excluding trading securities) during 1997, 1996 and 1995 were $205,901,000, $146,580,000, and $140,291,000, respectively. Gross gains of $1,236,000, $841,000, and $1,599,000 and gross losses of $423,000, $150,000, and $809,000 were realized on those sales for 1997, 1996, and 1995, respectively. During 1997, 1996, and 1995 there were no sales of securities classified as held-to-maturity.
On August 1, 1997, securities held-to-maturity were reclassified to available-for-sale upon consummation of the CB merger to conform to Pinnacle's classification of investment securities. At the date of transfer, the securities had an amortized cost and net unrealized gain of $14.0 million and $200,000, respectively.
Mortgage-backed securities include mortgage-backed securities and collateralized mortgage obligations. The mortgage-backed securities represent participating interest of pools of long-term first mortgage loans originated and serviced by the issuers of the securities. Collateralized mortgage obligations are debt securities that are secured by mortgage loans or other mortgage-backed securities.
Securities with an amortized cost of $40,206,000 and $356,602,000 at December 31, 1997 and 1996, respectively, were pledged to secure public deposits and securities sold under agreements to repurchase and for other purposes as required by law or contract.
The Company did not have any investment securities that individually exceeded 10% of stockholders' equity at December 31, 1997 and 1996.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 LOANS
The following summarizes loans by classification at December 31 of each year.
MORTGAGE LOANS PURCHASED UNDER AGREEMENTS TO RESELL
The Company has entered into agreements with mortgage companies in which the Company purchases, at its discretion, mortgage loans from the mortgage companies at par, net of certain fees, and later sells them back to the mortgage companies at the same amount and without recourse provisions. The Company records interest income on the loans during the funding period and the Company records fee income (recorded as noninterest income) received from the mortgage company for each loan when resold. The interest income recorded is based on a rate of interest tied to the prime rate (as established from time to time by a major Chicago-based financial institution) during the funding period, and not the rates on individual loans. Such loans are reviewed, prior to purchase, for evidence that the loans are of secondary market quality or meet the Company's internal underwriting guidelines. An assignment of the mortgage to the Company is required. In addition, the Company either takes possession of the original note and forwards such note to the end investor or the Company receives a certified copy of the note and subsequently receives acknowledgment from the end investor of receiving the original note. A commitment to purchase from an end investor is generally required prior to purchase by the Company. In the event that the end investor would not honor this commitment and the mortgage companies would not be able to honor their repurchase obligations, the Company would then need to sell these loans in the secondary market at the fair value of these loans. Purchase money and refinance loans are generally held no more than 90 days by the Company and are typically resold within 30 days. The Company also purchases interim construction loans under this program and holds these loans for the duration of the construction loan period which typically approximates one year or less. The Company had approximately $21,566,000 and $25,407,000 of interim construction loans purchased under agreements to resell at December 31, 1997 and 1996.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 LOANS (CONTINUED)
The following summarizes nonaccrual loans and loans greater than 90 days delinquent which are still accruing interest at December 31 of each year.
For the years ended December 31, 1997, 1996 and 1995, if nonaccrual loans had been maintained current in accordance with their original terms, additional interest income of $840,000, $1,100,000, and $449,000, respectively, would have been realized.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 LOANS (CONTINUED)
The recorded investment in impaired loans at December 31, 1997 and 1996 totaled $16.5 million and $13.3 million, respectively, for which a specific allowance for loan losses of $2.9 million and $1.6 million, respectively, was required as of and for the years then ended. As of December 31, 1997 and 1996, the average recorded investment in impaired loans approximated $15.4 million and $10.9 million, respectively. For the years ended December 31, 1997 and 1996, interest income recorded on such loans totaled $1,031,000 and $688,000, respectively, of which $547,000 and $475,000 respectively has been recorded on a cash basis.
Certain officers, directors, and entities with which they are affiliated have borrowed funds from the Company. These loans were made in the ordinary course of business on substantially the same terms as loans to other persons and, in the opinion of management, do not involve more than the normal risks of collectibility or present other unfavorable features. Such loans at December 31, 1997 and 1996 aggregated approximately $19,413,000 and $14,903,000, respectively. The net increase of $4,510,000 in such loans resulted from new loans of $5,087,000 and collections on loans of $577,000.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summarizes the activity in the allowance for loan losses for the years ended December 31.
NOTE 8 PREMISES AND EQUIPMENT, NET
The following summarizes premises and equipment by classification at December 31.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 TIME DEPOSITS
The following summarizes time deposits and their remaining maturities, included in interest-bearing deposits at December 31.
NOTE 10 BORROWINGS
The following is a schedule of securities sold under repurchase agreements and other borrowings at December 31 of each year.
Securities sold under repurchase agreements represent an indebtedness of the Company secured by certain securities. At December 31, 1997 and 1996, the interest cost with regard to daily averages was 5.11% and 4.36%, respectively. Securities with an amortized cost of $31.8 million and $29.9 million and an estimated fair value of approximately $ 31.9 million and $29.8 million were pledged as collateral for these agreements at December 31, 1997 and 1996, respectively.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Federal funds purchased, which mature daily, had an interest cost of 6.24% at December 31, 1996. There were no federal funds purchased at December 31, 1997.
Federal Home Loan Bank advances represent borrowings from Federal Home Loan Bank. Advances of $927.0 million, and $728.9 million, were drawn upon during 1997, and 1996, respectively. At December 31, 1997, 1996, and 1995, respectively, the interest cost with regard to daily averages was 5.67 %, 5.78%, and 6.13%, with maturities of one to ninety-four months. These borrowings are secured by Federal Home Loan Bank stock (carried at $30.9 million), by all eligible first mortgage loans on one-to-four family dwellings held by the Bank (approximately $553.0 million at December 31, 1997) and by specific securities with a carrying value of approximately $269.9 million.
