IBT BANCORP, INC. 2003 ANNUAL REPORT SELECTED FINANCIAL INFORMATION IBT BANCORP, INC & SUBSIDIARY AT OR FOR THE YEARS ENDED 2003 2002 2001 2000 1999 (Dollars in thousands, except per share amounts) SELECTED BALANCE SHEET DATA: Assets $ 629,530 $ 584,035 $ 524,044 $ 496,379 $ 445,721 Cash and cash equivalents 15,829 15,066 25,218 21,746 19,264 Securities available for sales 172,448 186,718 162,968 167,874 151,063 Securities held to maturity - - - - - Loans receivable (net) 416,286 359,872 315,132 291,914 260,502 Deposits 492,158 468,257 422,462 409,638 368,680 Repurchase agreements 12,611 14,526 11,207 9,022 6,457 Federal funds purchased 7,900 - - - 7,000 FHLB advances 53,308 40,000 35,000 28,000 22,000 Shareholders' equity 59,606 56,151 49,725 44,615 37,905 Selected Results of Operations Interest income $ 33,398 $ 33,560 $ 35,185 $ 33,787 $ 29,731 Net interest income 22,083 20,732 18,226 17,200 16,087 Provision for loan losses 600 1,100 500 300 300 Net interest income after provision for loan losses 21,483 19,632 17,726 16,900 15,787 Other income 5,891 5,317 4,009 2,946 2,764 Other expense 14,300 12,831 11,284 10,181 9,233 Net income 9,646 8,937 7,465 6,705 6,336 PER SHARE DATA: Net Income Basic $ 3.24 $ 3.00 $ 2.49 $ 2.23 $ 2.10 Diluted 3.19 2.99 2.49 2.23 2.10 Cash dividends declared 1.40 1.20 1.04 0.92 0.80 SELECTED RATIOS: Return on average assets 1.59% 1.61% 1.45% 1.44% 1.49% Return on average equity 16.54% 16.95% 15.57% 16.87% 16.54% Ratio of average equity to average assets 9.59% 9.47% 9.31% 8.52% 8.99% Dividend payout 43.21% 40.00% 41.77% 41.26% 38.10% A MESSAGE TO OUR STOCKHOLDERS 2003 FINANCIAL PERFORMANCE. Following 2002's "record-breaking" performance, 2003 was a year of "ground-breaking" accomplishments resulting in continued growth, strong earnings and impressive stock performance for IBT Bancorp, Inc. With its stock price closing the year at $59.23, IBT Bancorp, Inc. shareholders achieved a $21.28 per share or 56% gain on their investment. When dividends are included, the total return was 60%. The gain was influenced by the company's decision to begin trading on the American Stock Exchange. Strong performance by IBT Bancorp, Inc.'s subsidiary Irwin Bank & Trust Company also contributed to the increase. For 2003, the company achieved 7.8% growth in assets, 7.9% growth in earnings and a 16.7% increase in the dividend. GROUND-BREAKING EVENTS. On April 1, 2003, IBT Bancorp, Inc. stock was listed and began trading on the American Stock Exchange under the symbol "IRW". The exposure of the listing positively impacted the stock's liquidity causing an immediate increase in the price of IBT Bancorp, Inc. shares. Average daily trading volume was positively affected, increasing 262% from 2002 to 2003. The stock is now part of the Russell 3000 index. On October 20, 2003, a new deposit product called Maximum Checking was introduced and added to the Bank's portfolio. It was designed to attract and retain customers that maintain higher checking account balances. Robust deposits indicated an enthusiastic customer response to the new account. Irwin Bank and Trust Company's deposit products now fully address competitive offerings and satisfy customer demand. In June 2003, Irwin Bank and Trust Company broke ground (literally) for construction of a new, full-service branch office in Greensburg, Pennsylvania. The new office opened on November 10, 2003. The facility expands the franchise in the market area's dominant community and further establishes the Bank as Westmoreland County's largest local financial institution. We will continue to assess other opportunities for expansion and take advantage of them when appropriate. A final highlight of 2003 was the introduction of check imaging technology in November. As part of the process, Irwin Bank & Trust Company also improved the quality and readability of customer statements. The new technology has enabled the Bank to be fully compliant with the Check 21 government mandate which requires all banks to implement check imaging. Groundbreaking for the new Greensburg office took place on June 10, 2003, attended by the Company's Directors, the Greensburg Advisory Committee, and Local, County and State Elected Officials. Shown from left to right, Westmoreland County Commissioner Tom Balya, Branch Manager Kathleen Jacquette-Tosh, Company President Charles G. Urtin, Greensburg Mayor Karl Eisaman and Chairman of the Board J. Curt Gardner. 1 CHALLENGES, TRENDS AND STRATEGY. As we had projected in 2002, continued margin compression throughout the banking industry in 2003 was caused by historically low interest rates. During 2003, the Company's net interest margin declined from 3.94% in 2002 to 3.83% in 2003. However, despite the decrease, net income for the year rose 7.9%. Contributing to the increase in net income was a 9.4% improvement in net interest income and an 10.8% increase in non-interest income, offset by an 11.4% increase in non-interest expenses. The overall increase in net interest income was the result of an increase in interest bearing assets. However, the increase was offset by the decrease in the net-interest margin. It appears that interest rates will remain low through 2004 and cause continued pressure on banks nationwide. Increasing bank deposits was a difficult challenge in 2003 due to aggressive competition and improved stock market performance. The robust stock market attracted investors away from insured bank deposit instruments. The low rate environment helped Company assets increase by way of record-breaking consumer and real-estate mortgage activity. However, there was a seasonal decline in consumer mortgage activity in the fourth quarter and there are indications that the refinancing boom may have peaked. This trend may be at least partially offset by new residential construction in our market area which remains strong. A projected increase