UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _____ to ____
Commission file number 33-24728C
CAPITOL BANCORP LTD.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2761672
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
200 WASHINGTON SQUARE NORTH, LANSING, MICHIGAN
(Address of principal executive offices)
48933
(Zip Code)
(517) 487-6555
(Registrant's telephone number)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Common stock, No par value: 11,187,263 shares outstanding as of October 15,
2002.
Page 1 of 29
INDEX
PART I. FINANCIAL INFORMATION
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this document, including Capitol's
consolidated financial statements, Management's Discussion and Analysis of
Financial Condition and Results of Operations and in documents incorporated into
this document by reference that are not historical facts, including, without
limitation, statements of future expectations, projections of results of
operations and financial condition, statements of future economic performance
and other forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, are subject to known and unknown
risks, uncertainties and other factors which may cause the actual future
results, performance or achievements of Capitol and/or its subsidiaries and
other operating units to differ materially from those contemplated in such
forward-looking statements. The words "intend", "expect", "project", "estimate",
"predict", "anticipate", "should", "believe", and similar expressions also are
intended to identify forward-looking statements. Important factors which may
cause actual results to differ from those contemplated in such forward-looking
statements include, but are not limited to: (i) the results of Capitol's efforts
to implement its business strategy, (ii) changes in interest rates, (iii)
legislation or regulatory requirements adversely impacting Capitol's banking
business and/or expansion strategy, (iv) adverse changes in business conditions
or inflation, (v) general economic conditions, either nationally or regionally,
which are less favorable than expected and that result in, among other things, a
deterioration in credit quality and/or loan performance and collectability, (vi)
competitive pressures among financial institutions, (vii) changes in securities
markets, (viii) actions of competitors of Capitol's banks and Capitol's ability
to respond to such actions, (ix) the cost of capital, which may depend in part
on Capitol's asset quality, prospects and outlook, (x) changes in governmental
regulation, tax rates and similar matters, and (xi) other risks detailed in
Capitol's other filings with the Securities and Exchange Commission. Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual outcomes may vary materially from those
indicated. All subsequent written or oral forward-looking statements
attributable to Capitol or persons acting on its behalf are expressly qualified
in their entirety by the foregoing factors. Investors and other interested
parties are cautioned not to place undue reliance on such statements, which
speak as of the date of such statements. Capitol undertakes no obligation to
release publicly any revisions to these forward-looking statements to reflect
events or circumstances after the date of such statements or to reflect the
occurrence of unanticipated events.
Page
----
Item 1. Financial Statements (unaudited):
Consolidated balance sheets - September 30, 2002 and
December 31, 2001. 3
Consolidated statements of income - Three months and nine
months ended September 30, 2002 and 2001. 4
Consolidated statements of changes in stockholders' equity -
Nine months ended September 30, 2002 and 2001. 5
Consolidated statements of cash flows - Nine months ended
September 30, 2002 and 2001. 6
Notes to consolidated financial statements. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 23
Item 4. Controls and Procedures. 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 24
Item 2. Changes in Securities and Use of Proceeds. 24
Item 3. Defaults Upon Senior Securities. 24
Item 4. Submission of Matters to a Vote of Security Holders. 24
Item 5. Other Information. 24
Item 6. Exhibits and Reports on Form 8-K. 24
SIGNATURES 25
CERTIFICATIONS 26
Page 2 of 29
PART I, ITEM I
CAPITOL BANCORP LIMITED
Consolidated Balance Sheets
As of September 30, 2002 and December 31, 2001
(Unaudited)
September 30 December 31
2002 2001
------------ ------------
(in thousands)
ASSETS
Cash and due from banks $ 119,281 $ 83,833
Money market funds, mutual funds and interest-bearing deposits 39,755 10,999
Federal funds sold 68,125 68,859
------------ ------------
Cash and cash equivalents 227,161 163,691
Loans held for resale 65,496 62,487
Investment securities:
Available for sale, carried at market value 37,821 35,598
Held for long-term investment, carried at
amortized cost which approximates market value 8,057 8,089
------------ ------------
Total investment securities 45,878 43,687
Portfolio loans:
Commercial 1,749,122 1,535,451
Real estate mortgage 130,713 121,676
Installment 78,985 77,462
------------ ------------
Total portfolio loans 1,958,820 1,734,589
Less allowance for loan losses (27,898) (23,238)
------------ ------------
Net portfolio loans 1,930,922 1,711,351
Premises and equipment 19,232 16,441
Accrued interest income 9,699 9,471
Goodwill and other intangibles 20,286 8,527
Other assets 28,920 28,351
------------ ------------
TOTAL ASSETS $ 2,347,594 $ 2,044,006
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 333,246 $ 272,593
Interest-bearing 1,684,805 1,467,792
------------ ------------
Total deposits 2,018,051 1,740,385
Debt obligations 83,168 89,911
Accrued interest on deposits and other liabilities 15,628 14,244
------------ ------------
Total liabilities 2,116,847 1,844,540
GUARANTEED PREFERRED BENEFICIAL INTERESTS
IN THE CORPORATION'S SUBORDINATED DEBENTURES 51,567 48,621
MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES 34,342 70,673
STOCKHOLDERS' EQUITY
Common stock, no par value, 25,000,000 shares authorized;
issued and outstanding: 2002 - 11,181,368 shares
2001 - 7,829,178 shares 124,022 67,692
Retained earnings 22,435 14,173
Market value adjustment (net of tax effect) for
investment securities available for sale (accumulated
other comprehensive income) 232 158
------------ ------------
146,689 82,023
Less note receivable from exercise of stock options
and unallocated ESOP shares (1,851) (1,851)
------------ ------------
Total stockholders' equity 144,838 80,172
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,347,594 $ 2,044,006
============ ============
Page 3 of 29
CAPITOL BANCORP LIMITED
Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2002 and 2001
(in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Interest income:
Portfolio loans (including fees) $ 38,807 $ 36,682 $ 111,508 $ 108,190
Loans held for resale 535 984 1,769 2,218
Taxable investment securities 357 455 1,142 1,802
Federal funds sold and other 763 937 1,859 3,556
--------- --------- --------- ---------
Total interest income 40,462 39,058 116,278 115,766
Interest expense:
Deposits 12,113 16,361 36,121 51,441
Debt obligations and other 2,156 1,989 6,720 5,453
--------- --------- --------- ---------
Total interest expense 14,269 18,350 42,841 56,894
--------- --------- --------- ---------
Net interest income 26,193 20,708 73,437 58,872
Provision for loan losses 3,918 2,316 8,692 5,637
--------- --------- --------- ---------
Net interest income after provision
for loan losses 22,275 18,392 64,745 53,235
Noninterest income:
Service charges on deposit accounts 1,041 836 2,980 2,356