Other borrowings at December 31, 1996 consisted of the guaranteed ESOP obligation. The ESOP entered into a loan agreement to borrow up to $1.2 million with an unrelated financial institution to purchase shares of common stock in the open market. The balance outstanding as of December 31, 1997 and 1996 was $ 0 and $203,000, respectively.
NOTE 11 INCOME TAXES
Income taxes (benefits) reported in the consolidated statements of income for the years ended December 31, 1997, 1996, and 1995 include the following components.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following federal income tax expense differs from the amounts computed by applying the federal income tax rate of 35% to pretax income at December 31 of each year.
The following presents the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31 of each year.
The valuation allowance for deferred tax assets of $61,000 as of December 31, 1996 was reduced to zero during 1997 due to the utilization of the capital loss carry forward.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 EMPLOYEE BENEFITS
The former Pinnacle, IFC and CB entities had various employee benefit programs for which certain plans have remained in place upon consummation of the merger transactions on August 1, 1997 and as of December 31, 1997. The details of each plan are described herein.
401(K) PLAN The Company sponsors a defined contribution 401(k) plan for the benefit of former Pinnacle employees. The Company matches employee contributions at levels dependent upon current operating results. In 1997, 1996, and 1995, the Company contributions amounted to $128,000, $63,000, and $121,000, respectively. Employee contributions to the plan are based upon optional percentages (ranging from 2% to 10%) of before tax compensation.
PENSION PLANS The Company sponsors a defined benefit pension plan which provides benefits to substantially all full time employees of the former Pinnacle entity. Benefits under the plan are based on the employees' years of service and compensation during the five highest paid plan years of the last ten years preceding retirement. The following presents the components of net pension income at December 31 of each year.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following presents the funded status of the former Pinnacle Bank's plan and amounts recognized in the consolidated balance sheets at December 31 of each year.
The plan assets are invested primarily in a collective investment trust at December 31, 1997, 1996, and 1995.
The Company is also a part of a multi-employer defined benefit pension plan covering substantially all former CB employees. The plan is administered by the directors of the Financial Institutions Retirement Fund. There is no separate actuarial valuation of plan benefits nor segregation of plan assets specifically for the Company. As of June 30, 1997, the latest actuarial valuation, the total plan assets exceeded the actuarially determined value of total vested benefits. The plan was terminated and assets transferred to participants in 1997. There was no pension plan expense or contribution for the years ended December 31, 1997, 1996, and 1995. The administrative cost of the plan is charged to expense and amounted to $1,600, 1,052, and $4,815 for the years ended December 31, 1997, 1996, and 1995, respectively.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company has a Retiree Medical Plan which provides a portion of retiree medical care premiums for certain former Pinnacle employees. The Company's level of contribution is based on age and service formula which provides benefits to substantially all retired participants until December 31, 1997 and will provide benefits to active participants in a 100% co-pay basis until age 65. The components of the 1997, 1996 and 1995 net periodic postretirement benefit cost are shown below:
The funded status of the plan and the amounts recognized in the consolidated balance sheets are shown below:
For measurement purposes, a 8.00%, 9.00%, and 10.00% annual rate of increase in the per capita cost of covered benefits (health care cost trend rate) was assumed for 1997, 1996, and 1995, respectively; the rate was further assumed to decline to 4.00% after 7 years. The health care cost trend rate assumption has an increasing effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $18,500 and $25,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $1,000, $2,000 and $2,000 for years ended December 31, 1997, 1996 and 1995, respectively. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.50% for December 31, 1997 and 1996, and 7.25% for December 31, 1995.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTAL RETIREMENT PLANS
The Company maintains a supplemental retirement plan for executives of the former CB entity. The plan requires acceleration of funding of benefits upon change of control of the former CB entity into the secular trusts already established. The cost of the plan charged to expense was $265,000 for the year ended December 31, 1997 which included the payments to fund the remaining liability under the plan as the merger transaction as described in Note 3 met the change in control provisions per the agreement. The cost of the plan charged to expense was $39,000 and $44,000 for the years ended December 31, 1996 and 1995, respectively. The Company has purchased corporate-owned life insurance to partially fund its obligation under this plan. The accrued liability to the company was $0 at December 31, 1997 and 1996.
The Company also maintains a supplemental retirement plan for certain senior executives of the former IFC entity. The plan requires acceleration of funding of benefits upon change of control of the former IFC entity for certain executives. The cost of the plan charged to expense was $$1,157,000 for the year ended December 31, 1997 which included the payments to fund the remaining liability under the plan for certain executives as the merger transaction described in Note 3 met the change in control provisions per the agreement as well as the annual, actuarially determined amounts for the remaining IFC executives. The cost of the plan charged to expense was $230,000 and $25,000 for the years ended December 31, 1996 and 1995, respectively. The Company has purchased corporate-owned life insurance to partially fund its obligation under this plan. The accrued liability to the Company was $1,387,000 and $230,000 at December 31, 1997 and 1996, respectively.
