SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

PELICAN FINANCIAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes o  No ý

 

The issuer’s voting stock trades on the American Stock Exchange under the symbol “PFI.”  The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing sale price of the registrant’s common stock on June 30, 2003, was $17,764,884 ($4.00 per share based on 4,441,221 shares of common stock outstanding).

 

As of March 15, 2004, there were issued and outstanding 4,488,351 shares of the registrant’s common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

1.                                       Portions of the Definitive Proxy Statement in connection with the Annual Meeting of Stockholders for the Fiscal Year Ended December 31, 2003 (Part II).

 

 

TABLE OF CONTENTS

 

Part I.
Item 1.	Business
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
Part II.
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6.	Selected Financial Data
Item 7.	Managements Discussion and Analysis of Financial Condition and Results of Operation
Item 7A	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A	Controls and Procedures
Part III.
Item 10.	Directors and Executive Officers of the Registrant
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13	Certain Relationships and Related Transactions
Item 14.	Principal Accountant Fees and Services
Part IV.
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Signatures

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Some of the statements in this Annual Report and Form 10-K, including some statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business,” are forward-looking statements about what may happen in the future.  They include statements regarding our current beliefs, goals, and expectations about matters such as our expected financial position and operating results, our business strategy, and our financing plans.  These statements can sometimes be identified by our use of forward-looking words such as “anticipate,” “estimate,” “expect,” “intend,” “may,” “will,” and similar expressions.  We cannot guarantee that our forward-looking statements will turn out to be correct or that our beliefs and goals will not change.  Our actual results could be very different from and worse than our expectations for various reasons, including those discussed in “Business – Factors that May Affect Future Results.”  You are urged to carefully consider these factors, as well as other information contained in this Annual Report and Form 10-K and in our other periodic reports and documents filed with the Securities and Exchange Commission.

 

PART I

 

Item 1.    Business

 

General

 

Pelican Financial, Inc. was incorporated in Delaware on March 3, 1997 to own and control all of the outstanding capital stock of Pelican National Bank and Washtenaw Mortgage Company.  On August 22, 2003, The Washtenaw Group, Inc. was incorporated in Michigan to own and control all of the outstanding capital stock of Washtenaw Mortgage Company.  In an internal reorganization, Pelican Financial transferred all the shares of Washtenaw Mortgage Company to The Washtenaw Group in exchange for all the outstanding shares of The Washtenaw Group.  At the close of business on December 31, 2003, Pelican Financial distributed to each record holder of its common stock, as of December 22, 2003, one share of common stock of The Washtenaw Group.

 

Pelican Financial has no employees other than executive officers who do not receive compensation from Pelican Financial for serving in this capacity.  See “Management - Director and Executive Officer Compensation.”  Pelican Financial engages in no other operations other than the management of its investments in Pelican National.  Pelican National is engaged primarily in retail banking.

 

Our internet address is www.PelicanFinancialInc.com.  We make available free of charge on www.PelicanFinancialInc.com. our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.  Our recently adopted Code of Business Conduct and Ethics is also available on our website.

 

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In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC.  Requests should be directed to:

 

Howard Nathan
Pelican Financial Inc.
3767 Ranchero Drive
Ann Arbor, Michigan 48108

 

The information on the website listed above, is not and should not be considered part of this annual report on Form 10-K and is not incorporated by reference in this document.  This website is and is only intended to be an inactive textual reference.

 

Pelican Financial is registered with the Board of Governors of the Federal Reserve System pursuant to the Bank Holding Company Act of 1956.  Because Pelican Financial is a bank holding company, its primary federal regulator is the Federal Reserve Board.

 

Pelican Financial currently operates in retail banking through its wholly-owned subsidiary.  However, for the year ended December 31, 2003, Pelican Financial’s revenues (net interest income and non-interest income) and earnings before income taxes are attributable to Pelican National and Washtenaw Mortgage, the discontinued operation.

 

At December 31, 2003, total assets of Pelican Financial (subsequent to the spin-off of Washtenaw Mortgage) were $221.5 million.  For the year ended December 31, 2003, net income was $8.5 million, of which $9.4 million was attributable to the discontinued operations of Washtenaw, $180,000 was a net loss of Pelican National, and $738,000 was a net loss at Pelican Financial.

 

Market Area

 

The following market area discussion relates only to the continuing operations of Pelican Financial through Pelican National.

 

The retail banking operations of Pelican National are located in Naples, San Carlos, Bonita Springs and Fort Myers, Florida.  Pelican National is a community-oriented banking institution offering a variety of financial products and services to meet the needs of the communities it serves.  Pelican National’s primary service area for attracting deposits and making loans includes the communities located in western Collier County, Florida and Lee County, Florida.  These communities include North Naples, Central Naples, East Naples, South Naples, Golden Gate, Marco Island, and the portion of Bonita Springs, which is in Collier County, which make up an area locally known as the “greater Naples area.”  Collier County has, and continues to experience population growth greater than the national and Florida averages.  The population of Collier County for 2003 is estimated at 265,000.

 

As a result of the opening of our branch office in San Carlos, Florida and the operation of our Fort Myers branch, Pelican National Bank’s secondary service area for attracting deposits and making loans includes the communities located in western Lee County, Florida.  These communities include North Fort Myers, Central Fort Myers, East Fort Myers, South Fort Myers, Fort Myers Beach, Sanibel Island, San Carlos, Captiva Island, Cape Coral, Lehigh Acres, and Pine Island.  Lee County has, and continues to experience population growth greater than the national and Florida averages.  The population of Lee County was estimated to be 455,000 in 2003.

 

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Because of the year-round subtropical climate, numerous golf facilities and pristine beaches, Collier and Lee Counties attracts approximately 2.7 million and 3.5 million visitors per year, respectively.  As a result, the service sector is one of the largest employers, particularly hotels such as those operated by Marriott Corporation, Hilton, and Radisson.  The next largest sector is retail trade followed by the government and construction.  Furthermore, the unemployment rate for both Lee and Collier counties are below the national average.

 

Competition

 

The following competition discussion relates only to the continuing operations of Pelican Financial through Pelican National.

 

Pelican Financial faces significant competition both in generating loans and attracting deposits at Pelican National.  Pelican National operates as a full-service community bank, offering a variety of financial services to meet the needs of its market area.  Those services include accepting time and demand deposits from the general public and, together with other funds, using the proceeds to originate secured and unsecured commercial and consumer loans, finance commercial transactions, and provide construction and mortgage loans, as well as home equity and personal lines of credit.  Other services offered by Pelican National include the sale of money orders, traveler’s checks, cashier’s checks, and savings bonds, wire transfer and direct deposit services, and safe deposit boxes.

 

Pelican National’s primary market area is highly competitive and Pelican National faces direct competition for loans and deposits from a significant number of financial institutions, many with a state wide or regional presence and, in some cases, a national presence.  Pelican National’s most direct competition for deposits has historically come from savings banks and associations, commercial banks and credit unions.  In addition, Pelican National faces increasing competition for deposits from non-bank institutions such as brokerage firms and insurance companies in instruments such as short-term money market funds, corporate and government securities funds, mutual funds, and annuities.  Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions.  Pelican National primarily seeks to distinguish itself from the competition based on the level of service offered and its variety of loan products.  As a full-service community bank, Pelican National believes that it can better serve individuals and small businesses that have become disenfranchised with the narrow guidelines of large national and regional banks.

 

Lending Activities

 

The following lending activity discussion relates only to the continuing operations of Pelican Financial through Pelican National except where specifically noted otherwise.

 

General.  Pelican National originates or acquires loans through its retail banking operations.  Loans are either held for investment or held available for sale in the secondary market.  In addition to residential mortgage loan production, Pelican National engages in the origination of commercial, commercial real estate, construction, and consumer loans.  Pelican National also purchases loan packages to supplement its loan portfolio.  For the year ended December 31, 2003, Pelican Financial’s combined wholesale and correspondent loan production (including Washtenaw Mortgage) totaled $3.6 billion and its retail loan production totaled $165.0 million.  Pelican National was responsible for $51.3 million in new loan production.

 

Residential mortgage loans are typically underwritten to secondary marketing standards.  The type of loan offered include fixed rate, variable rate and balloon products.  Construction loans will be offered as well, however the underwriting criteria will be more restrictive than a traditional mortgage

 

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loan.  Pelican National will retain a portion of residential mortgage loans depending on its liquidity position and the type of loan.  Pelican National will be more likely to retain variable rate loans to minimize the interest rate risk.

 

Commercial loans are a loan product provided by the Pelican National as well.  The commercial loan products include; commercial real estate; non real estate loans for items such as equipment, inventory and working capital lines; construction and multifamily.  The commercial loans are underwritten to ensure adequate cash flow exists to cover the debt service.  Pelican National also looks to ensure there is adequate collateral minimize its risk.  Finally, Pelican National may obtain guarantors with a strong personal financial status to protect their interest.

 

The following are a various consumer loan products that Pelican National Bank currently offers its customers:

 

Overdraft Protection		The overdraft protection loan product is unsecured and linked to a Pelican National checking account.  The overdraft protection line is treated as open-ended credit transactions. In order to obtain an overdraft protection line the customer must meet certain minimum credit score criteria.
Automobile Loans		Automobile loans are made for the purpose of purchasing new and used vehicles. The collateral value for new cars are based on dealer invoices. The collateral value for used vehicles will be based on invoice and N.A.D.A. values.
Boat and Recreational Vehicle Loans		The dealer’s invoice is used to value new vehicle. Used vehicle values are determined by N.A.D.A. values.
Motorcycle Loans		Retail installment loans for the purchase of motorcycles are made for the purchase of new motorcycles only.
Home Equity Lines of Credit		Home Equity Lines of Credit are secured with a first or second lien on residential property.  In order to obtain a home equity line of credit, certain maximum loan to value ratios are enforced.

 

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The following table contains selected data relating to the composition of Pelican Financial’s loan portfolio by type of loan at the dates indicated.  This table includes mortgage loans available for sale and mortgage loans held for investment.  Pelican Financial had no concentrations of loans exceeding 10% of total loans that are not otherwise disclosed below.  The table excludes the discontinued operations of Washtenaw Mortgage.

 

		December 31,
		2003					2002					2001					2000					1999
		Amount			Percent		Amount			Percent		Amount			Percent		Amount			Percent		Amount			Percent
		(Dollars in thousands)
Real estate loans:
Residential, one to four units		$	44,094		39.83	%	$	37,074		35.29	%	$	44,028		47.32	%	$	41,780		47.12	%	$	47,938		68.06	%
Commercial and industrial real estate		43,151			38.98		58,014			55.22		32,954			35.43		28,662			32.32		16,987			24.12
Construction		1,327			1.19		2,905			2.77		3,673			3.95		6,339			7.15		1,706			2.42
Total real estate loans		88,572			80.00		97,993			93.28		80,655			86.70		76,781			86.59		66,631			94.60
Other loans:
Business, commercial		1,534			1.39		963			0.92		703			0.76		1,116			1.26		679			0.96
Automobile		478			0.43		739			0.70		1,252			1.35		268			0.30		106			0.15
Boat		14,578			13.17		—			—		—			—		2,731			3.08		—			—
Other consumer		5,546			5.01		5,357			5.10		10,412			11.19		7,779			8.77		3,024			4.29
Total other loans		22,136			20.00		7,059			6.72		12,367			13.30		11,894			13.41		3,809			5.40
Total gross loans		110,708			100.00	%	105,052			100.00	%	93,022			100.00	%	88,675			100.00	%	70,440			100.00	%
Unearned fees, premiums and  discounts, net		420					92					(305		)			(775		)			(2,647		)
Allowance for loan losses		(1,330		)			(1,062		)			(856		)			(507		)			(374		)
Total Loans, net		$	109,798				$	104,082				$	91,861				$	87,393				$	67,419

 

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The following table contains certain information at December 31, 2003 regarding the maturity of Pelican Financial’s loan portfolio along with the dollar amounts of loans due after one year that have fixed and variable rates.  All loans are shown maturing based upon contractual maturities and include scheduled payments but not potential prepayments.  Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.  Loan balances have not been reduced for undisbursed loan proceeds, unearned discounts, and the allowance for loan losses.  Scheduled contractual principal repayments are not necessarily predictive of the actual maturities of loans because of prepayments.  The average life of mortgage loans, particularly fixed-rate loans, tends to increase when prevailing mortgage loan interest rates are substantially higher than interest rates on existing mortgage loans, and conversely, decrease when interest rates on existing mortgages are substantially higher than prevailing mortgage rates.  The table excludes the discontinued operations of Washtenaw Mortgage.