Trust fee income 712 400 1,882 1,409
Fees from origination of non-portfolio residential
mortgage loans 2,011 803 4,382 2,194
Realized gains (losses) on sale of investment
securities available for sale 12 -- (6) 3
Other 377 343 1,137 1,032
--------- --------- --------- ---------
Total noninterest income 4,153 2,382 10,375 6,994
Noninterest expense:
Salaries and employee benefits 12,113 9,355 34,916 28,098
Occupancy 1,655 1,571 4,797 4,274
Equipment rent, depreciation and maintenance 1,052 1,170 3,396 3,320
Other 4,109 3,773 13,653 11,666
--------- --------- --------- ---------
Total noninterest expense 18,929 15,869 56,762 47,358
--------- --------- --------- ---------
Income before federal income taxes and
minority interest 7,499 4,905 18,358 12,871
Federal income taxes 2,686 1,437 6,380 4,238
--------- --------- --------- ---------
Income before minority interest 4,813 3,468 11,978 8,633
Minority interest in net income of
consolidated subsidiaries (366) (696) (574) (878)
--------- --------- --------- ---------
NET INCOME $ 4,447 $ 2,772 $ 11,404 $ 7,755
========= ========= ========= =========
NET INCOME PER SHARE -- Note C
Basic $ 0.42 $ 0.35 $ 1.17 $ 1.00
========= ========= ========= =========
Diluted $ 0.40 $ 0.35 $ 1.12 $ 0.98
========= ========= ========= =========
Page 4 of 29
CAPITOL BANCORP LIMITED
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2002 and 2001
(in thousands except share data)
Note
Receivable
from Exercise
of Stock
Accumulated Options and
Other Unallocated
Common Retained Comprehensive ESOP
Stock Earnings Income Shares Total
--------- --------- --------- --------- ---------
NINE MONTHS ENDED SEPTEMBER 30, 2001
Balances at January 1, 2001 $ 65,939 $ 6,569 $ (108) $ (1,996) $ 70,404
Proceeds from the sale of 130,000 shares
of common stock and 32,500 warrants to
purchase common stock 1,495 1,495
Issuance of 3,287 shares of common stock
upon exercise of warrants 36 36
Issuance of 17,043 shares of common stock
upon exercise of stock options 161 161
Cash dividends paid ($.30 per share) (2,328) (2,328)
Components of comprehensive income:
Net income for the period 7,755 7,755
Market value adjustment for investment
securities available for sale (net of
income tax effect) 379 379
---------
Comprehensive income for the period 8,134
--------- --------- --------- --------- ---------
BALANCES AT SEPTEMBER 30, 2001 $ 67,631 $ 11,996 $ 271 $ (1,996) $ 77,902
========= ========= ========= ========= =========
NINE MONTHS ENDED SEPTEMBER 30, 2002
Balances at January 1, 2002 $ 67,692 $ 14,173 $ 158 $ (1,851) $ 80,172
Issuance of common stock and stock options to
acquire shares of Sun Community Bancorp held
by shareholders other than Capitol 43,160 43,160
Issuance of common stock and stock options to
acquire shares of Sunrise Capital Corporation held
by shareholders other than Capitol 6,725 6,725
Issuance of restricted common stock and stock options
to acquire shares of Indiana Community Bancorp held
by shareholders other than Capitol 4,259 4,259
Issuance of 113,398 shares of common stock
upon exercise of stock options 1,340 1,340
Issuance of 53,804 shares of common stock
upon exercise of warrants 596 596
Issuance of 15,598 shares of restricted common
stock in exchange for investment security 250 250
Cash dividends paid ($.32 per share) (3,142) (3,142)
Components of comprehensive income:
Net income for the period 11,404 11,404
Market value adjustment for investment
securities available for sale (net of
income tax effect) 74 74
---------
Comprehensive income for the period 11,478
--------- --------- --------- --------- ---------
BALANCES AT SEPTEMBER 30, 2002 $ 124,022 $ 22,435 $ 232 $ (1,851) $ 144,838
========= ========= ========= ========= =========
Page 5 of 29
CAPITOL BANCORP LTD.
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2002 and 2001
2002 2001
--------- ---------
(in thousands)
OPERATING ACTIVITIES
Net income $ 11,404 $ 7,755
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Provision for loan losses 8,692 5,637
Depreciation of premises and equipment 2,517 2,522
Amortization of goodwill and other intangibles 266 602
Net accretion of investment security discounts (33) (75)
Loss (gain) on sale of premises and equipment (4) 106
Minority interest in net income of consolidated subsidiaries 574 878
Originations and purchases of loans held for resale (593,581) (444,502)
Proceeds from sales of loans held for resale 590,572 423,505
Increase in accrued interest income and other assets (3,710) (4,506)
Increase in accrued interest expense and other liabilities 1,384 3,037
--------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 18,081 (5,041)
INVESTING ACTIVITIES
Proceeds from sale of investment securities available for sale 6,477 500
Proceeds from calls, prepayments and maturities of investment securities 45,865 49,301
Purchases of investment securities (54,388) (24,098)
Net increase in portfolio loans (228,263) (305,481)
Proceeds from sales of premises and equipment 56 301
Purchases of premises and equipment (5,360) (4,976)
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (235,613) (284,453)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts and
savings accounts 213,679 206,704
Net increase in certificates of deposit 63,987 79,891
Net borrowings from (payments on) debt obligations (6,743) 19,287
Resources provided by minority interests 8,386 3,729
Net proceeds from issuance of common stock 1,936 1,692
Net proceeds from issuance of trust-preferred securities 2,899 24,248
Cash dividends paid (3,142) (2,328)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 281,002 333,223
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 63,470 43,729
Cash and cash equivalents at beginning of period 163,691 142,784
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 227,161 $ 186,513
========= =========
Page 6 of 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD.
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Capitol Bancorp Ltd. ("Capitol") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions for Form 10-Q. Accordingly, they do not include all information and
footnotes necessary for a fair presentation of consolidated financial position,
results of operations and cash flows in conformity with generally accepted
accounting principles.
The statements do, however, include all adjustments of a normal recurring
nature (in accordance with Rule 10-01(b)(8) of Regulation S-X) which Capitol
considers necessary for a fair presentation of the interim periods.
The results of operations for the nine-month period ended September 30,
2002 are not necessarily indicative of the results to be expected for the year
ending December 31, 2002.
The consolidated balance sheet as of December 31, 2001 was derived from
audited consolidated financial statements as of that date. Certain 2001 amounts
have been reclassified to conform to the 2002 presentation.
NOTE B - NEW BANKS AND OTHER BANK DEVELOPMENT ACTIVITIES
Bank of Las Vegas, located in Las Vegas, Nevada, opened in February 2002.
It is majority-owned by Nevada Community Bancorp Limited, which is a
majority-owned subsidiary of Capitol.
Napa Community Bank, located in Napa, California, opened in March 2002. It
is majority-owned by First California Northern Bancorp, which is a
majority-owned subsidiary of Capitol.
Sunrise Bank of Arizona, a wholly-owned subsidiary of Sunrise Capital
Corporation (a wholly-owned subsidiary of Capitol) has expanded its operations
in 2002 through opening a private banking center in Scottsdale, Arizona and loan
production offices in the states of California, Georgia and Texas.