EMPLOYEE STOCK OWNERSHIP PLANS
The Company has established a leveraged Employee Stock Ownership Plan ("ESOP") in which all former IFC employees who attain minimum age and service requirements are eligible to participate. The Company recorded compensation expense related to the plan of $724,335 , $278,000, and $407,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The Company's 1997 contribution to the ESOP was $257,995 compared to $350,350 in 1996 and $382,628 in 1995. The ESOP plan was terminated in 1997 upon repayment of the ESOP loan and allocation of all remaining shares to participants.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1997 and 1996, the outstanding ESOP loan balance was $0 and $203,096, respectively. The interest incurred on the ESOP loan amounted to $7,507 in 1997, $18,950 in 1996, and $31,250 in 1995. Dividends paid on the unallocated ESOP shares totaled $14,536 in 1997, $45,519 in 1996, and $50,023 in 1995. The table below summarizes shares of Company Stock held by the ESOP.
The Company also maintains an ESOP in which all former CB employees who attain minimum age and service requirements are eligible to participate. The Company recorded compensation expense of $192,634 for the year ended December 31, 1997 and $64,211 for each of the years ended December 31, 1996 and 1995. The Company's contribution to the ESOP was $208,686, $82,993, and $88,772 for the years ended December 31, 1997, 1996, and 1995, respectively. The ESOP plan was terminated in 1997 upon repayment of the ESOP loan and the allocation of all remaining shares to participants. At December 31, 1997 and 1996, the outstanding ESOP loan balance was $0 and $176,852, respectively. The interest incurred on the ESOP loan amounted to $16,052, $18,782, and $24,561 for the years ended December 31, 1997, 1996, and 1995, respectively. The table below summarizes shares of Company stock held by the ESOP.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECOGNITION AND RETENTION PLANS
The Company has established the Recognition and Retention Plans (RRP) as a method of providing directors, officers and other key employees of the former CB entity with a proprietary interest in the Company in a manner designed to encourage such persons to remain with the Company. The terms of each RRP will be identical, only the participants and the number of shares awarded to each participant vary. Eligible directors, officers and other key employees of the Company will earn (i.e., become invested in) shares of common stock covered by the award at a rate of 20% per year. The Company contributed funds to the RRP to enable the Plans to acquire in the aggregate 46,600 shares of common stock. An expense of $7,705, $16,475, and $26,968 was recorded for these Plans for the years-ended December 31, 1997, 1996, and 1995.
DIRECTORS COMPENSATION PLANS
The Company sponsors a stock-based deferred compensation plan for directors of the former IFC entity, in which directors can defer fees and purchase phantom units of the Company's common stock at $11.63. The amount charged to expense related to this plan was $925,497, $156,839, and $162,199, in 1997, 1996, and 1995, respectively. At December 31, 1997, the directors had purchased 38,523 phantom units of which 6,629 were purchased in 1997.
The Company also sponsors a deferred compensation plan for its Board of Directors of the former CB entity. Under the terms of the plan, directors may elect to defer a portion of their fees which would be retained by the Company with interest being credited to the participant's deferred balance. The plan was terminated on August 1, 1997 and directors were paid their accumulated deferred balance which approximated $267,000.
The former CB Board of Directors adopted the Outside Directors' Consultation and Retirement Plan (the "Directors' Consultation Plan"). The purpose of the Directors' Consultation Plan is to provide possible retirement benefits to directors who are not officers or employees of the former CB entity to ensure that the Company will have their continued service and assistance, if annually contracted for by the Board of Directors in the conduct of the Company's business in the future. Effective April 1, 1996, the Board of Directors of the Company approved the Outside Director's Emeritus Plan (the "Directors' Emeritus Plan) to replace the Outside Directors' Consultation and Retirement Plan. The purpose of the Directors' Emeritus Plan is to ensure that the Company may, if the Board so desires, have the continued service and assistance of directors who are not officers or employees of the Company in the conduct of the Company's business in the future.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The resulting liability from the Directors' Emeritus Plan approximates the liability accrued under the Directors' Consultation Plan. An expense of approximately $18,000, 33,000 and $37,000 was recorded for these plans for the years ended December 31, 1997, 1996 and 1995, respectively. The Directors' Emeritus Plan was terminated in 1997 and final payment of $240,000 was made to the directors. Therefore, the resulting liability to the Company was approximately $0 and $244,000 at December 31, 1997 and 1996, respectively.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 STOCK OPTION PLANS
At Pinnacle's 1993 Annual Stockholders Meeting, a non-qualified stock option plan (the "Plan") was presented to and approved by the stockholders of the Company. The Compensation Committee of the Board of Directors, none of whom is eligible to participate in the Plan, awarded certain key employees options to purchase shares of the Company's common stock at an exercise price which approximates the fair market value at the date of grant. All stock options have five year terms and vest and become fully exercisable after five years from date of grant. The Board of Directors of the former CB entity has adopted the CB Bancorp, Inc. 1992 Stock Option Plan for outside directors (the Directors' Plan") of the former CB entity. Options for the purchase of shares of common stock are authorized under the Directors' Plan. The option exercise price must be at least 100% of the fair market value of the common stock on the date of the grant, and the option term cannot exceed 10 years. Eligible directors may exercise 100% of the options awarded to them.
The Company also awards incentive and non-qualified stock options to certain former directors, officers and key employees. All options granted have 10 year terms and vest and become fully exercisable over a 5 year period from the grant date.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the Company's stock options activity and related information for the year ended December 31, is as follows:
At December 31, 1997, the range of exercise prices and weighted average remaining contractual life of outstanding options was $4.62 to $21.16 and 6.0 years, respectively.
The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Proforma information regarding net income and net income per share has been determined under a fair value method. The per share weighted-average fair value of stock options granted during 1997, 1996 and 1995 was $6.63, $4.80, and $3.99, respectively. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
For purposes of pro forma disclosures, if the estimated fair value of the options is amortized to expense over the options' vesting period, the effect on net income would be (in thousands, except per share data):
Pro forma net income and earnings per share reflect only options granted since December 31, 1994. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in pro forma net income and earnings per share presented above because compensation cost is reflected over the options' vested period of generally five years and compensation cost for options granted prior to January 1995 is not considered.