 

		1 to 4 Family Real Estate			Commercial & Industrial Real Estate			Construction			Business, Commercial			Consumer			Total
Non-accrual loans		$	283		$	172		$	—		$	—		$	—		$	455
Amounts Due:
Within 3 months		$	1,002		$	5,980		$	762		$	359		$	5,171		$	13,274
3 months to 1 year		6,948			8,218			565			20			398			16,149
Total due within 1 year		7,950			14,198			1,327			379			5,569			29,423
After 1 year:
1 to 3 years		4,898			13,781			—			1,140			1,277			21,096
3 to 5 years		5,199			8,593			—			15			1,643			15,450
5 to 10 years		4,570			837			—			—			4,030			9,437
10 to 15 years		2,089			3,098			—			—			8,083			13,270
Over 15 years		19,388			2,644			—			—			—			22,173
Total due after 1 year		36,144			28,953			—			1,155			15,033			81,426
Total		$	44,094		$	43,151		$	1,327		$	1,534		$	20,602		$	110,708
Fixed rate		$	27,168		$	14,901		—			$	1,155		$	15,019		$	58,243
Variable rate		9,117			14,052			—			—			14			23,183
Total due after 1 year		$	36,285		$	28,953		$	—		$	1,155		$	15,033		$	81,426

 

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Asset Quality

 

Pelican Financial is exposed to certain credit risks related to the value of the collateral that secures loans held in its portfolio and the ability of borrowers to repay their loans.  Pelican Financial’s senior officers closely monitor the loan and real estate owned portfolios for potential problems on a continuing basis and report to the Board of Directors of Pelican National and Pelican Financial at regularly scheduled meetings.  These officers regularly review the classification of loans and the allowance for losses.  Pelican National also has regular, independent loan reviews of a portion of the loan portfolio, the results are then reported to Board of Directors.

 

Nonperforming assets consist of nonaccrual loans and real estate owned.  Loans are usually placed on nonaccrual status when the loan is past due 90 days or more, or the ability of a borrower to repay principal and interest is in doubt.  Real estate or other collateral acquired by Pelican Financial as a result of foreclosure or repossession is classified as other real estate owned or repossessed assets until the time it is sold.  Pelican Financial generally tries to sell the property at a price no less than its net book value, but will consider discounts where appropriate to expedite the return of the funds to an earning status.  When the property is acquired, it is initially recorded at the lower of cost or fair value, establishing a new cost basis.  After foreclosure or repossession, valuations are periodically performed by management and adjusted through a charge to income for changes in the fair value or cost to sell.

 

Pelican Financial establishes an allowance for loan losses based upon a quarterly or more frequent evaluation by management of various factors including the estimated market value of the underlying collateral, the growth and composition of the loan portfolio, current delinquency trends and prevailing economic conditions, including property values, employment and occupancy rates, interest rates, and other conditions that may affect borrowers’ abilities to comply with repayment terms.  If actual losses exceed the amount of the allowance for loan losses, earnings could be adversely affected.

 

The following table summarizes nonperforming loans, other real estate owned, and restructured loans at the periods indicated for the continuing operations of Pelican Financial.  During the periods indicated, Pelican Financial had no restructured loans.

 

		December 31,
		2003			2002			2001			2000			1999
		(Dollars in thousands)
Nonaccrual loans		$	455		$	1,558		$	1,894		$	975		$	0
Loans past due 90 days or more but not on  nonaccrual		—			97			—			209			1,084
Total nonperforming loans		455			1,655			1,894			1,184			1,084
Other real estate owned		333			76			77			33			246
Total nonperforming assets		$	788		$	1,731		$	1,971		$	1,217		$	1,330
Total nonperforming assets to total assets		0.36		%	0.45		%	0.53		%	0.60		%	0.85		%
Allowance for loan losses to nonperforming loans		292.31		%	64.21		%	45.22		%	42.82		%	34.50		%
Nonperforming loans to total assets		0.21		%	0.43		%	0.51		%	0.58		%	0.70		%

 

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in its loan portfolio, the general economy as well as the historical performance of the loan portfolio.  In addition, management considers various characteristics of each individual loan, or pool of loans, such as credit scores, loan to value ratios, the type of collateral and payment history.  Management will also look at the financial strength of personal guarantors when applicable.   Typically, management allocates a smaller portion of the allowance for loan losses to those loans or pools of loans with lower historical losses.  The allowance for loan losses is maintained at an

 

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amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management.

 

In addition, various regulatory agencies, as an integral part of their examination process, periodically review Pelican Financial’s allowance for loan losses.  These agencies may require Pelican Financial to make additional provisions for estimated loan losses based upon their judgments about information available to them at the time of their examination.  Pelican Financial will continue to monitor and modify its allowance for loan losses as conditions dictate.  While management believes Pelican Financial’s allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that Pelican Financial’s level of allowance for loan losses will be sufficient to cover loan losses incurred by Pelican Financial or that adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.

 

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The following table contains information with respect to Pelican Financial’s allowance for loan losses for the periods indicated.

 

		At or for the Year Ended December 31,
		2003			2002			2001			2000			1999
		(Dollars in thousands)
Average loans outstanding, net		$	110,875		$	110,355		$	89,743		$	76,890		$	68,136
Total gross loans outstanding at end of period		$	110,708		$	105,052		$	93,022		$	88,675		$	70,440
Allowance balance at beginning of period		$	1,062		$	856		$	507		$	374		$	127
Provision for loan losses		1,058			300			562			257			255
Actual charge-offs:
1-4 family residential real estate		671			53			171			118			0
Other		198			54			44			8			8
Total charge-offs		869			107			215			126			8
Recoveries:
Total recoveries		79			13			2			2			0
Net chargeoffs		790			94			213			124			8
Allowance balance at end of period		$	1,330		$	1,062		$	856		$	507		$	374
Net chargeoffs as a percent of average loans		0.71		%	0.09		%	0.24		%	0.16		%	0.01		%
Allowance for loan losses to total gross loans at end of period		1.20		%	1.01		%	0.92		%	0.29		%	0.29		%

 

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The following table summarizes the allocation of the allowance for loan losses by loan type and the percent of loans in each category compared to total loans at the dates indicated:

 

		December 31,
		2003					2002					2001					2000					1999
		Allowance Amount			Percent of Loans in Each Category to Total Loans		Allowance Amount			Percent of Loans in Each Category to Total Loans		Allowance Amount			Percent of Loans in Each Category to Total Loans		Allowance Amount			Percent of Loans in Each Category to Total Loans		Allowance Amount			Percent of Loans in Each Category to Total Loans
		(Dollars in thousands)
1-4 family residential real estate		$	589		39.83	%	$	716		35.29	%	$	499		47.32	%	$	300		47.12	%	$	138		68.06	%
Commercial and industrial real estate		614			38.98		153			55.22		94			35.43		162			32.32		85			24.12
Construction		2			1.19		—			2.77		14			3.95		2			7.15		11			2.42
Business, commercial		6			1.39		3			0.92		3			0.76		3			1.26		132			0.96
Boat		100			13.17		—			—		—			—		27			3.08		—			—
Other		19			5.44		190			5.80		246			12.54		13			9.07		8			4.44
Unallocated		—					—					—					—					—
Total		$	1,330		100.00	%	$	1,062		100.00	%	$	856		100.00	%	$	507		100.00	%	$	374		100.00	%

 

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Investment Activities

 

Since the start of Pelican Financial’s retail banking activities, primarily conducted through Pelican National, deposit in-flows to Pelican National have been adequate to match Pelican National’s loan demand.  In addition, Pelican National sells a portion of its loans into the secondary market, thus replenishing its liquidity on a regular basis.  Pelican National currently invests excess liquidity in a variety of interest-earning assets.   The investment policy related to the retail banking operations of Pelican Financial, as approved by the Board of Directors of Pelican National, requires management to maintain adequate liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and to complement Pelican Financial’s lending activities.  Pelican Financial primarily utilizes investments in securities for liquidity management and as a method of deploying excess funding not utilized for investment in loans.  Generally, Pelican Financial’s investment policy is more restrictive than applicable regulations allow and, accordingly, Pelican Financial has invested primarily in U.S. government and agency securities, federal funds, and U.S. government sponsored agency issued mortgage-backed securities.  As required by Statement of Financial Accounting Standards, (“SFAS”) No. 115, Pelican Financial has established an investment portfolio of securities that are categorized as held-to-maturity, available-for-sale, or held for trading.  At December 31, 2003, all of the investment securities held in Pelican Financial’s investment portfolio were classified as available for sale.

 

At December 31, 2003, Pelican Financial had invested $24.3, or 11% of total assets, in Fannie Mae, Freddie Mac, and Ginnie Mae mortgage-backed securities.  These were primarily composed of adjustable rate mortgages.  In addition, at December 31, 2003, $25.4 million, or 11%, of total assets, were debt obligations issued by federal agencies and sponsored entities, which generally have stated maturities from one year to twenty-five years.  Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to these instruments thereby changing the net yield on these securities.  There is also reinvestment risk associated with the cash flows from these securities or if these securities are redeemed by the issuer.  In addition, the market value of these securities may be adversely affected by changes in interest rates.

 

The following table contains information on the market value of Pelican Financial’s investment portfolio at the dates indicated.  At December 31, 2003, the market value of Pelican Financial’s investment portfolio totaled $50.7 million.  During the periods indicated and except as otherwise noted, Pelican Financial had no securities of a single issuer that exceeded 10% of stockholders’ equity.

 

		At December 31,
		2003			2002			2001
		(In thousands)
U.S. Government agency		$	25,403		$	2,517		$	3,570
Mortgage-backed securities		24,327			43			1,515
Federal Reserve Bank and FHLB stock		949			1,330			1,070
Total investment securities		$	50,679		$	3,890		$	6,155

 

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The following table contains certain information regarding the market values, weighted average yields, and contractual maturity distribution, excluding periodic principal payments, of Pelican Financial’s investment securities portfolio at December 31, 2003.

 

		Within One Year					After One Year But Within Five Years					After Five Years But Within Ten Years					After Ten Years					Total
		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield		Amount			Yield
		(Dollars in thousands)
U.S. Government Agency		$	4,970		1.18	%	$	18,114		3.22	%	$	—		—	%	$	2,319		5.34	%	$	25,403		3.03	%
Mortgage-backed securities		—			—		—			—		—			—		24,327			4.02		24,327			4.02
Other		—			—		—			—		—			—		949			6.49		949			6.49
Total		$	4,970		1.18	%	$	18,114		3.22	%	$	—		—	%	$	27,595		4.22	%	$	50,679		3.57

 

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Source of Funds

 

Pelican National funds its retail banking activities primarily with deposits, loan repayments and prepayments, and cash flows generated from operations.  Pelican National offers a variety of deposit accounts with a range of interest rates and terms.  Pelican National’s deposits consist of checking, money market, savings, NOW, and certificate of deposit accounts.  At December 31, 2003, approximately 21% of the funds deposited in Pelican National were in certificate of deposit accounts.  At December 31, 2003, core deposits (savings, NOW, and money market) represented 41% of total deposits.  The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition.  Pelican National’s deposits are obtained predominantly from the area around its offices in Naples, San Carlos, Bonita Springs and Fort Myers, Florida.  In addition, Washtenaw has placed all or their investor accounts for principal, interest, taxes and insurance at Pelican National.  Pelican National has relied primarily on customer service and competitive rates to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect Pelican National’s ability to attract and retain deposits.  Pelican National uses traditional means of advertising its deposit products, including print media and generally does not solicit deposits from outside its market area.  Pelican National does not actively solicit certificate accounts in excess of $100,000 to obtain deposits.  At December 31, 2003, $15.7 million, or 40% of Pelican National’s certificate of deposit accounts were to mature within one year.  Pelican National believes that substantially all of the certificate of deposit accounts that mature within one year will be rolled-over into new certificate of deposit accounts.  To the extent that certificate of deposit accounts are not rolled-over, Pelican National believes that it has sufficient resources to fund these withdrawals.