Bank development efforts are currently under consideration at September 30,
2002 in the states of California, Indiana and Michigan. Activities include
pre-development exploratory discussions in a number of other states.
Page 7 of 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - CONTINUED
NOTE C - NET INCOME PER SHARE
The computations of basic and diluted earnings per share were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
------------------------- -------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Numerator--net income for the period $ 4,447,000 $ 2,772,000 $11,404,000 $ 7,755,000
=========== =========== =========== ===========
Denominator:
Weighted average number of common shares
outstanding (denominator for basic earnings
per share) 10,713,287 7,822,606 9,776,774 7,769,316
Effect of dilutive securities--stock options
and warrants 525,301 197,753 420,179 151,008
----------- ----------- ----------- -----------
Denominator for dilutive net income per share--
Weighted average number of common shares
and potential dilution 11,238,588 8,020,359 10,196,953 7,920,324
=========== =========== =========== ===========
Number of antidilutive stock options excluded
from diluted earnings per share computation 160,637 121,665 249,849 158,190
=========== =========== =========== ===========
NOTE D - SHARE EXCHANGE TRANSACTIONS
Share exchange transactions regarding Sunrise Capital Corporation (Sunrise)
and Indiana Community Bancorp Limited (Indiana) were completed effective
September 30, 2002. An earlier share exchange transaction regarding Sun
Community Bancorp Limited (Sun) was completed effective March 31, 2002. In each
transaction, the shares acquired from shareholders other than Capitol were
exchanged for Capitol's common stock according to a fixed, but differing,
exchange ratio. To the extent those subsidiaries had stock options outstanding,
such stock options were similarly exchanged for stock options of Capitol.
Capitol's common shares issued in the Sun and Sunrise share exchanges are
unrestricted; shares issued in the Indiana exchange have resale and transfer
restrictions which expire in 2004. In total, Capitol has issued approximately
3.2 million shares of its common stock and 1.1 million stock options resulting
from these share exchanges (for aggregate consideration approximating $54.1
million), of which about 450,000 shares were issued effective September 30,
2002. These transactions have been recorded using the purchase-method of
accounting. Had these transactions occurred at the beginning of the periods
presented, net income would have approximated $11.7 million ($1.01 per diluted
share) and $7.9 million ($.71 per diluted share) for the nine months ended
September 30, 2002 and 2001, respectively.
Page 8 of 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - CONTINUED
NOTE D - SHARE EXCHANGE TRANSACTIONS - CONTINUED
Sun, Sunrise and Indiana were previously included in Capitol's consolidated
financial statements. The carrying value of assets and liabilities of those
entities closely approximated their fair values at the date of the share
exchanges with Capitol. Identified intangible assets (principally core deposit
intangibles relating to the Sun share exchange) were estimated to approximate
$2.7 million, and are being amortized over a period of approximately five years.
Additionally, goodwill of approximately $9.4 million was recorded in conjunction
with the share exchanges and will not be amortized, but will be reviewed at
least annually for impairment (see Note E).
As of September 30, 2002, potential share exchange transactions were
pending regarding the minority shareholders of Detroit Commerce Bank and East
Valley Community Bank which, if completed, would result in Capitol issuing
approximately 54,000 additional shares of common stock and those majority-owned
subsidiaries becoming wholly-owned.
NOTE E - IMPACT OF NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
Statement No. 141 requires that all business combinations be accounted for under
a prior standard of purchase accounting, eliminating the so-called
pooling-method which was used to account for some business combinations. This
standard did not have a material effect on Capitol's consolidated financial
statements.
Statement No. 142 requires that goodwill no longer be amortized and charged
against earnings, but instead be reviewed for impairment. Amortization of
goodwill ceased upon adoption of the Statement on January 1, 2002. This new
standard requires that goodwill be reviewed annually for impairment and,
accordingly, impairment adjustments of goodwill be charged against earnings, if
and when determined.
Capitol's previous business combinations (generally, acquisitions of
minority interests) have been accounted for using the purchase method. As of
September 30, 2002, the net carrying amount of reporting-unit goodwill
approximated $17.9 million and other intangible assets approximated $2.4
million. Upon implementation, this new standard has not had a material effect on
Capitol's consolidated financial statements, other than the elimination of
goodwill amortization.
Page 9 of 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - CONTINUED
NOTE E - IMPACT OF NEW ACCOUNTING STANDARDS - CONTINUED
Statement No. 142 requires that intangible assets not subject to
amortization, such as Capitol's reporting-unit goodwill, be tested for
impairment annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired. Such potential impairment is measured
by comparing the fair value of a reporting unit with its carrying amount within
the consolidated group.
When goodwill is reviewed for potential impairment, impairment losses must
be charged against earnings if and when determined. Substantially all of
Capitol's recorded reporting-unit goodwill relates to acquisitions of minority
interests in consolidated subsidiaries. Such acquisitions have been made at
modest premiums in relation to the underlying fair value of net assets when
acquired. Based on management's review of recorded reporting-unit goodwill at
the transition date for Statement No. 142, January 1, 2002, no impairment losses
were identified as of that date.
Paragraph 61 of Statement No. 142 requires supplemental disclosure of
historical information, as adjusted to exclude amortization of goodwill no
longer being amortized, which is summarized below (in $1,000s except per share
amounts):
Periods Ended
September 30, 2001 Year Ended December 31
------------------------- ---------------------------------------
Three Months Nine Months 2001 2000 1999(1)
------------ ----------- ----------- ----------- -----------
Net income, as reported $ 2,772 $ 7,755 $ 10,718 $ 8,035 $ 5,409
Add back -- goodwill
amortization 216 602 979 561 318
----------- ----------- ----------- ----------- -----------
Net income, as adjusted $ 2,988 $ 8,357 $ 11,697 $ 8,596 $ 5,727
=========== =========== =========== =========== ===========
Net income per share,
as reported:
Basic $ 0.35 $ 1.00 $ 1.38 $ 1.14 $ 0.84
=========== =========== =========== =========== ===========
Diluted $ 0.35 $ 0.98 $ 1.35 $ 1.13 $ 0.83
=========== =========== =========== =========== ===========
Add back -- goodwill
amortization
per share:
Basic $ 0.03 $ 0.08 $ 0.12 $ 0.08 $ 0.05
=========== =========== =========== =========== ===========
Diluted $ 0.02 $ 0.08 $ 0.12 $ 0.08 $ 0.05
=========== =========== =========== =========== ===========
Net income per share,
as adjusted:
Basic $ 0.38 $ 1.08 $ 1.50 $ 1.22 $ 0.89
=========== =========== =========== =========== ===========
Diluted $ 0.37 $ 1.06 $ 1.47 $ 1.21 $ 0.88
=========== =========== =========== =========== ===========
(1) Including cumulative effect of change in accounting principle, which
required write-off of previously capitalized start-up costs as of January
1, 1999 ($197, net of income tax effect, or $.03 per share).