The following table reconciles the denominators for basic and diluted net income per share:
There were no dilutive securities for the years ended December 31, 1997, 1996, and 1995 in calculating the numerator for basic and diluted net income per share.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14 SUPPLEMENTARY INCOME STATEMENT INFORMATION
Other than the items listed below, other noninterest income and other noninterest expenses did not include any accounts that exceeded 1% of total revenue, which is the sum of total interest income and total noninterest income.
NOTE 15 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company 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 are loan commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The contract amount of these instruments reflects the extent of involvement the Company has in these financial instruments.
The following presents financial instruments with off-balance sheet risk at December 31 of each year.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Loan 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 Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the counter party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. All letters of credit are short-term guarantees of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company has a secured interest in various assets as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held on those commitments at December 31, 1997 and 1996 is in excess of the committed amount.
NOTE 16 PARENT COMPANY FINANCIAL INFORMATION
CONDENSED PARENT COMPANY ONLY BALANCE SHEETS
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
CONDENSED PARENT COMPANY ONLY STATEMENTS OF INCOME
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
CONDENSED PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 DIVIDENDS FROM HOLDING COMPANY
The Company is a legal entity separate and distinct from its subsidiaries. Substantially all of the Company's revenues result from dividends paid to it by its subsidiaries and from earnings on investments. There are statutory and regulatory requirements applicable to the payment of dividends by Pinnacle Bank as well as by the Company to its stockholders. Under the foregoing dividend restrictions, Pinnacle Bank, without obtaining government approvals, could declare aggregate dividends in 1997 of approximately $33.2 million.
NOTE 18 COMMITMENTS AND CONTINGENT LIABILITIES
There are various other matters of litigation pending against the Company that have arisen during the normal course of business. Management is vigorously defending themselves in all matters. Management believes that the impact to the financial statements resulting from the ultimate resolution of these matters will not be significant.
PINNACLE FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19 SUBSEQUENT EVENT- PENDING ACQUISITION
On October 14, 1997, the Company entered into a definitive agreement to sell the Company to CNB Bancshares, Inc. (CNB) of Evansville, Indiana ($4.4 billion in total assets). The fixed exchange ratio is 1.0365 shares of CNB Common Stock issued for each share issued and outstanding of Pinnacle Common Stock, and it is anticipated to be accounted for using the pooling-of-interests method of accounting. The sale is subject to shareholder approval and is expected to close in the second quarter of 1998.
SELECTED QUARTERLY FINANCIAL INFORMATION
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of March 20, 1998, the directors and executive officers of Pinnacle are as indicated in the following table. The table also indicates the positions held by such persons at Pinnacle Bank.
John P. Cunningham is a director of both Pinnacle and Pinnacle Bank. He also is a member of the Audit Committee, Retirement Committee, the Compensation Committee and the Merger and Acquisition Committee of the Pinnacle Board. He is also a member of the Audit Committee, the Retirement Committee, the Merger and Acquisition Committee and the Compensation Committee of the Board of Directors of Pinnacle Bank. He is currently the President and Chief Executive Officer of Boston Optical Fiber, Inc., a manufacturer of plastic optical fiber. Prior to 1998, he was the Chief Financial Officer of Whirlpool Corporation, a publicly-held appliance manufacturer with securities listed on the New York Stock Exchange. In 1995 he was the Chief Financial Officer of Maytag, a publicly-held appliance manufacturer with securities listed on the New York Stock Exchange. Prior to that time he was the Controller of IBM, a publicly-held company with securities listed on the New York Stock Exchange.
Terrence A. Friedman is a director of both Pinnacle and Pinnacle Bank and is a member of the Compensation Committee and the Merger and Acquisition Committee of the Board of Directors of Pinnacle. He is also a member of the Executive Committee, the Compensation Committee, the Merger and Acquisition Committee and the Loan Review Committee of the Board of Directors of Pinnacle Bank. He is currently the Chairman of Trelleborg-YSH, Inc., a manufacturer of rubber components primarily for the auto industry.
Joseph F. Heffernan has been a director of both Pinnacle and Pinnacle Bank, and the President of the Mortgage Repurchasing Division of Pinnacle Bank, since August 1, 1997. Prior thereto, Mr. Heffernan was the Chairman of the Board, President and Chief Executive Officer of CB Bancorp, Inc. and Community Bank. He is a member of the Merger
and Acquisition Committee and the Strategic Planning Committee of the Pinnacle Board. He is also a member of the Merger and Acquisition Committee and the Strategic Planning Committee of the Board of Directors of Pinnacle Bank.
James E. Hutton has been a director of both Pinnacle and Pinnacle Bank since August 1, 1997. He is a member of the Audit Committee, the Retirement Committee and the Compensation Committee of the Pinnacle Board. He is also a member of the Executive Committee, the Audit Committee, the Retirement Committee and the Compensation Committee of the Board of Directors of Pinnacle Bank. Since June 1993, Mr. Hutton has served as Vice President in charge of operations for Burrell Professionals Labs, Inc., a professional photo processing company with operations throughout the United States. Prior thereto, Mr. Hutton was Managing Partner of the Northern Indiana office of Geo. S. Olive and Co., an accounting firm. Mr. Hutton is a certified public accountant.