 

The following table contains information on the amount and maturity of jumbo certificates of deposit (i.e., certificates of deposit of $100,000 or more) at December 31, 2003.

 

Time Remaining Until Maturity		Jumbo Certificates of Deposit
		(In thousands)
Less than 3 Months		$	2,683
3 Months to 6 Months		1,393
6 Months to 12 Months		4,618
Greater than 12 Months		12,018
Total		$	20,712

 

Employees

 

At December 31, 2003, Pelican Financial had no employees other than executive officers.  At December 31, 2003, Pelican National had 62 full-time equivalent employees.  None of the employees of Pelican Financial or its subsidiary were represented by a collective bargaining agreement.  Management of Pelican Financial considers its relationship with its employees to be satisfactory.

 

Subsidiary Activities

 

Pelican Financial will conduct business through its wholly-owned subsidiary, Pelican National.  Pelican National is a national banking association organized on March 7, 1997 pursuant to the laws of the United States.  Pelican National has no subsidiaries.

 

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REGULATION

 

Economic Conditions, Government Policies, Legislation, and Regulation

 

Pelican Financial’s profitability, like most financial institutions, is primarily dependent on interest rate differentials.  In general, the difference between the interest rates paid by Pelican Financial on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by Pelican Financial on its interest-earning assets, such as loans extended to its clients and securities held in its investment portfolio, comprise the major portion of the Pelican Financial’s earnings.  Interest rates are highly sensitive to many factors that are beyond the control of Pelican Financial, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on Pelican Financial cannot be predicted.

 

The business of Pelican Financial is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “FRB”). The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions.  The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities.  The nature and impact on Pelican Financial of any future changes in monetary and fiscal policies cannot be predicted.

 

From time to time, legislation, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers.  Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are frequently made in the U.S. Congress, in the state legislatures, and before various regulatory agencies. This legislation may change banking statutes and the operating environment of Pelican Financial and its subsidiaries in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Pelican Financial cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of Pelican Financial or any of its subsidiaries. See “Item 1. Business - Supervision and Regulation.”

 

Supervision and Regulation

 

General

 

Bank holding companies and banks are extensively regulated under both federal and state law.  This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of stockholders of Pelican Financial.  Set forth below is a summary description of the material laws and regulations that relate to the operations of Pelican Financial and Pelican National.  The description is qualified in its entirety by reference to the applicable laws and regulations.

 

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Pelican Financial

 

Pelican Financial is a registered bank holding company, and subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  Pelican Financial is required to file with the FRB periodic reports and such additional information as the FRB may require pursuant to the BHCA.  The FRB may conduct examinations of Pelican Financial and its subsidiaries.

 

The FRB may require that Pelican Financial terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries.  The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt.  Under certain circumstances, Pelican Financial must file written notice and obtain approval from the FRB prior to purchasing or redeeming its equity securities.

 

Further, Pelican Financial is required by the FRB to maintain certain levels of capital.  See “—Capital Standards.”

 

Pelican Financial is required to obtain the prior approval of the FRB for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company.  Prior approval of the FRB is also required for the merger or consolidation of Pelican Financial and another bank holding company.

 

Pelican Financial is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries.  However, Pelican Financial, subject to the prior approval of the FRB, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

 

Under FRB regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner.  In addition, it is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks.  A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB’s regulations or both.

 

Pelican Financial’s securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  As such, Pelican Financial is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act.

 

As a national banking association, Pelican Financial is subject to primary supervision, examination, and regulation by the Office of the Comptroller of the Currency (the “OCC”).  To a lesser extent, Pelican Financial is also subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) as administrator of the Bank Insurance Fund (“BIF”) and the FRB.  If, as a result of an examination of Pelican Financial, the OCC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of Pelican Financial’s

 

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operations are unsatisfactory or that Pelican Financial or its management is violating or has violated any law or regulation, various remedies are available to the OCC.  Such remedies include the power to enjoin “unsafe or unsound practices,” to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of Pelican Financial, to assess civil monetary penalties, and to remove officers and directors.  The FDIC has similar enforcement authority, in addition to its authority to terminate Pelican Financial’s deposit insurance in the absence of action by the OCC and upon a finding that Pelican Financial is in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that its conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors.

 

The Sarbanes-Oxley Act of 2002

 

On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002.  This new legislation addresses accounting oversight and corporate governance matters, including:

 

•                  the creation of a five-member oversight board appointed by the Securities & Exchange Commission that will set standards for accountants and have investigative and disciplinary powers

•                  the prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every five years

•                  increased penalties for financial crimes

•                  expanded disclosure of corporate operations and internal controls and certification of financial statements

•                  enhanced controls on and reporting of insider trading, and

•                  statutory separations between investment bankers and analysts.

 

The new legislation and its implementing regulations will result in increased costs of compliance, including certain outside professional costs.

 

USA Patriot Act of 2001

 

On October 26, 2001, President Bush signed the USA Patriot Act of 2001. The Patriot Act is intended is to strengthen the U.S law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including:

 

•                  due diligence requirements for financial institutions that administer, maintain, or manage private banks accounts or correspondent accounts for non-US persons;

•                  standards for verifying customer identification at account opening;

•                  rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; and

•                  reports by non-financial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000, and filing of suspicious activities reports securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.

 

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Financial Services Modernization Legislation

 

General.  On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999, also known as the Financial Services Modernization Act (the “FSMA”).  The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a Financial Holding Company.

 

The law also:

 

•                  Broadened the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries;

•                  Provided an enhanced framework for protecting the privacy of consumer information;

•                  Adopted a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system;

•                  Modified the laws governing the implementation of the Community Reinvestment Act; and

•                  Addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.

 

Pelican Financial does not believe that the FSMA will have a material adverse effect on operations in the near-term.  However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation.  The FSMA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis.  Nevertheless, this act may have the result of increasing the amount of competition that Pelican Financial faces from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than Pelican Financial.

 

Expanded Bank Activities.  The FSMA permits national banks to engage in expanded activities through the formation of financial subsidiaries.  A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a financial holding company.  Financial activities include all activities permitted under new sections of the BHCA or permitted by regulation.

 

A national bank seeking to have a financial subsidiary, and each of its depository institution affiliates, must be “well-capitalized,” “well-managed” and in compliance with the Community Reinvestment Act.  The total assets of all financial subsidiaries may not exceed the lesser of 45% of a bank’s total assets, or $50 billion.  A national bank must exclude from its assets and equity all equity investments, including retained earnings, in a financial subsidiary.  The assets of the subsidiary may not be consolidated with the bank’s assets.  The bank must also have policies and procedures to assess financial subsidiary risk and protect the bank from such risks and potential liabilities.

 

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Privacy.  Under the FSMA, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, effective July 1, 2001, financial institutions must provide:

 

•                  initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;

•                  annual notices of their privacy policies to current customers; and

•                  a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

 

These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. Since the FSMA’s enactment, a number of states have implemented their own versions of privacy laws.  Pelican Financial has implemented its privacy policies in accordance with the law.

 

Interagency Guidance on Response Programs to Protect Against Identity Theft

 

On August 12, 2003, the Federal bank and thrift regulatory agencies requested public comment on proposed guidance that would require financial institutions to develop programs to respond to incidents of unauthorized access to customer information, including procedures for notifying customers under certain circumstances.  The proposed guidance:

 

•                  interprets previously issued interagency customer information security guidelines that require financial institutions to implement information security programs designed to protect their customers’ information; and

•                  describes the components of a response program and sets a standard for providing notice to customers affected by unauthorized access to or use of customer information that could result in substantial harm or inconvenience to those customers, thereby reducing the risk of losses due to fraud or identity theft.

 

We are not able at this time to determine the impact of any such proposed guidance on our financial condition or results of operation.

 

Dividends and Other Transfers of Funds

 

Dividends from Pelican National constitute the principal source of income to the Pelican Financial.  Pelican Financial is a legal entity separate and distinct from Pelican National. Pelican National is subject to various statutory and regulatory restrictions on its ability to pay dividends to Pelican Financial. Under such restrictions, the amount available for payment of dividends to Pelican Financial by Pelican National totaled $2.5 million at December 31, 2003.  This is the maximum allowable under any existing agreements, however it is unlikely management would make the decision to dividend the entire amount to Pelican Financial.  In addition, Pelican National’s regulators have the authority to prohibit them from paying dividends, depending upon their financial conditions, if such payment is deemed to constitute an unsafe or unsound practice.

 

Regulation - Pelican National

 

General.  The Office of the Comptroller of the Currency is primarily responsible for the supervision, examination, and regulation of Pelican National, because Pelican National is a national banking association.  If, as a result of an examination of Pelican National, the OCC should determine that

 

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the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of Pelican National’s operations are unsatisfactory or that Pelican National or its management is violating or has violated any law or regulation, various remedies are available to the OCC.  These remedies include the power to enjoin “unsafe or unsound practices,” to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of Pelican National, to assess civil monetary penalties, and to remove officers and directors.  The FDIC has similar enforcement authority, in addition to its authority to terminate a bank’s deposit insurance, in the absence of action by the OCC and upon a finding that a bank is in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that its conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors.

 

The deposits of Pelican National will be insured by the FDIC in the manner and to the extent provided by law.  For this protection, Pelican National will pay a quarterly statutory assessment.  See “- Premiums for Deposit Insurance.” Various other requirements and restrictions under the laws of the United States affect the operations of Pelican National.  Federal statutes and regulations relate to many aspects of Pelican National’s operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, capital requirements, and disclosure obligations to depositors and borrowers.  Further, Pelican National is required to maintain certain levels of capital.  See “- Capital Standards.”

 

Restrictions on Transfers of Funds to Pelican Financial by Pelican National.  Pelican Financial is a legal entity separate and distinct from Pelican National.  The prior approval of the OCC is required if the total of all dividends declared by Pelican National in any calendar year exceeds Pelican National’s net profits (as defined) for that year combined with its retained net profits (as defined) for the preceding two years, less any transfers to surplus.

 

The OCC also has authority to prohibit Pelican National from engaging in activities that, in the OCC’s opinion, constitute unsafe or unsound practices in conducting its business.  It is possible, depending upon the financial condition of the financial institution in question and other factors, that the OCC could assert that the payment of dividends or other payments might, in some circumstances, be an unsafe or unsound practice.  Further, the OCC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction.  Compliance with the standards in these guidelines and the restrictions that are or may be imposed pursuant to the prompt corrective action provisions of federal law could limit the amount of dividends which Pelican National may pay to Pelican Financial.  See “- Prompt Corrective Regulatory Action and Other Enforcement Mechanisms” and “- Capital Standards” for a discussion of these additional restrictions on capital distributions.

 

Transactions with Affiliates

 

Pelican National is required to comply with certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, Pelican Financial or other affiliates, the purchase of or investments in stock or other securities thereof, the taking of these securities as collateral for loans and the purchase of assets of Pelican Financial or other affiliates.  These restrictions prevent Pelican Financial and other affiliates from borrowing from Pelican National unless the loans are secured by marketable obligations of designated amounts.  Further, these secured loans and investments by Pelican National to or in Pelican Financial or to or in any other affiliate is limited to 10% of Pelican National’s capital and surplus (as defined by federal regulations) and these secured loans and investments are limited, in the aggregate, to 20% of Pelican National’s capital and surplus (as defined by federal regulations).  Additional restrictions on transactions with affiliates may be imposed on Pelican

 

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National pursuant to the prompt corrective action provisions of federal law.  See “- Prompt Corrective Action and Other Enforcement Mechanisms.”