Page 10 of 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. - CONTINUED
NOTE E - IMPACT OF NEW ACCOUNTING STANDARDS - CONTINUED
Statement No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, becomes
effective January 1, 2003. Management has not completed its analysis of this new
standard; however, implementation of this new standard is not expected to have a
material impact on Capitol's consolidated financial statements.
Statement No. 144, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF, became effective on January 1, 2002.
This new standard did not have a material impact on Capitol's consolidated
financial statements.
Statement No. 145, which updates, clarifies and simplifies certain existing
accounting pronouncements (rescission of Statements No. 4, 44 and 64, amendment
of Statement No. 13 and technical corrections) beginning at various dates in
2002/2003 is not expected to have a material effect on Capitol's consolidated
financial statements.
Statement No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL
ACTIVITIES, becomes effective January 1, 2003. Management has not completed its
analysis of this new standard; however, it is not expected to have a material
impact on Capitol's consolidated financial statements, upon implementation.
Statement No. 147, ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS, amends
prior standards relating to some acquisitions of financial institutions,
requiring such transactions to be accounted for in accordance with Statements
No. 141 and 142 and is generally effective October 1, 2002. Management has not
completed its analysis of this new standard; however, it is not expected to have
a material effect on Capitol's consolidated financial statements, upon
implementation.
A variety of proposed or otherwise potential accounting standards are
currently under study by standard-setting organizations and various regulatory
agencies. Because of the tentative and preliminary nature of these proposed
standards, management has not determined whether implementation of such proposed
standards would be material to Capitol's consolidated financial statements.
Page 11 of 29
PART I, ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Total assets approximated $2.3 billion at September 30, 2002, an increase
of $304 million from the December 31, 2001 level of $2.0 billion. The balance
sheet includes Capitol and its consolidated subsidiaries:
Total Assets
(in $1,000's)
--------------------------
Sept 30 Dec 31
2002 2001
----------- -----------
Great Lakes Region:
Ann Arbor Commerce Bank $ 310,263 $ 271,116
Brighton Commerce Bank 77,834 70,530
Capitol National Bank 200,824 173,177
Detroit Commerce Bank 30,250 33,768
Grand Haven Bank 119,008 98,740
Kent Commerce Bank 72,992 66,873
Macomb Community Bank 86,072 97,113
Muskegon Commerce Bank 85,301 74,284
Oakland Commerce Bank 119,755 115,249
Paragon Bank & Trust 103,947 93,667
Portage Commerce Bank 138,170 127,884
Indiana Community Bancorp Limited:
Elkhart Community Bank 47,875 35,939
Goshen Community Bank 36,907 28,681
----------- -----------
Great Lakes Region Total 1,429,198 1,287,021
Southwestern Region:
Arrowhead Community Bank 43,557 33,658
Bank of Tucson 128,665 121,075
Camelback Community Bank 78,439 67,210
East Valley Community Bank 35,490 39,591
Mesa Bank 58,305 52,308
Southern Arizona Community Bank 76,169 55,423
Valley First Community Bank 42,276 58,625
Yuma Community Bank 37,336 23,202
Nevada Community Bancorp Limited:
Bank of Las Vegas(2) 23,486 n/a
Black Mountain Community Bank 59,857 50,909
Desert Community Bank 56,488 56,844
Red Rock Community Bank 103,498 84,971
Sunrise Capital Corporation:
Sunrise Bank of Albuquerque 44,017 35,984
Sunrise Bank of Arizona 75,411 63,141
----------- -----------
Southwestern Region Total 862,994 742,941
California Region:
Sunrise Bank of San Diego(1) 53,951 37,912
First California Northern Bancorp:
Napa Community Bank(2) 29,855 n/a
----------- -----------
California Region Total 83,806 37,912
Other, net (28,404) (23,868)
----------- -----------
Consolidated $ 2,347,594 $ 2,044,006
=========== ===========
n/a Not applicable
(1) Commenced operations as a DE NOVO bank in 2001. Sunrise Bank of
San Diego is a majority-owned subsidiary of Sunrise Capital
Corporation.
(2) Commenced operations as DE NOVO banks in 2002.
Page 12 of 29
Portfolio loans increased during the nine-month 2002 period by
approximately $224 million. Loan growth was funded primarily by higher levels of
time deposits. The majority of portfolio loan growth occurred in commercial
loans, consistent with the banks' emphasis on commercial lending activities.
Portfolio loan growth in 2002 is net of about $51 million of commercial loans
sold to other financial institutions.
The allowance for loan losses at September 30, 2002 approximated $28
million or 1.42% of total portfolio loans, an increase from the year-end 2001
ratio of 1.34%.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb potential losses inherent in the loan portfolio at the
balance sheet date. Management's determination of the adequacy of the allowance
is based on evaluation of the portfolio (including potential impairment of
individual loans and concentrations of credit), past loss experience, current
economic conditions, volume, amount and composition of the loan portfolio, loan
commitments outstanding and other factors. The allowance is increased by
provisions charged to operations and reduced by net charge-offs.
The table below summarizes portfolio loan balances and activity in the
allowance for loan losses for the interim periods (in thousands):
2002 2001
---------- ----------
Allowance for loan losses at January 1 $ 23,238 $ 17,449
Loans charged-off:
Commercial 4,079 1,269
Real estate mortgage 204 42
Installment 206 301
---------- ----------
Total charge-offs 4,489 1,612
Recoveries:
Commercial 318 314
Real estate mortgage 61 36
Installment 78 25
---------- ----------
Total recoveries 457 375
---------- ----------
Net charge-offs 4,032 1,237
Additions to allowance charged to expense 8,692 5,637
---------- ----------
Allowance for loan losses at September 30 $ 27,898 $ 21,849
========== ==========
Average total portfolio loans for period ended
September 30 $1,847,149 $1,513,528
========== ==========
Ratio of net charge-offs (annualized) to average
portfolio loans outstanding 0.29% 0.11%
========== ==========
Page 13 of 29
Net charge-offs of loans increased $2.8 million in 2002, compared to the
nine-month period in 2001. Of that increase, $1.4 million occurred during the
quarter ended September 30, 2002, mainly due to losses associated with loans
secured by business equipment and accounts receivable. Loan charge-offs have
increased throughout 2002.
The amounts of the allowance for loan losses allocated in the following
table (in thousands) include all loans for which, based on Capitol's loan rating
system, management has concerns, and should not be interpreted as an indication
of future charge-offs.
September 30, 2002 December 31, 2001
---------------------- ----------------------
Percentage Percentage
of Total of Total
Portfolio Portfolio
Amount Loans Amount Loans
---------- ---------- ---------- ----------
Commercial $ 26,167 1.34% $ 20,570 1.19%
Real estate mortgage 185 0.01 1,630 0.09
Installment 1,546 0.07 1,038 0.06
---------- ----- ---------- -----
Total allowance for loan losses $ 27,898 1.42% $ 23,238 1.34%
========== ===== ========== =====
Total portfolio loans outstanding $1,958,820 $1,734,589
========== ==========
In addition to the allowance for loan losses, certain commercial loans in
Michigan and Indiana are enrolled in state-sponsored loan programs and have
additional reserves established to provide for loss protection. At September 30,
2002, total loans under these programs approximated $32 million. Reserves
related to these loans, which are represented by earmarked funds on deposit at
some of the bank subsidiaries, approximated $1.1 million and are not included in
the allowance for loan losses.