Donald A. Lesch has been a director of both Pinnacle and Pinnacle Bank, and the Vice Chairman, President and Chief Operating Officer of Pinnacle, since August 1, 1997. He is an ex-officio member of all of the committees of the Pinnacle Board. He is also a member of the Executive Committee, and an ex- officio member of all of the committees of the Board of Directors of Pinnacle Bank. Prior thereto, Mr. Lesch was the Chairman of the Board of IFC and IndFed Bank since June 1, 1993. He became Chief Executive Officer of both of those entities in 1996. Prior thereto, Mr. Lesch was an investor and consultant to Gough and Lesch Development Corporation, a real estate development company located in Merrillville, Indiana.
Richard L. Schanze is a director of both Pinnacle and Pinnacle Bank and is an ex-officio member of all of the committees of the Board of Directors of Pinnacle, and a member of the Executive Committee and an ex-officio member of all of the committees of the Board of Directors of Pinnacle Bank. He is currently the Chairman and Chief Executive Officer of Pinnacle and the Chairman and Chief Executive Officer of Pinnacle Bank.
Howard Silverman has been a director of both Pinnacle and Pinnacle Bank since August 1, 1997. He is a member of the Merger and Acquisition Committee and the Strategic Planning Committee of the Pinnacle Board. He is also a member of the Merger and Acquisition Committee and the Strategic Planning Committee of the Board of Directors of Pinnacle Bank. Mr. Silverman is Chairman of the Board of Directors of Reliance Acceptance Group, Inc., a specialty consumer finance company, since the split-off of its subsidiary bank in February 1997. On February 9, 1998, Reliance Acceptance Group, Inc. filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. He has also been Chairman of the Board of Reliance Acceptance Corporation, its operating subsidiary, since its incorporation in 1992. For more than five years, Mr. Silverman has also been President of Silverman and Associates, a consulting firm furnishing services to businesses and financial institutions which provided services to Indiana Federal Corporation, which was merged into Pinnacle effective August 1, 1997. During his earlier career, he served as Chairman and Executive Officer of a multi-bank and financial services company, which included a finance company subsidiary, and as President of a securities broker/dealer. Mr. Silverman is also a director of Forrest Holdings, Inc. which owns and operates Forrest Financial Corporation, a leasing company that provides financing solutions for the acquisition of information systems.
Arnold L. Weaver is a director of both Pinnacle and Pinnacle Bank and is an ex-officio member of all of the committees of the Board of Directors of Pinnacle, and a member of the Executive Committee and an ex-officio member of all of the committees of the Board of Directors of Pinnacle Bank. He is currently the Vice Chairman of Pinnacle and the President and Chief Operating Officer of Pinnacle Bank.
Alton C. Wendzel is a director of both Pinnacle and Pinnacle Bank and is a member of the Audit Committee and the Strategic Planning Committee of the Board of Directors of Pinnacle. He is also a member of the Audit Committee, Strategic Planning Committee and the Loan Review Committee of the Board of Directors of Pinnacle Bank. He is currently the President of Greg Orchards and Produce, Inc. and Coloma Frozen Foods, Inc., processors of fresh and frozen producer.
Fred A. Wittlinger has been a director of both Pinnacle and Pinnacle Bank since August 1, 1997. He also is a member of the Audit
Committee and the Merger and Acquisition Committee of the Pinnacle Board. He is a member of the Audit Committee and the Merger and Acquisition Committee of the Board of Directors of Pinnacle Bank. Since 1988, Mr. Wittlinger has served as President and Chief Executive Officer of United Consumers Club, Inc., a consumer buying club franchising corporation located in Merrillville, Indiana.
Barbara A. Young has been a director of both Pinnacle and Pinnacle Bank since August 1, 1997. She is a member of the Compensation Committee and the Retirement Committee of the Pinnacle Board. She is also a member of the Compensation Committee, the Retirement Committee and the Risk Management Committee of the Board of Directors of Pinnacle Bank. Since January 1, 1994, Ms. Young has served as President of Benchmark LTD, a real estate development company located in Valparaiso, Indiana. Prior thereto, Ms. Young was an attorney with the law firm of Hoeppner, Wagner & Evans, located in both Valparaiso and Merrillville, Indiana.
Donald E. Radde is an Executive Vice President and the Secretary of Pinnacle. He is also a Director, an Executive Vice President, Chief Lending Officer and Secretary of Pinnacle Bank.
David W. Kolhagen is a Senior Vice President and the Treasurer of Pinnacle and a Senior Vice President and the Chief Financial Officer of Pinnacle Bank.
John A. Newcomer is a Vice President and the Corporate Affairs Officer of Pinnacle and of Pinnacle Bank.
Directors of Pinnacle are elected annually by the stockholders of Pinnacle. Executive officers of Pinnacle are appointed by the Pinnacle Board and serve until their successors are appointed and qualified. No director or executive officer of Pinnacle or Pinnacle Bank is related to any other director or to any executive officer of Pinnacle or of any of its subsidiaries by blood, marriage or adoption, and there are no arrangements or understandings between a director or executive officer and any other person pursuant to which such person was elected a director or executive officer of Pinnacle or any of its subsidiaries.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE.
The following table sets forth information concerning compensation for services in all capacities awarded to, earned by or paid to each of the five most highly compensated executive officers and/or employees of Pinnacle and its subsidiaries (the "Named Pinnacle Executives") for the last three completed fiscal years whose salary and bonus exceeded $100,000.
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(1) Amounts shown consist of director fees paid by Pinnacle and by Pinnacle Bank, and gains on exercise of stock options.