 

Loans-to-One Borrower Limitations

 

With certain limited exceptions, the maximum amount that a national bank may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral.  At December 31, 2003, Pelican National’s loans-to-one-borrower limit was $2.4 million based upon the 15% of unimpaired capital and surplus measurement.  At December 31, 2003, Pelican National’s largest single lending relationship had an outstanding balance of $2.1 million, and consisted of a loan secured by real estate in Pelican National’s lending area, and was performing in accordance with its terms.

 

Capital Standards

 

The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions which are recorded as off balance sheet items.  Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk federal banking agencies, to 100% for assets with relatively high credit risk.

 

The guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%.  In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio.  For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%.  In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

 

The following table presents the amounts of regulatory capital and the capital ratios for Pelican Financial, compared to its minimum regulatory capital requirements of the Federal Reserve Board as of December 31, 2003.

 

		December 31, 2003
		Actual					Required to be Adequately Capitalized					Excess over Minimum Required
		Amount			Percent		Amount			Percent		Amount			Percent
Total Capital (to Risk-Weighted Assets)		$	18,124		15.50	%	$	9,356		8.00	%	$	8,678		7.50	%
Tier 1 Capital (to Risk-Weighted Assets)		16,794			14.36		4,678			4.00		12,116			10.36
Tier 1 Capital (to Average Assets)		16,794			7.96		8,436			4.00		8,358			3.96

 

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The following table presents the amounts of regulatory capital and the capital ratios for Pelican National, compared to its minimum regulatory capital requirements to be considered well capitalized as of December 31, 2003.

 

		As of December 31, 2003
		Actual					Required to be Well Capitalized					Excess
		Amount			Ratio		Amount			Ratio		Amount			Ratio
		(Dollars in thousands)
Total risk-based ratio		$	15,912		13.66	%	$	11,652		10.00	%	$	4,260		3.66	%
Tier 1 risk-based ratio		14,582			12.51		6,991			6.00		7,591			6.51
Leverage ratio		14,582			7.20		10,125			5.00		4,457			2.20

 

In addition, federal banking regulators may set capital requirements higher than the minimums described above for financial institutions whose circumstances warrant it. For example, a financial institution experiencing or anticipating significant growth may be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.

 

Predatory Lending

 

The term “predatory lending,” much like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. But typically predatory lending involves at least one, and perhaps all three, of the following elements:

 

•                  making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation (“asset-based lending”)

•                  inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”)

•                  engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower.

 

On October 1, 2002, FRB regulations aimed at curbing such lending became effective.  The rule significantly widens the pool of high-cost home-secured loans covered by the Home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers.  The following triggers coverage under the act:

 

•                  interest rates for first lien mortgage loans in excess of 8 percentage points above comparable Treasury securities,

•                  subordinate-lien loans of 10 percentage points above Treasury securities, and

•                  fees such as optional insurance and similar debt protection costs paid in connection with the credit transaction, when combined with points and fees if deemed excessive.

 

In addition, the regulation bars loan flipping by the same lender or loan servicer within a year.  Lenders also will be presumed to have violated the law — which says loans should not be made to people unable to repay them — unless they document that the borrower has the ability to repay.  Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid.

 

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Prompt Corrective Action and Other Enforcement Mechanisms

 

Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios.  Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.  At December 31, 2003, Pelican National exceeded the required ratios for classification as “well/adequately capitalized.”

 

An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment.  At each successive lower capital category, an insured depository institution is subject to more restrictions.  The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.

 

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency.  Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized – without the express permission of the institution’s primary regulator.

 

On October 16, 2003, Pelican National entered into an informal, non-binding, memorandum of understanding with the Office of the Comptroller of Currency.  The memorandum of understanding puts in place additional operational and reporting requirements on the Management and Board of Directors of Pelican National Bank.  The memorandum of understanding does not include any financial covenants.  In the opinion of Management, the memorandum of understanding will not have a material adverse effect upon the business operations or future profitability of Pelican National.

 

Safety and Soundness Standards

 

The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These new guidelines also set forth standards for evaluating and

 

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monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.

 

Premiums for Deposit Insurance

 

Through the Bank Insurance Fund (BIF), the FDIC insures Pelican National’s deposit accounts up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.  As a result of the Memorandum of Understanding with the Office of the Comptroller of Currency issued to Pelican National, the assessment rate increased.

 

Due to continued growth in deposits and some recent bank failures, the BIF is nearing its minimum ratio of 1.25% of insured deposits as mandated by law.  If the ratio drops below 1.25%, it is likely the FDIC will be required to assess premiums on all banks for the first time since 1996.  Any increase in assessments or the assessment rate could have a material adverse effect on the Pelican Financial’s earnings, depending on the amount of the increase.

 

The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance for Pelican National could have a material adverse effect on Pelican Financial’s earnings.

 

Interstate Banking and Branching

 

The BHCA permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide- and state-imposed concentration limits.  Pelican National has the ability, subject to certain restrictions, to acquire by acquisition or merger branches outside its home state.  The establishment of new interstate branches is also possible in those states with laws that expressly permit it.  Interstate branches are subject to certain laws of the states in which they are located.  Competition may increase further as banks branch across state lines and enter new markets.

 

Community Reinvestment Act and Fair Lending Developments

 

Banks are subject to certain fair lending requirements and reporting obligations involving Community Reinvestment Act activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws.  The federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities.  Furthermore, financial institutions are subject to annual reporting and public disclosure requirements for certain written agreements that are entered into between insured depository institutions or their affiliates and nongovernmental entities or persons that are made pursuant to, or in connection with, the fulfillment of the CRA.

 

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A bank’s compliance with its CRA obligations is based a performance-based evaluation system which bases CRA ratings on an institution’s lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the FRB will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.

 

Federal Home Loan Bank System

 

Pelican National is a member of the Federal Home Loan Bank of Atlanta.  Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, we would be required to own capital stock in an FHLB in an amount equal to the greater of:

 

•                  1% of its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year; or

•                  5% of its FHLB advances or borrowings.

 

A new capital plan of the FHLB-SF was approved by the Federal Housing Finance Board and will be implemented on April 1, 2004.  The new capital plan incorporates a single class of stock with a par value of $100 per share, and may be issued, exchanged, redeemed, and repurchased only at par value.  Each member to own stock in amount equal to the greater of:

 

•                  a membership stock requirement with an initial cap of $25 million (100% of “membership asset value” as defined), or

•                  an activity based stock requirement (based on percentage of outstanding advances).

 

The new capital stock is redeemable on five years’ written notice, subject to certain conditions.

 

We do not believe that the initial implementation of the FHLB-Atlanta new capital plan as approved will have a material impact upon our financial condition, cash flows, or results of operations.  However, Pelican National could be required to purchase as much as 50% additional capital stock or sell as much as 50% of its proposed capital stock requirement at the discretion of the FHLB-Atlanta.

 

Federal Reserve System

 

The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits.  At December 31, 2003, Pelican National was in compliance with these requirements.

 

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Item 2.    Properties

 

(a)                                  Properties.

 

Pelican Financial utilizes the offices of Washtenaw Mortgage Company.  Pelican Financial pays no rent or other consideration for use of this facility.  The retail banking activities of Pelican Financial are primarily conducted from the offices of Pelican National located at

 

811 Anchor Rode Drive,
Naples, Florida 34103

 

12730 New Brittany Boulevard,
Fort Myers, Florida 33907

 

19059 South Tamiami Trail,
Fort Myers, Florida 33907

 

28000 Spanish Wells Boulevard
Bonita Springs, Florida 34135
804 Cape Coral Parkway
Cape Coral, Florida 33904
(Branch scheduled to open May 15, 2004)

 

17120 San Carlos Boulevard
Fort Myers Beach, Florida 33931
(Branch scheduled to open March 15, 2004)

 

(b)                                 Investment Policies.

 

See “Item 1. Business” above for a general description of Pelican National’s investment policies and any regulatory or board of directors’ percentage of assets limitations regarding certain investments.  All investment policies are reviewed and approved by the board of directors, and these policies, subject to regulatory restrictions (if any), can be changed without a vote of stockholders. Pelican National’s investments are primarily acquired to produce income, and to a lesser extent, possible capital gain.

 

(1)  Investments in Real Estate or Interests in Real Estate.  See “Item 1. Business - Lending Activities,” “Item 1.  Business - Regulation,” and “Item 2. Property. (a)  Properties” above.

 

(2)  Investments in Real Estate Mortgages. See “Item 1. Business - Lending Activities” and  “Item 1.  Business – Regulation.”

 

(3)  Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities.  See “Item 1. Business - Lending Activities” and “Item 1.  Business – Regulation.”

 

(c)  Description of Real Estate and Operating Data.

 

Not Applicable.

 

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Item 3.    Legal Proceedings

 

Pelican Financial and Pelican National are not party to any material pending legal proceedings at December 31. 2003.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

No matters were submitted to shareholders for a vote during the quarter ended December 31, 2003.

 

PART II

 

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

 

As of March 9, 2004, there were 4,488,351 shares of common stock of Pelican Financial outstanding held by approximately 100 shareholders of record.  The following table sets forth the high and low sales prices of the common stock for the periods indicated.  The prices do not include retail markups, markdowns, or commissions.  Our common stock has traded on the American Stock Exchange under the symbol “PFI” since November 10, 1999.  The following share prices were adjusted for the spin-off of The Washtenaw Group on December 31, 2003.  The prices reflect approximately 44% of the high and low sales price.  This is the approximate value of Pelican Financial on December 31, 2003, based on the  aggregate closing price of The Washtenaw Group and Pelican Financial.

 

Year Ended		High			Low
2003
First Quarter		$	2.65		$	1.96
Second Quarter		$	4.20		$	2.59
Third Quarter		$	5.20		$	3.87
Fourth Quarter		$	5.94		$	4.73
2002
First Quarter		$	2.63		$	1.71
Second Quarter		$	6.26		$	2.54
Third Quarter		$	4.34		$	2.20
Fourth Quarter		$	2.34		$	1.81
2001
First Quarter		$	1.61		$	1.03
Second Quarter		$	1.72		$	1.03
Third Quarter		$	2.98		$	1.39
Fourth Quarter		$	2.56		$	2.03
2000
First Quarter		$	2.11		$	1.51
Second Quarter		$	1.81		$	1.05
Third Quarter		$	1.48		$	1.11
Fourth Quarter		$	1.12		$	0.60
1999
Fourth Quarter (from November 10, 1999)		$	2.97		$	1.51

 

Pelican Financial paid $0.40 in cash dividends during 2003.  Future dividends have been suspended so that future earnings can be invested in the company.  The Board of Directors will approve any future dividends.  Because we do not conduct any operations other than managing our investment in Pelican National we are dependent for income on dividends received from Pelican National.  Also

 

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applicable to us are certain regulatory restrictions imposed by the Federal Reserve Board on the payment of dividends to our stockholders.  Declaration of dividends by the Board of Directors of Pelican National will depend upon a number of factors, including, but not limited to, investment opportunities available to Pelican National, capital requirements, regulatory limitations, and general economic conditions.  Generally, Pelican National may not declare or pay dividends on its capital stock if the payment would cause its regulatory capital to be reduced below the minimum requirements imposed by regulations of the Office of the Comptroller of the Currency.

 

Item 6.    Selected Financial Data

 

We are providing the following information to aid you in your analysis of Pelican Financial.    The information is only a summary and you should read it in conjunction with our historical financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 7 below.