The state agency administering the Michigan program has announced plans to
terminate its program. Upon termination of the program, loans previously
enrolled in the program and related reserves will continue until the underlying
loans are repaid, but no new loans will be enrolled in the program. While this
program has complimented the lending efforts of Capitol's Michigan banks,
termination of the program is not expected to have a material adverse affect on
those banks' lending activities in the future. The termination of the program
may adversely affect the future availability of credit for those borrowers who
otherwise would have been eligible for enrollment in the program.
Page 14 of 29
Nonperforming loans (i.e., loans which are 90 days or more past due and
loans on nonaccrual status) are summarized below (in thousands):
Sept 30 Dec 31
2002 2001
-------- --------
Nonaccrual loans:
Commercial $ 16,198 $ 11,220
Real estate 986 356
Installment 682 466
-------- --------
Total nonaccrual loans 17,866 12,042
Past due (>=90 days) loans:
Commercial 6,721 4,290
Real estate 1,444 787
Installment 270 119
-------- --------
Total past due loans 8,435 5,196
-------- --------
Total nonperforming loans $ 26,301 $ 17,238
======== ========
Nonperforming loans increased approximately $9 million during the
nine-month period ended September 30, 2002. Of the nonperforming loans at
September 30, 2002, about 70% are real estate secured. Those loans, when
originated, had appropriate loan-to-value ratios and, accordingly, have loss
exposure which is expected to be minimal; however, underlying real estate values
depend upon current economic conditions and liquidation strategies. Most other
nonperforming loans are generally secured by other business assets.
Nonperforming loans at September 30, 2002 are in various stages of resolution
for which management believes such loans are adequately collateralized or
otherwise appropriately considered in its determination of the adequacy of the
allowance for loan losses.
In addition to the identification of nonperforming loans involving
borrowers with payment performance difficulties (i.e., nonaccrual loans and
loans past-due 90 days or more), management utilizes an internal loan review
process to identify other potential problem loans which may warrant additional
monitoring or other attention. This loan review process is a continuous activity
which periodically updates internal loan ratings. At inception, all loans are
individually assigned a rating which grades the credits on a risk basis, based
on the type and discounted value of collateral, financial strength of the
borrower and guarantors and other factors such as nature of the borrower's
business climate, local economic conditions and other subjective factors. The
loan rating process is fluid and subjective.
Potential problem loans include loans which are generally performing as
agreed; however, because of loan review's and/or lending staff's risk
assessment, increased monitoring is deemed appropriate. In addition, some loans
are assigned a more adverse classification, with specific performance issues or
other risk factors requiring close management and development of specific
remedial action plans.
Page 15 of 29
At September 30, 2002, potential problem loans (including the previously
mentioned nonperforming loans) approximated $93 million, or about 5% of total
consolidated portfolio loans. These potential problem loans do not necessarily
have significant loss exposure (nor are they necessarily deemed `impaired'), but
rather are classified by management in this manner to aid in loan administration
and risk management. Management believes such loans to be adequately considered
in its evaluation of the adequacy of the allowance for loan losses. Management
believes, however, that current general economic conditions may result in higher
levels of future loan losses, in comparison to previous years, as evidenced by
higher loan losses in the interim 2002 period.
Other real estate owned (generally real estate acquired through foreclosure
or a deed in lieu of foreclosure and classified as a component of other assets)
approximated $3.7 million at September 30, 2002 and $3.0 million at December 31,
2001. The majority of these properties had sale offers pending at September 30,
2002.
The following comparative analysis summarizes each bank's total portfolio
loans, allowance for loan losses, nonperforming loans and ratio of the allowance
as a percentage of portfolio loans (dollars in thousands):
Allowance as a
Percentage
Total Allowance for Nonperforming of Total
Portfolio Loans Loan Losses Loans Portfolio Loans
----------------------- ----------------------- ----------------------- ---------------
Sept 30 Dec 31 Sept 30 Dec 31 Sept 30 Dec 31 Sept 30 Dec 31
2002 2001 2002 2001 2002 2001 2002 2001
---------- ---------- ---------- ---------- ---------- ---------- ------- ------
Great Lakes Region:
Ann Arbor Commerce Bank $ 271,217 $ 233,920 $ 3,810 $ 3,219 $ 3,743 $ 1,960 1.40% 1.38%
Brighton Commerce Bank 66,227 60,984 822 732 227 227 1.24 1.20
Capitol National Bank 152,402 144,485 2,212 1,983 1,597 465 1.45 1.37
Detroit Commerce Bank 28,666 29,243 463 351 669 539 1.62 1.20
Grand Haven Bank 109,980 89,989 1,548 1,212 1,503 1,234 1.41 1.35
Kent Commerce Bank 69,317 63,782 853 766 362 55 1.23 1.20
Macomb Community Bank 70,685 79,844 1,083 1,088 2,265 1,431 1.53 1.36
Muskegon Commerce Bank 78,152 70,151 977 842 1,439 123 1.25 1.20
Oakland Commerce Bank 82,861 81,711 997 1,063 2,623 406 1.20 1.30
Paragon Bank & Trust 87,238 81,430 1,131 1,018 3,240 586 1.30 1.25
Portage Commerce Bank 125,947 109,393 1,700 1,550 3,208 2,845 1.35 1.42
Indiana Community Bancorp Limited:
Elkhart Community Bank 40,670 31,492 611 473 420 222 1.50 1.50
Goshen Community Bank(1) 33,299 22,966 500 345 -- -- 1.50 1.50
---------- ---------- ---------- ---------- ---------- ----------
Great Lakes Region Total 1,216,661 1,099,390 16,707 14,642 21,296 10,093
Southwestern Region:
Arrowhead Community Bank(1) 35,595 30,430 534 457 72 -- 1.50 1.50
Bank of Tucson 93,735 88,218 1,500 1,224 421 407 1.60 1.39
Camelback Community Bank 66,836 56,555 877 743 96 334 1.31 1.31
East Valley Community Bank 26,797 27,402 389 423 121 432 1.45 1.54
Mesa Bank 54,213 45,672 797 594 456 542 1.47 1.30
Southern Arizona Community Bank 59,321 50,879 867 662 241 298 1.46 1.30
Valley First Community Bank 34,170 41,851 619 670 331 1,018 1.81 1.60
Yuma Community Bank(1) 24,158 18,539 363 285 -- -- 1.50 1.54
Nevada Community Bancorp Limited:
Bank of Las Vegas(1) 16,506 n/a 248 n/a -- n/a 1.50 n/a
Black Mountain Community Bank(1) 52,257 40,111 784 602 144 240 1.50 1.50
Desert Community Bank 42,818 50,361 694 806 447 989 1.62 1.60
Red Rock Community Bank(1) 80,446 67,117 1,352 1,008 1,791 942 1.68 1.50
Sunrise Capital Corporation:
Sunrise Bank of Albuquerque(1) 34,919 28,061 472 379 292 614 1.35 1.35
Sunrise Bank of Arizona 60,448 55,730 817 753 593 1,329 1.35 1.35
---------- ---------- ---------- ---------- ---------- ----------
Southwestern Region Total 682,219 600,926 10,313 8,606 5,005 7,145
California Region:
Sunrise Bank of San Diego(1) 42,738 32,910 577 455 -- -- 1.35 1.38
First California Northern Bancorp:
Napa Community Bank(1) 13,695 n/a 206 n/a -- n/a 1.50 n/a
---------- ---------- ---------- ---------- ---------- ----------
California Region Total 56,433 32,910 783 455 -- --
Other, net 3,507 1,363 95 (465)
---------- ---------- ---------- ---------- ---------- ---------- ----- -----
Consolidated $1,958,820 $1,734,589 $ 27,898 $ 23,238 $ 26,301 $ 17,238 1.42% 1.34%
========== ========== ========== ========== ========== ========== ===== =====
n/a Not applicable
(1) As a condition of charter approval, bank is required to maintain an
allowance for loan losses of not less than 1% for the first three years of
operations.