(2) Amounts shown for 1997 consist of the following: (i) Mr. Schanze: matching contributions under Pinnacle Bank's 401-k plan of $2,375, personal use of Company-owned automobile of $2,860, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $181,213; (ii) Mr. Lesch: matching contributions under Pinnacle Bank's 401-k plan of $1,057, personal use of Company-owned automobile of $1,202, and contributions under IFC's Employee Stock Ownership Plan of $8,974; (iii) Mr. Weaver: matching contributions under Pinnacle Bank's 401-k plan of $2,375, personal use of Company-owned automobile of $2,855, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $61,161; (iv) Mr. Radde: matching contributions under Pinnacle Bank's 401-k plan of $2,375, personal use of Company-owned automobile of $2,281, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $9,218; and (v) Mr. Kolhagen: matching contributions under Pinnacle Bank's 401-k plan of $2,375, personal use of Company-owned automobile of $5,448, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $2,837. Amounts shown for 1996 consist of the following: (i) Mr. Schanze: matching contributions under Pinnacle Bank's 401-k plan of $2,375, personal use of Company-owned automobile of $3,304, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $31,526; (ii) Mr. Weaver: matching contributions under Pinnacle Bank's 401-k plan of $2,375, and personal use of Company-owned automobile of $3,184; (iii) Mr. Radde: matching contributions under Pinnacle Bank's 401-k plan of $2,375 and personal use of Company-owned automobile of $2,425; and (iv) Mr. Kolhagen: matching contributions under Pinnacle Bank's 401-k plan of $2,375 and personal use of Company-owned automobile of $4,741. Amounts shown for 1995 consist of the following: (i) Mr. Schanze: matching contributions under Pinnacle Bank's 401-k plan of $4,620, personal use of Company-owned automobile of $3,192, and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $27,591; (ii) Mr. Weaver: matching contributions under Pinnacle Bank's 401-k plan of $4,620, personal use of Company-owned automobile of $3,770 and contributions under Pinnacle Bank's Deferred Compensation Plan for Executive Officers of $2,443; (iii) Mr. Radde: matching contributions under Pinnacle's 401-k plan of $4,620 and personal use of Company-owned automobile of $1,300; and (iv) Mr. Kolhagen: matching contributions under Pinnacle Bank's 401-k plan of $3,781 and personal use of Company-owned automobile of $4,753.
OPTION/SAR GRANTS IN LAST FISCAL YEAR. The following table sets forth certain information concerning stock options/SARs granted during 1997 to the Named Pinnacle Executives.
The above listed stock options were granted pursuant to Pinnacle's Executive Long-Term Incentive Plan, which is administered by the Compensation Committee of the Board of Directors of Pinnacle. All of the above listed stock options that were granted in 1997 became fully vested and immediately exercisable on August 1,1997 upon consummation of the mergers of IFC and CB with and into Pinnacle; and all of the above listed options were exercised prior to December 31, 1997.
PENSION PLAN
The following table shows estimated annual benefits payable upon retirement to, and credited years of services for, each of the Named Executive Officers.
The benefits shown above are payable in a straight-life annuity and are not offset by any other benefits, including Social Security. The final average annual compensation is determined under the defined benefit plan by the average of the five highest consecutive years of annual compensation (including salary and bonus payments) during the last ten years of employment, subject to a maximum of $150,000 for 1994, 1995 and 1996, and $160,000 for all subsequent years. As of December 31, 1997, Mr. Schanze had 22 years of credited service, Mr. Lesch had 5 years of credited service, Mr. Weaver had 21 years of credited service, Mr. Radde had 16 years of credited service, and Mr. Kolhagen had 17 years of credited service.
SEVERANCE AGREEMENTS
Pinnacle currently has in effect certain severance agreements (the "Severance Agreements") with seven executive officers (the "Executives"), which include, among other things, provisions regarding payments under certain circumstances following a "change in control." The Executives with Severance Agreements are Richard L. Schanze, Chairman and Chief Executive Officer, Arnold L. Weaver, Vice Chairman of Pinnacle and President and Chief Operating Officer of Pinnacle Bank, Donald E. Radde, Executive Vice President, David W. Kolhagen, Senior Vice President and Chief Financial Officer, John A. Newcomer, Vice President and Corporate Affairs Officer, Donald A. Lesch, Vice Chairman, President and Chief Operating Officer, and Michael J. Griffin, Senior Vice President of Pinnacle Bank. Approval of the merger agreement with CNB by the Pinnacle shareholders will constitute a "change in control" under each of the Severance Agreements.
The Severance Agreements provide, among other things, that upon a "change in control," an Executive will be entitled to receive certain amounts in the event that, within twenty-four months after the change in control, such Executive's employment is terminated for any reason other than "cause" (as defined in the Severance Agreements) or such Executive terminates his employment for "good reason" (as defined in the Severance Agreements). In such an event, the appropriate Severance Agreement provides that Mr. Schanze would be entitled to receive the greater of 299% of his base amount, as determined under Section 280G of the Code (the "Base Amount") or $1,118,000; Mr. Weaver would be entitled to receive the greater of 299% of his Base Amount or $559,000; Mr. Radde would be entitled to receive the greater of (a) the lesser of (i) 200% of his total compensation or (ii) 299% of his Base Amount, or (b) $354,000; Mr. Kolhagen would be entitled to receive the greater of (a) the lesser of (i) 200% of his total compensation or (ii) 299% of his Base Amount, or (b) $287,000; Mr. Newcomer would be entitled to receive the greater of (a) the lesser of (i) 100% of his total compensation or (ii) 299% of his Base Amount, or (b) $156,000; Mr. Lesch would be entitled to receive the greater of (a) 299% of his Base Amount, or (b) $568,100; and Mr. Griffin would be entitled to receive the greater of 200% of his Base Amount or $87,816.