 

Summary Financial and Other Data

 

		At December 31,
		2003			2002			2001			2000			1999
		(Dollars in thousands, except per share information)
Balance Sheet Data:
Total assets		$	221,515		$	386,251		$	374,554		$	201,236		$	155,587
Cash and cash equivalents		55,420			57,362			16,885			10,174			1,883
Total loans, net		109,939			122,772			108,707			87,579			67,925
Mortgage-backed securities and securities available for sale		49,730			2,560			5,085			5,864			5,877
Assets of discontinued operations		—			198,657			240,897			94,610			75,714
Nonperforming loans		455			1,655			1,894			1,184			1,084
Real estate acquired through foreclosure		333			76			77			33			246
Total nonperforming assets		788			1,731			1,971			1,217			1,330
Deposits		191,913			153,834			103,572			82,109			62,410
Note payable		292			792			1,295			1,792			2,000
Federal Home Loan Bank borrowings		12,000			18,000			16,000			14,000			8,000
Liabilities of discontinued operations		—			180,947			224,483			81,690			61,762
Total liabilities		204,625			354,420			346,370			179,872			134,596
Stockholders’ equity		16,890			31,831			28,184			21,364			20,991
Shares outstanding		4,488,351			4,440,241			4,393,194			4,392,120			4,392,120
Book value per share		$	3.76		$	7.17		$	6.42		$	4.86		$	4.78
Other Data:
Number of:
Full-service retail banking facilities		4			3			2			2			2
Full-time equivalent employees (continuing operations)		62			39			35			32			19

 

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Summary of Operations

 

		For the Year Ended December 31,
		2003			2002			2001			2000			1999
		(In thousands, except per share data)
Operations Data:
Interest and dividend income		$	10,142		$	10,825		$	9,989		$	8,878		$	5,231
Interest expense		3,473			4,305			4,909			4,388			2,262
Net interest income		6,669			6,520			5,080			4,490			2,969
Provision for loan losses		1,058			300			562			257			255
Net interest income after provision for loan losses		5,611			6,220			4,518			4,233			2,714
Noninterest income		232			772			318			287			175
Noninterest expense		7,234			4,683			4,232			3,204			2,255
Earnings (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle		(1,391		)	2,309			604			1,316			634
Income tax expense (benefit)		(473		)	787			208			449			183
Earnings (loss) from continuing operations before cumulative effect of change in accounting principle		(918		)	1,522			396			867			451
Income from operations of discontinued mortgage subsidiary		14,279			2,763			10,673			(970		)	4,683
Income tax (benefit)		4,841			956			3,646			(323		)	1,609
Income (loss) on discontinued operations		9,438			1,807			7,027			(647		)	3,074
Income (loss) before cumulative effect of change in accounting principle		8,520			3,329			7,423			220			3,525
Cumulative effect of change in accounting principle		—			413			(420		)	—			(97		)
Net income		$	8,520		$	3,742		$	7,003		$	220		$	3,428
Per Share Data:
Basic earnings per share from continuing operations before cumulative effect of change in accounting principle		$	(0.21	)	$	0.35		$	0.09		$	0.20		$	0.13
Diluted earnings per share from continuing operations before cumulative effect of change in accounting principle		$	(0.21	)	$	0.34		$	0.09		$	0.20		$	0.13
Per share effect of discontinued operations		$	2.12		$	0.41		$	1.60		$	(0.15	)	$	0.88
Per share cumulative effect of change in accounting principle		$	—		$	0.09		$	(0.10	)	$	—		$	(0.03	)
Basic earnings per share		$	1.91		$	0.85		$	1.59		$	0.05		$	0.98
Diluted earnings per share		$	1.91		$	0.84		$	1.59		$	0.05		$	0.98
Weighted Average number of shares outstanding		4,455,281			4,420,938			4,392,570			4,392,120			3,483,670

 

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Key Operating Ratios

 

		For the Year Ended December 31,
		2003		2002		2001		2000		1999
		(Dollars in thousands)
Performance Ratios (1):
Return on average assets		(0.48	)%	0.96	%	0.34	%	0.94	%	0.82	%
Return on average common equity		(6.15	)	11.32		4.73		10.14		8.12
Interest rate spread		2.09		2.58		2.94		3.98		5.18
Net interest margin		3.67		4.31		4.52		5.01		5.65
Noninterest expense to average assets		3.74		2.96		3.63		3.47		4.09
Efficiency ratio		104.82		64.22		78.40		67.07		71.72
Cash dividend payout ratio		20.94		7.14		3.14		—		—
Asset Quality Ratios:
Nonperforming assets to total assets at end of period		0.36		0.45		0.53		0.60		0.85
Nonperforming loans to total gross loans at end of period		0.41		1.57		2.04		1.34		1.54
Allowance for loan losses to total gross loans at end of period		1.20		1.01		0.92		0.57		0.53
Allowance for loan losses to nonperforming loans at end of period		292.31		64.21		45.22		42.82		34.50

 

(1) Ratios calculated using continuing operations only, except dividend payout ratio.

 

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

OVERVIEW

 

Pelican Financial currently serves as the holding company of Pelican National and until the distribution on December 31, 2003, Washtenaw Mortgage Company.  Pelican Financial’s operations involved both mortgage banking and retail banking, but will focus on retail banking in the future.  The mortgage banking segment involved the origination and purchase of single-family residential mortgage loans in approximately 40 states, the sale of these loans, usually on a pooled and securitized basis, in the secondary market, and the servicing of mortgage loans for investors.  The retail banking segment involves attracting deposits from the general public and using these funds to originate consumer, commercial, commercial real estate, residential construction, and single-family residential mortgage loans, from its offices in Naples, Fort Myers, Bonita Springs and San Carlos, Florida.

 

Pelican Financial’s earnings are primarily dependent upon three sources: net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities; fee income from customers; and gains realized on sales of loans.  These revenues are in turn significantly affected by factors such as changes in prevailing interest rates and in the yield curve (that is, the difference between prevailing short-term and long-term interest rates).

 

The earnings performance of the continuing operations of Pelican Financial was a concern to management.  Management is attempting to improve this by a variety of factors including liquidity management, cross selling of products and managing operating expenses.

 

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Management is also focusing on increasing core deposits to allow the opportunity to cross sell other products and services.  As part of this objective, Pelican National anticipates two additional branch locations opening during the first half of 2004.

 

SPIN-OFF

 

On December 31, 2003, Pelican Financial distributed all of the outstanding shares of The Washtenaw Group, Inc. to the holders of Pelican Financial common stock on a share for share basis (based on Pelican Financial shareholders of record on December 22, 2003).  Upon completion of the distribution on December 31, 2003, Washtenaw is no longer a subsidiary of Pelican Financial.  Following the distribution certain individuals will serve as officers of both Washtenaw and Pelican Financial.  Washtenaw will pay their salaries and all other compensation.   Pelican Financial will reimburse Washtenaw, as part of a Transitional Services Agreement, for time spent on Pelican Financial matters.  Prior to the distribution, Pelican did not reimburse Washtenaw for these services.  After the distribution, officers and other employees providing services to both companies will be required to maintain records of their time spent on the affairs of each company as a basis for determining the reimbursements.

 

INTERCOMPANY TRANSACTIONS

 

During the periods covered, Pelican National entered into various transactions with Washtenaw Mortgage, which is affiliated by common ownership.  The Washtenaw Group, Inc., wholly owns Washtenaw Mortgage.  These transactions were primarily the sale of loans, the servicing of loans, the establishment of custodial accounts on deposit and borrowings.

 

During the years ended December 31, 2003, 2002 and 2001, Washtenaw sold loans to Pelican National totaling $15,730,311, zero and $8,578,757.  The sales were executed at current market prices, and resulted in gains of $170,829, zero and $231,148 to Washtenaw, respectively.

 

During the years ended December 31, 2003, 2002 and 2001, Pelican National paid servicing and loan underwriting fees to Washtenaw of $104,761, $77,208 and $30,915.

 

Washtenaw established and maintained escrow and custodial funds aggregating approximately $63,469,501, $73,564,542 and $30,535,000 at Pelican National at December 31, 2003, 2002 and 2001.  These custodial funds are not assets of Washtenaw, but are deposits of Pelican National and are included in the consolidated financial statements.

 

Pelican National paid interest income on these funds totaling $82,412 for the year ended December 31, 2001 and no amount in other periods presented.

 

Pelican National provided a secured borrowing for a portion of Washtenaw’s loans held for sale.  The outstanding balance at December 31, 2003, 2002 and 2001 was zero, $5,174,618 and zero, respectively.  During the years ended December 31, 2003, 2002 and 2001, Washtenaw paid Pelican National Bank $568,288, $336,951 and zero in related interest income.  This transaction was intended to take advantage of Pelican National Bank’s excess liquidity and provide a higher yielding short term asset than federal funds sold.

 

At December 31, 2003 Washtenaw was a guarantor on a term loan for Pelican Financial in the amount of $291,665.  The guaranty was secured by a blanket pledge of the mortgage servicing portfolio.  The loan was paid in full in January 2004.

 

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TECHNOLOGY

 

Pelican National tries to offer its customers and employees the best available solutions in technology in a cost effective manner.  During 2003, the following significant projects were completed:

 

•                  Introduced online banking to all customers.

 

•                  Improved functionality and appearance of the Pelicannational.com website.

 

•                  Upgraded the internal networks to allow for improved reliability and security of internal systems.

 

CRITICAL ACCOUNTING POLICIES

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  On an on-going basis, management evaluates its estimates and judgments.  Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estmates under different assumptions or conditions.

 

The accounting policy that has the greatest impact on the Pelican Financial’s financial condition and results of operations and that require the most judgment relates to its accounting for the allowance for loan losses.  The discontinued operations critical accounting policies involved accounting for gains on sales of loans and mortgage servicing rights (MSR), valuation and amortization of MSRs, accounting for derivatives and interest rate risk management activities, and accounting for litigation and claims against the company.

 

Allowance for Loan Losses

 

The allowance for loan losses represents management’s estimate of credit losses inherent in Pelican Financial’s loan portfolio as of the balance sheet date.  Determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.  The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.

 

Our methodology for measuring the appropriate level of allowance relies on several key elements, which include specific allowances for identified problem loans, general allocations for graded loans, and general allocations based on historical trends for pools of similar un-graded loans.

 

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Specific allowances are established in cases where senior credit management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired. The specific allowance is determined by methods prescribed by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”.

 

A general allocation on commercial and commercial real estate loans not considered impaired is calculated by applying loss factors to outstanding loans based on the internal risk grade of such loans.  Loans are assigned a loss allocation factor for each loan classification category. The lower the grading assigned to a loan category, the greater the allocation percentage that is applied. Changes in risk grade of both performing and nonperforming loans affect the amount of the allocation. Loss factors are based on our loss experience and may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the analysis date.

 

Groups of homogeneous loans, such as residential real estate and consumer loans, receive an allowance allocation based on loss trends.  We use historical loss trends based on our experience in determining an adequate allowance for these pools of loans. General economic and business conditions, credit quality trends, seasoning of the portfolios and recent loss experience are conditions considered in connection with allocation factors for these similar pools of loans.

 

DISCONTINUED OPERATIONS CRITICAL ACCOUNTING POLICIES

 

Gain on Sale of Loans and Mortgage Servicing Rights

 

The discontinued operation of Washtenaw Mortgage securitized substantially all of the mortgage loans it produced in exchange for all of the beneficial interests in the resulting securities, and then sold those securities on a regular basis in the secondary mortgage market. By-products of those securitizations are MSRs which were generally either held as long term investments or sold immediately.

 

Loans held for sale were carried at the lower of cost or fair value, in aggregate.  Fair value was based on outstanding sales commitment prices for the related loans or stated market prices for similar loans in normal market outlets used by Washtenaw.  Mortgage servicing rights were included in the carrying value of loans held for sale until the sale of loans on a servicing retained basis, at which time the servicing rights were established as a separate asset.  Gains or losses realized on loan sales were recorded at the settlement date, which was the date the sales price is received and control of the loan had been surrendered to the buyer.  Gains or losses realized on the sale of servicing rights were recorded when title and substantially all risks and rewards of ownership have passed to the buyer, and any protection provisions retained by Washtenaw (such as refunding sales premiums upon prepayment of the related loans within 90-120 days of sale) were minor and can be reasonably estimated.