Page 16 of 29
RESULTS OF OPERATIONS
Net income for the quarter ended September 30, 2002, was $4.4 million, an
increase of $1.7 million or 60% over the same period last year. Diluted earnings
per share were $0.40 compared to $0.35 for the prior year period. Net income for
the nine-month 2002 period was $11.4 million ($1.12 per diluted share), a 47%
increase from $7.8 million ($0.98 per diluted share) in the comparable period of
2001. The percentage increase in net income per share was less than the
percentage increase in the amount of net income in 2002 because of the larger
share base resulting from Capitol's share exchange regarding Sun Community
Bancorp effective March 31, 2002. The share exchange transactions regarding
Sunrise Capital Corporation and Indiana Community Bancorp, which are discussed
elsewhere in this narrative, had no significant effect on results of operations
for the interim 2002 periods inasmuch as those share exchange transactions were
consummated effective September 30, 2002.
Net interest income for the third quarter of 2002 totaled $26.2 million, a
26% increase as compared to $20.7 million for the comparable period in 2001. Net
interest income for the nine-month 2002 period was $73.4 million, compared to
$58.9 million for the same period in 2001, an increase of 25% during the
nine-month period versus 22% in the corresponding period of 2001. These
increases are attributable to the expansion in number of banks, the banks'
growth and a stable interim 2002 interest rate environment.
Noninterest income for the quarter ended September 30, 2002 was $4.2
million, an increase of $1.8 million, or 74%, over the same period in 2001. On a
year-to-date basis, noninterest income totaled $10.4 million in 2002, compared
to $7.0 million in 2001. Fees from origination of non-portfolio residential
mortgage loans totaled $2 million for the third quarter of 2002, and were $4.4
million for the nine-month period, as compared to $803,000 and $2.2 million for
the comparable periods in 2001, respectively, due to higher loan volume
resulting from lower interest rates. Service charges on deposit accounts and
trust fee income both increased in the third quarter of 2002 by 42% on a
combined basis, compared to 2001. Service charges on deposits and trust fee
income totaled $3 million and $1.9 million, respectively, for the nine-month
period in 2002, as compared to $2.4 million and $1.4 million, respectively, in
2001. Increases in service charges on deposit accounts and trust fee income in
2002 resulted from increased transaction volume.
The provision for loan losses for the third quarter of 2002 was $3.9
million as compared to $2.3 million during the corresponding 2001 period. The
loan loss provision for the nine-month 2002 period was $8.7 million, compared to
$5.6 million in 2001. Increases in the provision for loan losses are principally
related to higher levels of loan charge-offs, increases in nonperforming loans
and aggregate loan growth. The provision for loan losses is based upon
management's analysis of the adequacy of the allowance for loan losses, as
previously discussed.
Noninterest expense totaled $18.9 million for the third quarter, and $56.8
million for the nine-month period in 2002, as compared to $15.9 million and
$47.4 million, respectively, for the comparable periods in 2001. The increase in
noninterest expense is associated with newly formed banks, growth and increases
in general operating costs. Increases in both occupancy and salaries and
employee benefits relate primarily to the growth in the number of banks within
the consolidated group.
Page 17 of 29
Operating results (dollars in thousands) were as follows:
Nine months ended September 30
--------------------------------------------------------------------------------------------
Return on Return on
Total Revenues Net Income Average Equity Average Assets
---------------------- ---------------------- ------------------ ------------------
2002 2001 2002 2001 2002 2001 2002 2001
--------- --------- --------- --------- ------- ------- ------- -------
Great Lakes Region:
Ann Arbor Commerce Bank $ 17,041 $ 17,586 $ 3,670 $ 3,075 22.23% 22.21% 1.71% 1.64%
Brighton Commerce Bank 4,204 4,217 679 407 14.46 9.74 1.21 .83
Capitol National Bank 9,670 10,074 2,307 1,914 22.28 21.96 1.69 1.64
Detroit Commerce Bank 1,752 2,001 (275) (155) n/a n/a n/a n/a
Grand Haven Bank 6,774 5,799 1,454 764 21.26 15.60 1.72 1.21
Kent Commerce Bank 4,378 3,431 745 (15) 14.09 n/a 1.33 n/a
Macomb Community Bank 4,441 6,582 438 823 8.25 11.96 .91 1.02
Muskegon Commerce Bank 4,829 4,716 1,038 545 14.46 11.93 1.21 1.07
Oakland Commerce Bank 5,502 6,688 1,034 1,013 15.76 17.30 1.35 1.30
Paragon Bank & Trust 6,132 6,258 664 127 9.47 2.40 .90 .20
Portage Commerce Bank 7,800 8,549 1,441 1,230 18.09 16.79 1.50 1.27
Indiana Community Bancorp Limited:
Elkhart Community Bank 2,093 1,833 163 (29) 4.65 n/a .54 n/a
Goshen Community Bank 1,663 788 75 (322) 2.28 n/a .30 n/a
--------- --------- --------- ---------
Great Lakes Region Total 76,279 78,522 13,433 9,377
Southwestern Region:
Arrowhead Community Bank 2,485 1,174 64 (359) 2.33 n/a .26 n/a
Bank of Tucson 7,439 7,873 1,688 1,609 21.62 23.63 1.82 2.00
Camelback Community Bank 4,461 3,770 449 325 8.39 9.58 .77 .81
East Valley Community Bank 2,061 2,509 (275) (35) n/a n/a n/a n/a
Mesa Bank 3,718 3,168 579 302 13.46 9.35 1.34 .95
Southern Arizona Community Bank 3,658 3,067 459 200 10.03 6.62 .89 .58
Valley First Community Bank 2,793 3,677 127 354 2.99 8.64 .33 .86
Yuma Community Bank 1,874 825 63 (356) 2.33 n/a .26 n/a
Nevada Community Bancorp Limited:
Bank of Las Vegas(2) 774 n/a (535) n/a n/a n/a n/a n/a
Black Mountain Community Bank 2,869 2,383 235 (12) 6.74 n/a .61 n/a
Desert Community Bank 3,260 3,261 129 100 3.44 2.97 .29 .29
Red Rock Community Bank 5,032 4,233 734 542 10.94 8.77 1.08 1.17
Sunrise Capital Corporation:
Sunrise Bank of Albuquerque 2,054 2,169 (61) 64 n/a 2.32 n/a .27
Sunrise Bank of Arizona 4,567 4,912 65 472 1.41 11.78 .13 .97
--------- --------- --------- ---------
Southwestern Region Total 47,045 43,021 3,721 3,206
California Region:
Sunrise Bank of San Diego(1) 2,971 1,740 250 (833) 4.55 n/a .75 n/a
First California Northern Bancorp:
Napa Community Bank(2) 816 n/a (535) n/a n/a n/a n/a n/a
--------- --------- --------- ---------
California Region Total 3,787 1,740 (285) (833)
Other, net (458) (523) (5,465) (3,995) n/a n/a n/a n/a
--------- --------- --------- --------- ------ ------ ----- -----
Consolidated $ 126,653 $ 122,760 $ 11,404 $ 7,755 13.78% 14.82% .70% .57%
========= ========= ========= ========= ====== ====== ===== =====
n/a Not applicable
(1) Commenced operations as a DE NOVO bank in 2001.