The Severance Agreements each also provide that in the event that an Executive's employment is terminated for cause or the Executive terminates his employment for any reason other than good reason, in either event upon or at any time following a change in control, such Executive will be entitled to the following payment: Mr. Schanze, $1,118,000; Mr. Weaver, $559,000; Mr. Radde, $354,000; Mr. Kolhagen, $287,000; Mr. Newcomer, $156,000; Mr. Lesch, $568,100; and Mr. Griffin, $87,816.
Pinnacle also currently has certain other severance contracts in effect with Joseph F. Heffernan, Daniel R. Buresh and James D. Neff. These severance contracts do not provide for additional payments upon a change in control, and no benefits will be payable thereunder solely as a result of the consummation of the merger with CNB. Under these severance contracts, in the event the employee's employment is terminated for "Cause" (as defined therein), no severance payment is due the employee; however, in the event the employee's employment is terminated for any reason other than "Cause", Mr. Heffernan would then be entitled to receive the greater of $223,000 or 100% of his then current annual salary and bonus payments; Mr. Buresh would then be entitled to receive the greater of $70,000 or 100% of his then current annual salary and bonus payments; and Mr. Neff would then be entitled to receive the greater of $95,000 or 100% of his then current annual salary and bonus payments.
OTHER COMPENSATION ARRANGEMENTS
Under Pinnacle Bank's Deferred Compensation Plan for Executive Officers, certain highly compensated employees of Pinnacle Bank or its affiliates may be granted certain awards of deferred compensation. These awards, which must be approved by the Board of Directors of Pinnacle Bank, may be granted annually. All awards remain the property of Pinnacle Bank until paid out. Awards, together with any accrued interest thereon, are to be distributed to a participant in annual installments over a ten-year period beginning on the January 1 following the calendar year in which such participant ceases to be an employee of Pinnacle Bank or its affiliates. (In the event of a participant's death the balance of his awards will be paid in full to his estate within 90 days of the date of his death.) These accounts are credited with interest at the end of each month at 110% of the rate then being paid on certain U.S. Treasury securities.
IFC EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENTS. Pinnacle has assumed the obligations of its predecessor, IFC, under Executive Supplemental Retirement Income Agreements ("IFC ESRIAs") with Mr. Lesch and certain other key officers. The IFC ESRIAs are unfunded, non-qualified agreements which provide for an annual benefit to each executive of an amount generally equal to a stated percentage (of between 15% and 45%) of the executive's highest five-year average "base compensation" (which includes salary, but excludes bonuses and fringe benefits), to be paid over a 15-year period. The IFC ESRIAs also provide for disability and death benefits, including a $10,000 burial expense payment. In addition, the IFC ESRIAs provide that the beneficiaries will be eligible to receive their full supplemental benefit in the event they involuntarily terminate their employment prior to reaching retirement age. Until disbursed, the amounts payable under the IFC ESRIAs are subject to the claims of general creditors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1997 only James E. Hutton, Terrence A. Friedman, and John P. Cunningham and Barbara A. Young, each a director of Pinnacle, served as members of the Compensation Committee of the Board of Directors of Pinnacle. No officers or employees of Pinnacle or Pinnacle Bank served as members of the Compensation Committee and no executive officer of Pinnacle served as a member of the Compensation Committee of another entity.
BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The compensation policy of Pinnacle, as applicable to executive officers, is designed to assure Pinnacle's ongoing ability to attract, retain and motivate, while at the same time recognizing the contributions of those individuals upon whose judgement, efforts and results Pinnacle is largely dependent for its success and future. Pinnacle is cognizant of the fact it competes for qualified individuals at the local and regional levels and to a lesser degree, nationally. As a result, compensation for executive officers is monitored carefully.
To assist in this process, the Compensation Committee reviews information from independent salary studies that include the financial industry and other industrial classifications.
While Pinnacle and Pinnacle Bank establish objective annual goals in targeted areas such as asset growth, earnings, loan originations, etc. and progress toward these goals is reviewed, a specific "trigger level" is not required to be reached in each area.
On a subjective basis, performance criteria encompass evaluation of each officer's initiative and contribution to overall corporate performance, the officer's managerial ability, the officer's leadership capacity and the officer's performance in any special projects which the officer may have undertaken. No formula was used to determine the Chief Executive Officer's, or other named executives', bonus or award of stock options. This was the fifth year stock options were awarded and the previous award schedule was taken into consideration while awarding 1997's stock options. In future years, if awards are granted, the Compensation Committee will take into consideration awards previously made to a potential recipient, the vesting schedule of such awards, and the number of awards outstanding in the aggregate to all recipients.
In reviewing Mr. Schanze's total compensation, the primary focus of the Compensation Committee was on Pinnacle's performance in 1997, which met established goals. The Compensation Committee also considered Mr. Schanze's contributions to various non-quantifiable community improvement activities and the positive impact they have had upon Pinnacle and to various long-range initiatives impacting the future of Pinnacle, including the acquisition strategies currently in place, as well as acquisitions completed in 1997.
Members of the Compensation Committee:
James E. Hutton John P. Cunningham Terrence A. Friedman Barbara A. Young
DIRECTOR COMPENSATION
Each director of Pinnacle is paid an annual retainer of $7,500 plus $1,000 for each meeting of the Board of Directors of Pinnacle attended. Each director of Pinnacle Bank is paid an annual retainer of $7,500 plus $1,000 for each meeting of the Board of Directors of Pinnacle Bank attended. Members of committees of the Board of Directors of Pinnacle Bank also receive $1,000 for each committee meeting attended. Messrs. Schanze, Lesch, and Weaver have waived all fees for attending meetings of committees of the Board of Directors of Pinnacle Bank in the past and intend to continue to do so in the future.