 

While Pelican Financial will continue to sell mortgage loans, this will be done on a whole loan basis under best efforts agreements.

 

Mortgage Servicing Rights (MSR) Valuation

 

MSRs were recorded based on the present value of the right to service loans in a portfolio.  The valuation of MSRs requires that we make estimates of numerous market assumptions.  Prepayment speeds, servicing costs, discount rates, and the payment performance of the underlying loans significantly affects our ongoing valuations and the rate of amortization of MSRs.  In general, during periods of declining interest rates, the value of MSRs decline due to increasing prepayments attributable to increased mortgage refinancing activity. Impairment valuations are performed by the Washtenaw Mortgage using a

 

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discounted cash flow model and market assumptions.  Washtenaw Mortgage validated the results of the discounted cash flow model by obtaining regular independent valuations of Washtenaw Mortgage’s MSRs and by reference to Washtenaw Mortgage’s on-going experience with sales of MSRs.  Independent valuations were obtained at least annually, and generally two to four times per year.

 

The recorded values of the MSRs were amortized in proportion to, and over the period of, the anticipated net cash flows from servicing the loans. MSRs were assessed periodically to determine if there had been any impairment to the recorded balance, based on the fair value at the date of the assessment and by stratifying the MSRs based on underlying loan characteristics, including loan type, term, interest rate and the year of capitalization.

 

The most significant assumption we used to value mortgage servicing rights was prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates.  Prepayments will increase or decrease in correlation with market interest rates, and actual prepayments generally differ from our initial estimates. If actual prepayment rates were different than we originally estimated, we may receive less mortgage servicing income, which could reduce the value of our mortgage servicing rights. We periodically evaluated our mortgage servicing rights for impairment, which was measured as the excess of carrying value over fair value of each stratum of MSR. In the event of impairment, the adjustment was recognized in our consolidated statements of operations.

 

Other assumptions, including discount rates and loan servicing costs, were used to estimate the fair value of MSRs.  These assumptions do not generally fluctuate from period to period to the same degree as prepayment rates, and the fair value of MSRs was less sensitive to changes in these assumptions.

 

Pelican Financial does not anticipate recording additional MSRs in the future.  The remaining servicing rights relate to marine loans that were sold with servicing retained.  In the future, Pelican National anticipates that marine loans will be sold as whole loans or placed in the portfolio.

 

Derivatives and Interest Rate Risk Management Activities

 

The discontinued operation utilized derivatives extensively in connection with its interest rate risk management activities.   Washtenaw Mortgage was exposed to interest rate risk on loans held for sale and the pipeline of loans in process.  As market rates increase or decrease, the market value of loans held for sale and loans in process will decline or increase.  To offset this interest rate risk, Washtenaw Mortgage entered into derivatives, including U.S. Treasury Options and forward contracts to deliver loans and mortgage backed securities.  In accordance with SFAS 133, all derivative instruments were recorded at fair value.  Accordingly, treasury options and forward contracts were carried at fair value, as determined by the amount payable or receivable to/from the counterparty as if the derivatives were settled at the balance sheet date.  The fair value of the forward sales contracts and treasury options are based on the end of the period pricing from Bloomberg.

 

Washtenaw Mortgage may have qualified for hedge accounting under SFAS 133 with regard to its interest rate risk management activities for loans held for sale. To qualify for hedge accounting under SFAS 133, Washtenaw Mortgage had to demonstrate, on an ongoing basis, that its interest rate risk management activity was highly effective.  If Washtenaw was unable to qualify certain of its interest rate risk management activities for hedge accounting, then the change in fair value of the associated derivative financial instruments was reflected in current period earnings, but the change in fair value of the related loans held for sale may not, thus creating an earnings mismatch.  However, if the activity is highly

 

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effective, the change in fair value of the hedged loans held for sale is recorded in earnings, which partially offsets the change in value of the derivatives and thereby reduces the net effect on earnings.  Management tested and documented the effectiveness of these hedging activities on a quarterly basis, by documenting that the change in fair value of the derivatives and the hedged loans move in opposite directions within a similar proportion as defined in SFAS 133.

 

In connection with its pipeline of loans in process, Washtenaw Mortgage issued interest rate lock commitments (“IRLCs”) to loan applicants and financial intermediaries. The IRLCs guarantee the loan terms for a period of time while the application is in process, primarily between five and 60 days. IRLCs are derivative instruments as defined by SFAS 133 and, therefore, were required to be recorded at fair value with changes in fair value reflected in current period earnings. Changes in the fair value of IRLCs will move in the opposite direction and will partially offset changes in the fair value of treasury options and forward contracts.  However, unlike Washtenaw Mortgage’s other derivative instruments, there is no active market for IRLCs that can be used to determine an IRLC’s fair value. Consequently, Washtenaw Mortgage has developed a methodology for estimating the fair value of its IRLCs.

 

Washtenaw Mortgage estimated the fair value of an IRLC based on the change in estimated fair value of the underlying mortgage loan, given the probability that the loan will fund within the terms of the IRLC. The change in fair value of the underlying mortgage loan is based upon quoted secondary market prices. The change in fair value of the underlying mortgage loan is measured from the lock date. Therefore, at the time of issuance the estimated fair value of an IRLC is zero. Subsequent to issuance, the value of an IRLC can be either positive or negative, depending on the change in value of the underlying mortgage loan. The probability that the loan will fund within the terms of the IRLC is driven by a number of factors, in particular, the change, if any, in mortgage rates subsequent to the lock date. In general, the probability increases if mortgage rates rise and decreases if mortgage rates fall. This is due primarily to the relative attractiveness of current mortgage rates compared to the applicant’s committed rate. The probability that a loan will fund within the terms of the IRLC also is influenced by the source of the applications, age of the applications and purpose of the loans (purchase or refinance). Washtenaw Mortgage has developed closing ratio estimates (“Fallout Curves”) using its historical empirical data that take into account all of these variables, as well as renegotiations of rate and point commitments that tend to occur when mortgage rates fall. The Fallout Curves are utilized to estimate the quantity of loans that will fund within the terms of the IRLCs.

 

Since the treasury options and forward commitments were used to manage the interest rate risk exposure of loans held for sale and IRLCs, it was generally expected that the fluctuations in fair value of the various derivatives and effectively hedged loans will largely, though not entirely, offset so that the net effect on earnings is not material.  However, the net effect on earnings was dependent on the effectiveness of hedging activities and a variety of other factors, including market interest rate volatility, actual fallout rates, the ability to fill the forward contracts before expiration, and the time period required to close and sell loans.

 

Pelican Financial does not currently, or have any plans to, use derivative instruments to hedge its interest rate risk.

 

Litigation and Claims

 

Washtenaw Mortgage is subject to contingent liabilities, including judicial and arbitration proceedings, and other claims arising from the conduct of our business activities.  Reserves are established for legal and other claims when it becomes probable that we will incur an expense and the amount can be reasonably estimated.  We involve internal and external experts, including attorneys, in assessing probability and in estimating any amounts involved.  Throughout the life of a contingency, we

 

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or our experts may learn of additional information that can impact our assessments about probability or about the estimates of amounts involved and changes in these assessments can lead to changes in recorded reserves.  In addition, the actual costs of resolving these claims may be substantially higher or lower than the amounts reserved for those claims.  See Item 8 – “Legal Proceedings” for a description of significant outstanding litigation and claims.  Management does not believe there are presently significant probable losses beyond attorney fees, which are expensed as the legal services are performed.

 

Though Pelican Financial is subject to contingent liabilities, including judicial and arbitration proceedings, and other claims arising from the conduct of our business activities, historically the significant litigation and claims of the company were attributable to operations of Washtenaw Mortgage.

 

FINANCIAL CONDITION

 

General.  At December 31, 2003, total assets were $221.5 million compared to $386.3 million at December 31, 2002.  Management is committed to growing the balance sheet with quality assets that provide the appropriate yields.  The following is a discussion of the significant fluctuations between the December 31, 2003 and 2002 balance sheets.  The balance sheet for 2002 includes the balances of Washtenaw Mortgage Company while the 2003 balance sheet does not.  All amounts related to  Washtenaw Mortgage are included in the discontinued asset and liability line items.

 

Assets

 

Cash and Cash Equivalents.  Cash and cash equivalents were $55.4 million at December 31, 2003 compared to $57.4 million at December 31, 2002.  The decrease of $2.0 million or 3% was primarily the result of a $13.7 million decrease in deposits attributed to Washtenaw maintaining all of the investor accounts related to its servicing portfolio at Pelican National.  The balances at December 31, 2003 decreased as loan payoffs from Washtenaw’s servicing portfolio decreased.  Due to the fluctuation in balances of these accounts, Pelican National typically invested the deposits in interest-bearing deposits and federal funds sold.  This was offset by a money market deposit program Pelican National Bank began offering in August, 2003 that has raised the amount of core deposits at Pelican National.

 

Loans Receivable.  Total portfolio loans were $109.8 million at December 31, 2003, an increase of $5.7 million or 5% from $104.1 at December 31, 2002.  This increase resulted primarily from an increase in residential real estate lending production at Pelican National and the transfer of $13.5 million in marine loans previously classified as held for sale.  The increased production and marine loan transfer was offset by a significant increase in loans being paid in full.  The marine loans were transferred to loans receivable due to management’s decision to hold them as an earning asset in an effort to offset the loans paid in full.  The loan payoffs were caused by the numerous reductions in key interest rate drivers by the federal government over the last several years.

 

Other Real Estate Owned.  Other real estate owned increased to $333,000 at December 31, 2003.  This was an increase of approximately $257,000 compared to $76,000 at December 31, 2002.  The small increase is related to additional foreclosures that have not been sold.

 

Premises and Equipment.  Premises and equipment increased to $2.7 million at December 31, 2003 from $1.2 million at December 31, 2002.  The $1.5 million increase was the result of opening one additional branch and the purchase of two additional buildings for future branch locations.

 

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Liabilities

 

Deposits.  Total deposits were $191.9 million at December 31, 2003 compared to $153.8 million at December 31, 2002, representing an increase of $38.2 million or 24%.  The increase was the result of a focus on developing new deposit relationships with customers.  This was achieved by increasing the yield paid on its money market account to one of the highest in the local market area.  In addition, the two newest branches, one opened in 2003 and the other at the end of the year in 2002, had collected approximately $20 million in deposits while the two existing branches increased the deposits collected by approximately $40 million.  This was offset by an approximate $14 million decrease in deposits from Washtenaw and a reduction of approximately $5 million in certificate of deposits obtained from brokers and the Internet.  Pelican National is attempting to reduce the reliance on this source of funds in the future and currently is allowing all certificates of deposits obtained in this manner to mature without replacing the funds.  At December 31, 2003, there were $10.4 million in deposits obtained from brokers and the Internet.

 

Federal Home Loan Bank Borrowings.  During the year, Federal Home Loan Bank borrowings decreased from $18.0 million to $12.0 million at December 31, 2003.  The decrease of $6.0 million or 33% was due to Pelican National settling two of the notes prior to maturity.  This was done as a result of the excess liquidity at Pelican National.  Pelican National was responsible for an early retirement fee that management estimates will be recovered within one year as a result of this strategy.

 

Comparison of Results of Operations for the Years Ended December 31, 2003 and 2002

 

General.  Pelican Financial’s net loss from continuing operations before cumulative effect of change in accounting principle for the year ended December 3l, 2003 was $918,000 compared to net income of $1.5 million for the year ended December 31, 2002.  The decrease of approximately $2.4 million for the year ended December 31, 2003 was primarily the result of increases in provision for loan losses and noninterest expense.  Pelican Financial’s net income for the year ended December 3l, 2003 was $8.5 million compared to $3.3 for the year ended December 31, 2002.  The increase is the result of a $7.6 million increase in income from discontinued operations resulting from a decrease in mortgage servicing right valuation adjustments and increase in loan originations related to the discontinued operations.