(2) Commenced operations as DE NOVO banks in 2002.
LIQUIDITY AND CAPITAL RESOURCES
The principal funding source for asset growth and loan origination
activities is deposits. Total deposits increased $278 million for the nine-month
2002 period, slightly less than the $287 million increase in the corresponding
period of 2001. Growth occurred in all deposit categories, with the majority
coming from time deposits. The banks generally do not rely on brokered deposits
as a key funding source; brokered deposits approximated $193 million as of
September 30, 2002, or about 10% of total deposits, an increase of $50 million
during the interim 2002 period. Brokered deposits, as a funding source, have
increased in recent periods due to competitive environments and selective
opportunities to grow deposits at a faster pace and/or lower cost than
traditional sources, and may similarly increase in future periods.
Page 18 of 29
Noninterest-bearing deposits approximated 17% of total deposits at
September 30, 2002 and 16% at December 31, 2001. Levels of noninterest-bearing
deposits fluctuate based on customers' transaction activity.
Interim 2002 deposit growth was deployed primarily into commercial loans,
consistent with the banks' emphasis on commercial lending activities.
Cash and cash equivalents amounted to $227 million or 10% of total assets
at September 30, 2002 as compared with $164 million or 8% of total assets at
December 31, 2001. As liquidity levels vary continuously based on customer
activities, amounts of cash and cash equivalents can vary widely at any given
point in time. Management believes the banks' liquidity position at September
30, 2002 is adequate to fund loan demand and meet depositor needs.
In addition to cash and cash equivalents, a source of long-term liquidity
is the banks' marketable investment securities. Liquidity needs have not
historically necessitated the sale of investments in order to meet funding
requirements. The banks have not engaged in active trading of their investments.
At September 30, 2002, the banks had approximately $38 million of investment
securities classified as available for sale which can be utilized to meet
various liquidity needs as they arise.
Some of the banks have secured lines of credit with a Federal Home Loan
Bank. Borrowings thereunder approximated $69.8 million and additional borrowing
capacity approximated $11.2 million at September 30, 2002. These borrowings
increased ($6.6 million in the interim periods of 2002) as a lower-cost funding
source versus various rates and maturities of time deposits. At September 30,
2002, Capitol had unused lines of credit from an unrelated financial institution
aggregating $15 million.
Share exchange transactions regarding Sunrise Capital Corporation (Sunrise)
and Indiana Community Bancorp Limited (Indiana) were completed effective
September 30, 2002. An earlier share exchange transaction regarding Sun
Community Bancorp Limited (Sun) was completed effective March 31, 2002. In each
transaction, the shares acquired from shareholders other than Capitol were
exchanged for Capitol's common stock according to a fixed, but differing,
exchange ratio. To the extent those subsidiaries had stock options outstanding,
such stock options were similarly exchanged for stock options of Capitol.
Capitol's common shares issued in the Sun and Sunrise share exchanges are
unrestricted; shares issued in the Indiana exchange have resale and transfer
restrictions which expire in 2004. In total, Capitol has issued approximately
3.2 million shares of its common stock and 1.1 million stock options resulting
from these share exchanges (for aggregate consideration approximating $54.1
million), of which about 450,000 shares were issued effective September 30,
2002. These transactions have been recorded using the purchase-method of
accounting. Had these transactions occurred at the beginning of the periods
presented, net income would have approximated $11.7 million ($1.01 per diluted
share) and $7.9 million ($.71 per diluted share) for the nine months ended
September 30, 2002 and 2001, respectively.
Page 19 of 29
As of September 30, 2002, potential share exchange transactions were
pending regarding the minority shareholders of Detroit Commerce Bank and East
Valley Community Bank which, if completed, would result in Capitol issuing
approximately 54,000 additional shares of common stock and those majority-owned
subsidiaries becoming wholly-owned.
Capitol and its banks are subject to complex regulatory capital
requirements, which require maintaining certain minimum capital ratios. These
ratio measurements, in addition to certain other requirements, are used by
regulatory agencies to determine the level of regulatory intervention and
enforcement applied to financial institutions. Management believes Capitol and
each of its banks are in compliance with regulatory requirements and are
expected to maintain such compliance.
Stockholders' equity, as a percentage of total assets, approximated 6.2% at
September 30, 2002 and increased from 3.9% at the beginning of the year,
primarily as a result of the previously-mentioned share exchanges regarding Sun,
Sunrise and Indiana. Total capital funds (Capitol's stockholders' equity, plus
minority interests in consolidated subsidiaries, plus guaranteed preferred
beneficial interests in the Corporation's subordinated debentures) aggregated
$230.7 million or 10% of total assets at September 30, 2002.
Capitol's operating strategy continues to be focused on the ongoing growth
and maturity of its existing banks, coupled with new bank expansion in selected
markets as opportunities arise. Accordingly, Capitol may invest in, acquire or
otherwise develop additional banks in future periods, subject to economic
conditions and other factors, although the timing of such additional banking
units, if any, is uncertain. Such future new banks and/or additions of other
operating units could be either wholly-owned, majority-owned or otherwise
controlled by Capitol.
TRENDS AFFECTING OPERATIONS
One of the most significant trends which can impact the financial condition
and results of operations of financial institutions are changes in market rates
of interest.