Pinnacle and Pinnacle Bank each maintain deferred compensation plans under which a director may elect to defer receipt of either all or 50% of directors' fees otherwise payable during a calendar year to a later calendar year. Amounts deferred are reflected as unsecured accounts payable on the books of the appropriate corporation and are subject to claims of such corporation's general creditors. These accounts are credited with interest at the end of each month at 110% of the rate being paid on U.S. Treasury Securities.
IFC DIRECTORS DEFERRED COMPENSATION AGREEMENTS. Pinnacle has assumed the obligations of its predecessor, IFC, under certain Director Deferred Compensation Agreements ("DDCA") with certain of its non-employee directors. The DDCAs are unfunded, non-qualified agreements which provide for retirement, death and disability benefits for the participants and their designated beneficiaries. Under the DDCAs, each non-employee director may, for a period of five years, make an annual election to defer receipt of all or a portion of his or her monthly director fees paid prior to August 1, 1997 into a Guaranteed Investment Contract ("GIC") Account and/or a Phantom Unit Account.
Deferred amounts allocated to the GIC Account will be credited with interest at the rate of .667% per month. Deferred amounts allocated to the Phantom Unit Account are used to "purchase" Phantom Units, each representing a share, initially of IFC Common Stock, and currently of Pinnacle Common Stock, at the market price on the date of the deferral election. Phantom Units are credited with dividends, and are adjusted for any stock splits or similar events. Directors do not have the option to receive dividends in cash, but may elect to reinvest such dividends in Phantom Units or in a GIC Account. Upon termination of the director's service, the Phantom Units are deemed to be sold, and the proceeds of such sale are distributed to the director in cash pursuant to the payment provisions of the DDCAs.
At normal retirement (age 65), each director will be entitled to receive over a 15-year period his or her accrued benefit, which is determined by annuitizing such benefit over the payment period using a monthly interest factor of .833%. The DDCAs also provide for disability and death benefits, including a $10,000 burial expense payment. Until disbursed, the amounts directed to be deferred are subject to the claims of general creditors.
PERFORMANCE GRAPH
The following graph compares the yearly percentage change in the cumulative total shareholder return on Pinnacle's Common Stock against the cumulative total return of the Standard & Poor's 500 Index and the Banks: Midwest Index for the periods shown.
PINNACLE FINANCIAL SERVICES, INC.; STANDARD & POORS 500; AND BANKS: MIDWEST INDEX
TOTAL RETURN ANALYSIS*
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* Shows performance results through December 31, 1997 for Pinnacle Financial Services, Inc. Common Stock, Standard & Poor's 500, and Banks: Midwest assuming $100 was invested at the close of trading December 1992 and all dividends are reinvested.
Source: FactSet Data Systems
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information provided by the persons indicated with respect to the beneficial ownership (as defined under applicable rules of the Commission) of shares of Pinnacle Common Stock as of March 20, 1998, by (i) each person known by Pinnacle who is the owner of more than 5% of the outstanding shares of Pinnacle Common Stock, (ii) each person who is a director or an executive officer of Pinnacle, and (iii) all persons who are directors or executive officers of Pinnacle as a group.
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(1) Unless otherwise noted, Pinnacle believes that all persons named in the table have (i) sole voting and investment power with respect to all shares of Pinnacle Common owned by them, except to the extent that authority is shared by spouses under applicable law, and (ii) record and beneficial ownership of such shares. The business address of Mr. Ansary, the only owner of more than 5% of the outstanding shares of Pinnacle Common, is 1725 K Street, N.W., Suite 410, Washington, D.C. 20006. The business address of all other persons named in the table is 830 Pleasant Street, St. Joseph, Michigan 49085.
(2) Number of shares and percentages with respect to beneficial ownership of Pinnacle Common are based on ownership of Pinnacle Common as of March 20, 1998 and have been calculated in accordance with Rule 13d-3(d)(1) under the Exchange Act and assuming 12,653,454 shares of Pinnacle Common are issued and outstanding. An asterisk indicates beneficial ownership of less than 1%.
(3) Director of Pinnacle.
(4) Executive Officer of Pinnacle.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The directors, officers and principal stockholders of Pinnacle and their associates may have had in the past, and expect to have in the future, transactions in the ordinary course of business with Pinnacle and its subsidiaries. Such transactions were, and are expected to be, on substantially the same terms as those prevailing at the time for comparable transactions with others.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits:
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* Filed herewith.
Management contracts and compensatory plans or arrangements:
The management contracts and compensatory plans or arrangements required to be filed as exhibits and included in such list of exhibits are as follows:
Index to Financial Statements and Financial Statement Schedules:
All schedules for which provision is made in Regulation S-X either (i) are not required under the related instructions or are inapplicable and, therefore, have been omitted, or (ii) the information required is included in the consolidated financial statements or the notes thereto that are a part hereof.
(b) Reports on Form 8-K:
Two (2) reports on Form 8-K were filed during the last quarter of the period covered by this report. One report on Form 8-K dated October 14, 1997, was filed to report, under Item 5, registrant's planned merger with CNB Bancshares, Inc., an Indiana corporation. The other report, being Amendment No. 1 to the Current Report on Form 8-K dated August 14, 1997, was filed to report, under Item 7, financial statements of businesses acquired by registrant through the mergers of Indiana Federal Corporation and CB Bancorp, Inc. with and into the registrant, effective as of August 1, 1997.
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.
PINNACLE FINANCIAL SERVICES, INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.