 

Net Interest Income.  Net interest income (interest earned net of interest charges) totaled $6.7 million for the year ended December 31, 2003, as compared to $6.5 million for the year ended December 31, 2002, representing an increase of $149,000 or approximately 2%.  The consistency in dollar amount is due to the reduction in interest rate earned on earning assets being offset by an increase in the average balance outstanding of earning assets and a reduction in the cost of funds.  The reduction in the cost of funds is due to a change in composition of depositwith a greater reliance in 2003 on money markets as compared to certificates of deposits which typically have a higher cost.  In addition, the certificates of deposits that matured in 2003 were typically replaced with lower yielding alternatives.

 

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Average Balance Sheet.  The following table contains for the periods indicated information regarding the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amount of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, and the net yield on interest-earning assets.  The table does not include any information related to the discontinued operations for any period presented.

 

		Years Ended December 31,
		2003								2002								2001
		Average Volume			Interest			Yield/Cost		Average Volume			Interest			Yield/Cost		Average Volume			Interest			Yield/Cost
		(Dollars in thousands)
ASSETS
Interest-earning assets:
Federal funds sold		$	51,126		$	563		1.10	%	$	19,303		$	323		1.67	%	$	5,270		$	220		4.17	%
Securities		9,253			430			4.65		7,799			474			6.08		6,525			412			6.31
Loans receivable, net		121,182			9,149			7.55		124,294			10,028			8.07		100,673			9,357			9.29
Total interest-earning assets		181,561			10,142			5.59		151,396			10,825			7.15		112,468			9,989			8.88
Noninterest-earning assets:
Cash and due from banks		8,286								5,448								3,002
Allowance for loan losses		(1,149		)						(1,028		)						(655		)
Other assets		4,492								2,325								1,788
Total assets		193,190								158,141								116,603
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
NOW accounts		$	827		6			0.73	%	$	813		7			0.86	%	$	1,106		22			1.99	%
Money market accounts		25,011			479			1.92		6,160			141			2.29		4,110			157			3.82
Savings deposits		12,191			183			1.50		11,874			297			2.50		12,576			425			3.38
Time deposits		44,230			1,806			4.08		57,671			2,796			4.85		52,869			3,297			6.24
Other borrowings		16,932			998			5.89		17,742			1,064			6.00		11,990			1,008			8.41
Total interest-bearing liabilities		99,191			3,472			3.50		94,260			4,305			4.57		82,651			4,909			5.94
Noninterest-bearing liabilities:
Demand deposits		78,724								48,169								14,725
Other liabilities		347								2,262								10,857
Stockholders’ equity		14,928								13,450								8,370
Total liabilities and stockholders’ equity		$	193,190							$	158,141							$	116,603
Interest rate spread								2.09	%							2.58	%							2.94	%
Net interest income and net interest margin					$	6,670		3.67	%				$	6,520		4.31	%				$	5,080		4.52	%

 

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Rate/Volume Analysis.  Changes in net interest income are attributable to three factors:

 

1.                                       a change in the volume of an interest-earning asset or interest-bearing liability,

2.                                       a change in interest rates, or

3.                                       a change attributable to a combination of changes in volume and rate.

 

The following table contains certain information regarding changes in interest income and interest expense of Pelican Financial (excluding discontinued operations) for the periods indicated.  For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to:

 

A.                                   changes in volume (changes in volume multiplied by the old interest rate); and

B.                                     changes in rates (changes in interest rates multiplied by the old average volume).

 

		Year Ended December 31, 2003 vs. Year Ended December 31, 2002									Year Ended December 31, 2002 vs. Year Ended December 31, 2001
		Total Change			Changes Due to						Total Change			Changes Due to
					Volume (1)			Rates (1)						Volume (1)			Rates (1)
		(Dollars in thousands)
INTEREST-EARNING ASSETS:
Federal funds sold		$	240		$	303		$	(63	)	$	103		$	133		$	(30	)
Securities		(44		)	168			(212		)	62			77			(15		)
Loans receivable, net		(879		)	(247		)	(632		)	671			1,533			(862		)
Total interest income		(683		)	224			(907		)	836			1,743			(907		)
INTEREST-BEARING LIABILITIES:
NOW accounts		(1		)	—			(1		)	(15		)	(5		)	(10		)
Money market accounts		338			357			(19		)	(16		)	65			(81		)
Savings deposits		(114		)	8			(122		)	(128		)	(23		)	(105		)
Time deposits		(990		)	(590		)	(400		)	(501		)	345			(846		)
Short term borrowings		(66		)	(48		)	(18		)	56			139			(83		)
Total interest expense		(833		)	(273		)	(560		)	(604		)	521			(1,125		)
Net change in interest income		$	150		$	497		$	(347	)	$	1,440		$	1,222		$	218

 

(1)                                  Changes in interest income/expense not arising from volume or rate variances are allocated proportionately to rate and volume.

 

Provision for Loan Losses.  The provision for loan losses is charged to earnings to bring the allowance for loan losses to a level deemed appropriate by management.  During the year ended December 31, 2003, the provision for loan losses was $1,058,000 compared to $300,000 for the year ended December 31, 2002.  The allowance for loan losses as of December 31, 2003 was $1.3 million, or 1.20% of total portfolio loans, compared to $1.1 million, or 1.01% of total loans at December 31, 2002.

 

During the year ended December 31, 2003 the provision for loan losses increased by $758,000.  The increase in the provision was deemed necessary despite the decrease in nonperforming loans, due to an increase in loans requiring specific allowances and an increase in the allowance allocation on the marine lending portfolio and a portfolio of loans located in  inner-city areas.

 

Net charge-offs for the year ended December 31, 2003 totaled $790,000 as compared to $94,000 for the same period in 2002. The increase in net charge-offs was due to the deterioration of several impaired loans.  These loans are located in inner-city areas where the overall neighborhoods are declining.  Several of these loans were made to one borrower who has declared bankruptcy, which has delayed collection efforts.

 

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The increase in net charge-offs also increased the historical loss rates used to calculate the allowance allocation for homogeneous loans.  This had the most significant impact on the marine lending portfolio and the loans remaining from a pool of purchased inner-city residential mortgage loans.  The specific allocations on certain loans, including a portion of the pool of inner-city residential mortgage loans, increased during the periods due to a decrease in the value of the collateral.  In addition, the principal balance of loans requiring specific allocations increased during 2003.

 

NonInterest Income.  Noninterest income totaled $231,000 for the year end December 31, 2003 compared to $772,000 for the year ended December 31, 2002.  The decrease is due to the decrease in gain on sale of securities from $163,000 to a $29,000 loss, the decrease in the gain on sales mortgage servicing rights and loans from  $370,000 to $94,000 and the decrease in other income from a $73,000 gain to a $30,000 loss.  The decrease in the gain on sale of securities resulted from the unfavorable market conditions at the time the securities were sold for liquidity purposes.  The decrease in gain on sales of mortgage servicing rights and loans, net resulted from the reduction in the sales of marine loans during 2003.  Other income decreased primarily due to the loss on the disposition of real estate owned and boat repossessions.

 

Compensation and Employee Benefits Expense.  Compensation and benefits totaled $3.6 million for the year ended December 31, 2003 compared to $2.2 million for the year ended December 31, 2002, representing an increase of approximately $1.4 million or 64%.  The increase during 2003 was partially the result of a $300,000 severance payment to the previous President of Pelican National Bank.  In addition, Pelican National’s third branch was open for the entire year and the fourth branch opened in the spring of 2003.  These costs may continue to increase due the scheduled opening of two additional branches during the first six months of 2004.

 

Occupancy and Equipment Expense.  Occupancy and equipment expense totaled $1.0 million for the year ended December 31, 2003 compared to $761,000 for the year ended December 31, 2002.  The increase was due to Pelican National opening a third bank branch during the fourth quarter of 2002, as well as opening a fourth branch in the spring of 2003. These costs may continue to increase due the scheduled opening of two additional branches during the first six months of 2004.

 

Legal.    Legal expenses increased to $408,000 compared to $283,000 for the years ended December 31, 2003 and 2002.  The increase is primarily due to the expenses related to various legal requirements and issues involved in the spin-off of Washtenaw Mortgage.

 

Accounting and Auditing.  Accounting and auditing expenses increased to $200,000 compared to $118,000 for the years ended December 31, 2003 and 2002.  The increase is primarily due to the expenses related to various audit work involved in the spin-off of Washtenaw Mortgage.

 

Data Processing.  Data Processing expense increased to $137,000 compared to $99,000 for the years ended December 31, 2003 and 2002.  The increase is due to network and software upgrades made during 2003.

 

Marketing and advertising.  Marketing and advertising expenses increased to $180,000 compared to $130,000 for the years ended December 31, 2003 and 2002.  The additional expenditures were related to advertising the new branch locations and the money market account promotion.

 

Loan and other real estate owned.  Loan and other real estate owned expenses increased to $443,000 compared to $225,000 for the years ended December 31, 2003 and 2002.  This is due to the costs associated with additional foreclosures and repossessions in 2003.

 

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Debt Extinguishments.  Debt extinguishments expenses increased to $310,000 compared to zero for the years ended December 31, 2003 and 2002.  The increase represents pre-payment penalties for the pay-off prior to maturity of $6.0 million in Federal Home Loan Bank borrowings.  This was done to reduce Pelican National Bank’s excess liquidity and to eliminate dept with rates above current market rates.  The weighted average interest rate on the two paid-off notes was 6.58%.

 

Other Noninterest Expense.  Other noninterest expenses increased to $929,000 compared to $834,000 for the years ended December 31, 2003 and 2002.  The increase is due to the additional branches and employees added during 2003.  These costs may continue to increase due the scheduled opening of two additional branches during the first six months of 2004.

 

Provision for Income Taxes.  For the year ended December 31, 2003 and 2002, the provision for income taxes was a benefit $473,000 and an expense of $769,000, a difference of $1.2 million between the comparable periods.  The decrease was due to the pre-tax loss in 2003.  The effective tax rate for both periods was constant at approximately 34%.

 

Comparison of Results of Operations for the Years Ended December 31, 2002 and 2001

 

General.  Pelican Financial’s net income from continuing operations before cumulative effect of change in accounting principle for the year ended December 3l, 2002 was $1.5 million compared to $396,000 for the year ended December, 31, 2001.  The increase of approximately $1.1 million for the year ended December 31, 2002 was primarily the result of increases in net interest income and noninterest income.  Pelican Financial’s net income for the year ended December 3l, 2002 was $3.7 million compared to $7.0 for the year ended December 31, 2001.  The decrease is primarily the result of a $4.1 million decrease in income from discontinued operations resulting from an increase in mortgage servicing right valuation adjustments related to the discontinued operations.

 

Net Interest Income.  Net interest income (interest earned net of interest charges) totaled $6.5 million for the year ended December 31, 2002, as compared to $5.1 million for the year ended December 31, 2001, representing an increase of $1.4 million or approximately 27%.  The change was due to the increase in the average balance of loans outstanding which increased interest income and the decrease in the cost of funds.

 

Provision for Loan Losses.  The provision for loan losses is charged to earnings to bring the allowance for loan losses to a level deemed appropriate by management.  During the year ended December 31, 2002, the provision for loan losses was $300,000 compared to $562,000 for the year ended December 31, 2001.  The allowance for loan losses as of December 31, 2002 was $1.1 million, or 1.01% of total portfolio loans, compared to $856,000, or 0.90% of total loans at December 31, 2001.

 

During the year ended December 31, 2002 the allowance for loan losses increased by $206,000.  The increase in the allowance was deemed necessary despite the decrease in nonperforming loans, due to an increase in loans requiring specific allowances and an increase in the allowance allocation on the marine lending portfolio and the remainder of loans located in the inner-city areas.  Net charge-offs for the year ended December 31, 2002 totaled $94,000 as compared to $213,000 for the same period in 2001.