Changes in interest rates, either up or down, have an impact on net
interest income (plus or minus), depending on the direction and timing of such
changes. At any point in time, there is an imbalance between interest
rate-sensitive assets and interest rate-sensitive liabilities. This means that
when interest rates change, the timing and magnitude of the effect of such
interest rate changes can alter the relationship between asset yields and the
cost of funds.
During 2001, the Open Market Committee of the Federal Reserve Board
decreased interbank interest rates on numerous separate dates, for an
unprecedented decrease of 475 basis points during the year. In the first nine
months of 2002, interest rates have remained relatively stable.
Page 20 of 29
Because variable rate loans reprice more rapidly than interest-bearing
deposits, such market interest rate decreases compressed net interest margins at
Capitol's banks in 2001. In 2002, however, a more stable interest rate
environment has favorably impacted net interest margins at Capitol's banks from
interest-bearing deposits repricing at lower rates. As the Open Market Committee
continues to influence interest rates and other economic policy during the
remainder of 2002, including the potential of rate increases (or decreases), net
interest margins may become more compressed (having an adverse impact on
earnings) in future periods.
Start-up banks generally incur operating losses during their early periods
of operations. Recently-formed start-up banks are expected to detract from
consolidated earnings performance and start-up banks formed in 2002 and beyond
will similarly negatively impact short-term profitability.
General economic conditions also have a significant impact on both the
results of operations and the financial condition of financial institutions.
Media reports of raising questions about the health of the domestic economy
have continued in 2002. In 2002, nonperforming loans have increased and it is
anticipated that levels of nonperforming loans and related loan losses may
increase as economic conditions, locally and nationally, evolve.
IMPACT OF NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, BUSINESS COMBINATIONS, and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
Statement No. 141 requires that all business combinations be accounted for under
a prior standard of purchase accounting, eliminating the so-called
pooling-method which was used to account for some business combinations. This
standard did not have a material effect on Capitol's consolidated financial
statements.
Statement No. 142 requires that goodwill no longer be amortized and charged
against earnings, but instead be reviewed for impairment. Amortization of
goodwill ceased upon adoption of the Statement on January 1, 2002. This new
standard requires that goodwill be reviewed annually for impairment and,
accordingly, impairment adjustments of goodwill be charged against earnings, if
and when determined.
Capitol's previous business combinations (generally, acquisitions of
minority interests) have been accounted for using the purchase method. As of
September 30, 2002, the net carrying amount of goodwill approximated $17.9
million and other intangible assets approximated $2.4 million. Upon
implementation, this new standard did not have a material effect on Capitol's
consolidated financial statements, other than the elimination of goodwill
amortization (such amortization approximated $602,000 for the nine months ended
September 30, 2001).
Page 21 of 29
Statement No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, becomes
effective January 1, 2003. Management has not completed its analysis of this new
standard; however, implementation of this new standard is not expected to have a
material impact on Capitol's consolidated financial statements.
Statement No. 144, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF, became effective on January 1, 2002.
This new standard did not have a material impact on Capitol's consolidated
financial statements.
Statement No. 145, which updates, clarifies and simplifies certain existing
accounting pronouncements (rescission of Statements No. 4, 44 and 64, amendment
of Statement No. 13 and technical corrections) beginning at various dates in
2002/2003 is not expected to have a material effect on Capitol's consolidated
financial statements.
Statement No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL
ACTIVITIES, becomes effective January 1, 2003. Management has not completed its
analysis of this new standard; however, it is not expected to have a material
impact on Capitol's consolidated financial statements, upon implementation.
Statement No. 147, ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS, amends
prior standards relating to some acquisitions of financial institutions,
requiring such transactions to be accounted for in accordance with Statements
No. 141 and 142 and is generally effective October 1, 2002. Management has not
completed its analysis of this new standard; however, it is not expected to have
a material effect on Capitol's consolidated financial statements, upon
implementation.
A variety of proposed or otherwise potential accounting standards are
currently under study by standard-setting organizations and various regulatory
agencies. Because of the tentative and preliminary nature of these proposed
standards, management has not determined whether implementation of such proposed
standards would be material to Capitol's consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
In May 2002, the Securities and Exchange Commission proposed significant
changes in disclosure rules applicable to public companies. One of those
proposed significant changes involves the identification of "critical accounting
policies". Capitol's significant accounting policies are described in the
financial section of its 2001 Annual Report. In the circumstances of Capitol,
management believes its "critical accounting policies" are those which encompass
the allowance for loan losses (due to the inherent subjectivity in estimating
loan losses), accounting for income taxes (due to the significant U.S. corporate
income tax rate and realization of deferred tax assets), accounting for loan
fees (relating to the periods of revenue recognition) and accounting for
goodwill (due to new accounting standards effective at the beginning of 2002).
Page 22 of 29
PART I, ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART I, ITEM 4
CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Disclosure controls and procedures were evaluated as of September 30, 2002
("Evaluation Date"). Such evaluation concluded that Capitol's disclosure
controls and procedures are effective to ensure that material information
relating to Capitol, including its consolidated subsidiaries, is made known
to Capitol's senior management, particularly during the period for which
this quarterly report has been prepared.
(b) CHANGES IN INTERNAL CONTROL.
As of the signature date of this report, there have been no significant
changes in Capitol's internal controls or in other factors that could
significantly affect internal controls subsequent to the Evaluation Date
referred to in (a) above.
(c) ASSET-BACKED ISSUERS.
Not applicable.
[The remainder of this page intentionally left blank]
Page 23 of 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Capitol and its subsidiaries are parties to certain ordinary, routine
litigation incidental to their business. In the opinion of management,
liabilities arising from such litigation would not have a material
effect on Capitol's consolidated financial position or results of
operations.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
99.1 Certification of Chief Executive
Officer, Joseph D. Reid, pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Certification of Chief Financial
Officer, Lee W. Hendrickson, pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the three
months ended September 30, 2002.
Page 24 of 29
SIGNATURES
Pursuant to the requirements 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.
CAPITOL BANCORP LTD.
(Registrant)
/s/ Joseph D. Reid
-----------------------------------
Joseph D. Reid
Chairman and CEO
(duly authorized to sign on behalf
of the registrant)
/s/ Lee W. Hendrickson
-----------------------------------
Lee W. Hendrickson
Executive Vice President and
Chief Financial Officer
Date: November 11, 2002
Page 25 of 29
CERTIFICATIONS
I, Joseph D. Reid, Chairman and CEO, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Capitol Bancorp Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
Page 26 of 29
CERTIFICATIONS--CONTINUED
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 11, 2002
/s/ Joseph D. Reid
-----------------------------------
Joseph D. Reid
Chairman and CEO
[The remainder of this page intentionally left blank]
Page 27 of 29
CERTIFICATIONS--CONTINUED
I, Lee W. Hendrickson, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Capitol Bancorp Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
Page 28 of 29
CERTIFICATIONS--CONTINUED
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 11, 2002
/s/ Lee W. Hendrickson
-----------------------------------
Lee W. Hendrickson
Executive Vice President and
Chief Financial Officer
[The remainder of this page intentionally left blank]
Page 29 of 29