 

NonInterest Income.  Noninterest income totaled $772,000 for the year end December 31, 2002 compared to $318,000 for the year ended December 31, 2001.  The increase is due to the increase in gain on sale of securities from zero to $163,000 and the increase in the gain on sales mortgage servicing rights and loans from  $164,000 to $370,000.  The increase in the gain on sale of securities resulted from the sale of securities during periods for liquidity purposes when market conditions were favorable.  The increase in gain on sales of mortgage servicing rights and loans, net resulted from the additional sales of marine loans during 2002.

 

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Compensation and Employee Benefits Expense.  Compensation and benefits totaled $2.2 million for the year ended December 31, 2002 compared to $1.8 million for the year ended December 31, 2001, representing an increase of approximately $400,000 or 22%.  The increase during 2002 was the result of additional staff hired during 2002 to assist in the growth of the loan portfolio and additional staff for the additional branch opened during the year

 

Occupancy and Equipment Expense.  Occupancy and equipment expense totaled $761,000 for the year ended December 31, 2002 compared to $661,000 on for the year ended December 31, 2001.  The increase was due to Pelican National opening a third bank branch during the fourth quarter of 2002.

 

Legal.              Legal expenses increased to $283,000 compared to $193,000 for the years ended December 31, 2002 and 2001.  The increase is primarily due to the expenses related to legal research performed while the Board of Directors discussed the spin-off of Washtenaw Mortgage.

 

Other Noninterest Expense.  Other noninterest expenses decreased to $834,000 compared to $1.1 million for the years ended December 31, 2002 and 2001.  The decrease is due to a reduction in various expenses including travel, entertainment, telephone and postage.

 

Provision for Income Taxes.  For the year ended December 31, 2002 and 2001, the provision for income taxes was $787,000 and $208,000, a difference of $578,000 between the comparable periods.  The increase was due to increased pre-tax income.  The effective tax rate for both periods was constant at approximately 34%.

 

Contractual Obligations

 

The following table provides information about Pelican Financial’s contractual obligations as of December 31, 2003.

 

Contractual Obligations		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
Short-term Borrowings		$	291,665		$	291,665		$	—		$	—		$	—
Long-Term Debt		12,000,000			—			—			—			12,000,000
Capital Lease Obligations		—			—			—			—			—
Operating Leases		1,566,416			506,813			750,285			309,318			—
Certificates of Deposit		39,543,958			15,728,083			8,292,343			15,523,532			—
Total		$	53,402,039		$	16,526,561		$	9,042,628		$	15,832,850		$	12,000,000

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity refers to the ability or the financial flexibility to manage future cash flows to meet the needs of depositors and borrowers and fund operations on a timely and cost-effective basis.  Pelican Financial’s primary source of funds is dividends paid by Pelican National.  In July 1997, Pelican Financial established a loan in the amount of $2.0 million, the proceeds of which were contributed to the capital of Pelican National.  The loan is payable on demand and the interest rate is the weighted average Federal Funds Rate plus 2.75%, which resulted in an effective rate of 3.75% at December 31, 2003 and 4.00% at December 31, 2002.  As of December 31, 2003, the only dividends received by Pelican Financial to make payments pursuant to the term loan have been from Washtenaw.  Subsequent to December 31, 2003, the balance of the term loan was paid in full.

 

Pelican Financial received approval from the Federal Reserve Board to increase its loan to a maximum of $3.0 million, prior to the spin-off.  Management believes that the addition of this amount will provide sufficient capital to meet it growth projections.  At this time, management is not actively attempting to achieve any additional financing.

 

At December 31, 2003, $63.5 million in non-interest bearing deposits at Pelican National Bank were attributable to Washtenaw Mortgage.  This represented 33% of total deposits.  Due to fluctuations in the outstanding balance of deposits from Washtenaw Mortgage during the month, the funds are typically deposited in short term interest bearing deposits and Federal Funds Sold.  At December 31, 2003, $49.1 million were invested in this manner.  In the event that Washtenaw Mortgage were to transfer the deposits to another financial institution, Pelican National Bank would be required to replace a portion of the deposits with interest bearing deposits. While this would have a negative impact on the financial performance of Pelican Financial, Pelican National Bank believes it could replace the deposits with new core deposits, short-term borrowings or long-term borrowings.

 

At December 31, 2003, Pelican National exceeded all applicable regulatory minimum capital requirements as well as the requirement to be considered “well capitalized” for regulatory purposes.  Pelican Financial also exceeded its regulatory minimum capital requirements at December 31, 2003.  For a detailed discussion of the regulatory capital requirements to which Pelican Financial and Pelican National are subject, and for a tabular presentation of compliance with these requirements, see “Regulation - Pelican Financial,” “Regulation - Pelican National - Capital Requirements,” and Note 13 of Notes to Consolidated Financial Statements.

 

IMPACT OF NEW ACCOUNTING STANDARDS

 

In June 2001 the Financial Accounting Standards Board (FASB) issued accounting standard SFAS 143, Accounting for Asset Retirement Obligations.  This statement covers the removal of a long term asset from service.  The statement was effective for fiscal years beginning after June 15, 2002.  The adoption of this statement did not have a material effect on the financial statements.

 

In April, 2002 the FASB issued accounting standard SFAS 145, Rescission of FASB Statement 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections.  This statement modifies the reporting of gains and losses from extinguishments of debt, accounting for intangible assets of motor carriers and accounting for leases.  The statement was effective for fiscal years beginning after May 15, 2002.  The adoption of this statement did not have a material effect on the financial statements.

 

In June, 2002 the FASB issued accounting standard SFAS 146, Accounting for Cost Associated with Exit or Disposal Activities.  This statement requires a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred.  The statement was effective for exit or disposal activities initiated after December 31, 2002.  The adoption of this statement did not have a material effect on the financial statements.

 

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In December 2002 the FASB issued accounting standard SFAS 148, Accounting for Stock Based Compensation – Transition and Disclosure.  This statement provided alternatives for companies that adopt the fair value based method of accounting for stock-based employee compensation and revised stock compensation disclosure requirements.  The disclosure requirements were effective for fiscal years ending after December 15, 2002, and other provisions are required for fiscal years beginning after December 15, 2003.  The adoption of this statement did not have a material effect on the financial statements.

 

SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133.  This statement was effective in the quarter beginning July 1, 2003.  The adoption of this statement did not have a material effect on the financial statements.

 

Under SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equities, , mandatorily redeemable instruments such as trust preferred securities are considered liabilities and not part of mezzanine (or temporary) equity.  This statement was effective in the quarter beginning July 1, 2003.  The company does not have any of these instruments and, therefore, adoption of this statement did not have an impact on the financial statements.

 

In November 2002, FASB issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires a guarantor to make additional disclosures in its interim and annual financial statements regarding the guarantor’s obligations. In addition, beginning in 2003, FIN 45 requires, under certain circumstances, that a guarantor recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken when issuing the guarantee.  The adoption of FIN 45 on January 1, 2003 did not have a material impact on Pelican Financial.

 

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 “Consolidation of Variable Interest Entities” which requires the consolidation of certain entities, including special purposes entities (SPE’s), by a company if it is determined to be the primary beneficiary of the variable interest entity’s operating activities. The adoption of this interpretation on January 31, 2003 did not have a material impact on Pelican Financial.

 

The Securities and Exchange Commission has issued Staff Accounting Bulletin (SAB) No. 105, “Application of Accounting Principles to Loan Commitments.”  SAB 105 states that future cash flows from servicing rights and other internally-developed intangible assets cannot be included in the determination of fair value of rate lock commitment derivatives.  The SAB also discusses disclosure requirements for rate lock commitment derivatives and is required to be applied to rate lock commitments entered into after March 31, 2004.  The Company does not expect this SAB to have an effect on the financial statements.

 

IMPACT OF INFLATION AND CHANGING PRICES

 

The Consolidated Financial Statements and Notes thereto presented in this Annual Report and Form 10-K 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 the changes in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of Pelican Financial’s operations.  Unlike most industrial companies, nearly all the assets and liabilities of Pelican Financial are monetary in nature.  As a result, interest rates have a greater impact on Pelican Financial’s performance than do the effects of general

 

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levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

 

The principal objective of Pelican Financial’s interest rate risk management is to evaluate the interest rate risk included in balance sheet accounts, determine the level of risk appropriate given Pelican Financial’s business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with Pelican Financial’s Interest Rate Risk Management Policy.  Through this management, Pelican Financial seeks to reduce the vulnerability of its operations to changes in interest rates.  The Board of Directors of Pelican Financial is responsible for reviewing asset/liability policies and interest rate risk position.  The Board of Directors reviews the interest rate risk position on a quarterly basis.  In connection with this review, the Board of Directors evaluates Pelican Financial’s business activities and strategies, the effect of those strategies on Pelican Financial’s net interest margin, the market value of the loan, servicing, and securities portfolios, and the effect the changes in interest rates will have on Pelican Financial’s loan, servicing, and securities portfolios and exposure limits.

 

The continuous movement of interest rates is certain, however, the extent and timing of these movements is not always predictable.  Any movements in interest rates has an effect on Pelican Financial’s profitability.  The value of loans, which Pelican Financial has either originated or purchased or committed to originate or purchase, decreases as interest rates rise and conversely, the value increases as interest rates fall.  Pelican Financial also faces the risk that rising interest rates could cause the cost of interest-bearing liabilities, such as loans and borrowings, to rise faster than the yield on interest-earning assets, such as loans and investments.  Pelican Financial’s interest rate spread and interest margin may be negatively impacted in a declining interest rate environment.  This is because loans and other interest-earning assets may be prepaid and replaced with lower yielding assets before the supporting interest-bearing liabilities reprice downward.  Pelican Financial’s interest margin may also be negatively impacted in a flat- or inverse-yield curve environment.

 

The overall objective of Pelican Financial’s interest rate risk management policies is to offset changes in the values of these items resulting from changes in interest rates.  Pelican Financial does not speculate on the direction of interest rates in its management of interest rate risk.

 

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The following table provides information about Pelican Financial’s financial instruments that are sensitive to changes in interest rates as of December 31, 2003.  The securities available for sale were based upon maturity unless callable by the issuer.  The expected maturity date values for loans receivable were calculated without adjusting the contractual maturity dates for prepayments.  Loans receivable are shown excluding the allowance for loan losses.  Loans held for sale are shown in the period in which they are expected to be sold.  Maturity dates for interest bearing core deposits were not based on estimates of the period over which the deposits would be outstanding, but rather the opportunity for repricing.

 

(Dollars in thousands)

 

		2004			2005			2006			2007			2008			Thereafter			Total			Fair Value 12/31/2003
Rate sensitive assets:
Federal funds sold		$	3,426																	$	3,426		$	3,426
Average interest rate		1.00		%
Interest bearing deposits with banks		$	45,639																	$	45,639		$	45,639
Average interest rate		1.02		%
Securities available for sale		$	28,239					7,055			12,063						$	2,319		$	49,730		$	49,730
Average interest rate		3.57		%				2.89		%	3.36		%				5.34		%
Loans held for sale		$	141																	$	141		$	142
Average interest rate		5.50		%
Fixed interest rate loans receivable		$	3,476		$	3,044		$	1,666		$	2,844		$	2,867		$	48,123		$	62,020		$	62,875
Average interest rate		7.86		%	8.64		%	7.41		%	10.94		%	6.98		%	7.10		%
Variable interest rate loans receivable		$	25,309		$	6,188		$	6,555		$	266		$	8,619		$	1,931		$	48,688		$	49,401
Average interest rate		6.85		%	7.36		%	6.49		%	6.63		%	5.84		%	7.12		%
Rate sensitive liabilities:
Savings deposits		$	78,364																	$	78,364		$	78,364
Average interest rate		1.73		%
Certificates of deposits		$	15,728		$	5,202		$	3,090		$	13,643		$	1,881					$	39,544		$	41,124
Average interest rate		3.74		%	4.26		%	3.08		%	5.00		%	3.85		%
Notes payable		$	292																	$	292		$	292
Average interest rate		4.06		%
Federal Home Loan Bank borrowings																	$	12,000		$	12,000		$	12,659
Average interest rate																	5.37		%

 

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