in demographic households locally and county-wide should also have a positive impact on loan demand. LOOKING AHEAD. Our expectation is for challenges to continue in 2004. The net interest margin will remain under pressure as long as interest rates remain at historic lows. To offset the challenge, we remain focused on controlling expenses, growing non-interest income, exploring prudent expansion opportunities and improving customer retention. Non-interest income growth potential exists in the Company's UVest and Trust divisions. Our marketing strategy will emphasize internal opportunity by improving the sales capability of our staff and improving our knowledge and management of customer relationships. To facilitate the process, branch managers now have direct access to customer relationship (CRM) data. We will continue to design and implement strategies that focus on what we do best, community banking. By listening to our customers and responding to their changing needs, we will continue to build strong customer relationships, deliver product value, and provide community leadership as our core community banking strategy. /S/ Charles G. Urtin /s/ J. Curt Gardner Charles G. Urtin J. Curt Gardner President & Chief Executive Officer Chairman of the Board IBT Bancorp, Inc. IBT Bancorp, Inc. 2 [GRAPHIC OMITTED] BOARD OF DIRECTORS / MANAGEMENT IRWIN BANK & Trust Company Management (Back row:) Raymond G. Suchta, Senior Vice President / CFO David A. Finui, Senior Vice President / COO (Seated front row:) Robert A. Bowell, Executive Vice President / Secretary-Treasurer / CLO Charles G. Urtin, President / CEO [GRAPHIC OMITTED] IBT BANCORP, INC. / IRWIN BANK & Trust Company Board of Directors (Back row:) J. Curt Gardner, Chairman Edwin A. Paulone, Director Dr. Grant J. Shevchik, Director Charles G. Urtin, President / CEO Richard L. Ryan, Director (Seated front row:) Thomas Beter, Director Robert Rebich, Director Richard J. Hoffman, Director, Robert C. Whisner, Director 3 THE AMERICAN STOCK EXCHANGE WELCOMES IBT BANCORP, INC. IBT Bancorp began trading on the American Stock Exchange under the symbol "IRW" on April 1, 2003. The AMEX listing benefits existing and future shareholders of IBT Bancorp, Inc. by ensuring an efficient and liquid market. Valuation based on supply and demand is enhanced by exposing fundamentals to the national and international investing community. The auction market and specialist system of the AMEX provide the fairest, most efficient, and most liquid market. The increased exposure to the institutional investment community earned the Company a listing on the Russell 3000 index. Bottom line: IBT Bancorp, Inc. shareholders enjoyed a 56% increase in value in 2003. Director Grant J. Shevchik, President and CEO Charles G. Urtin, COO David A. Finui and CFO Raymond G. Suchta ring the opening bell at the American Stock Exchange on the first day of Company stock trading, April 1, 2003. A NEW FULL SERVICE BANKING FACILITY On November 12, 2003, Irwin Bank and Trust Company opened its new branch banking facility in Greensburg, Pennsylvania. The Company's design committee and architect Barry Morris, developed a design concept that expresses Irwin Bank and Trust Company's commitment to this important market. Consistent with customer survey results, the design minimizes the use of delivery automation in favor of a high touch approach to customer service. The floor plan offers a warm transaction area while providing a comfortable and private waiting and office area for new account openings, lending and investment appointments. Brand awareness is apparent with the exterior presentation of a bold roof design in the Company's signature color of blue. [GRAPHIC OMITTED] Irwin Bank & Trust Company's newest branch office opened on November 12, 2003. Cutting the ribbon (L-R) are Directors Thomas Beter, Richard J. Hoffman and Richard L. Ryan, Assistant Vice President and Branch Manager Kathleen Jacquette-Tosh, Assistant Manager Megan Schaffer, Company President Charles G. Urtin and Director Robert C. Whisner. 4 [GRAPHIC OMITTED] Completion of Irwin Bank and Trust Company's 2003 technology initiatives will provide customers with better statements and service and the Company with improved capital management in 2004. AN INVESTMENT IN TECHNOLOGY IMPROVES AUTOMATION, PROVIDES BETTER CUSTOMER SERVICE AND ACHIEVES A COMPLIANCE MANDATE Check Imaging went online in November of 2003. At the same time, new statement rendering and printing technology was initiated. Multiple images of processed checks are gang-printed on letter-sized pages that accompany easier to read monthly statements. Research is dramatically faster and can be provided by several bank resources such as the Call Center and Customer Service Representatives. The processing, printing and mailing of customer statements are now one automated process requiring significantly reduced manpower. Check Imaging now places Irwin Bank and Trust Company in compliance with the recently adopted Check 21 federal regulation, requiring all banks to process check images by October of 2004. PRODUCT DEVELOPMENT FILLS A GAP IN OUR MARKETING MIX Irwin Bank and Trust Company launched a new checking product in October of 2003 called Maximum Checking. This product positions well in the family of competitive offerings known as "relationship" accounts. It combines a wealth of banking services in one simple account for a monthly fee. However, the fee is waived if the customer achieves certain deposit or loan relationship balances. In addition, Maximum Checking pays interest on the account balance. Customer response has been enthusiastic. The product has out-performed all previous new product launches and completes a family of checking accounts that fulfills the needs of every market segment. "We Offer Everything in One Simple Package" and "Maximum Reward, Maximum Value" are the advertising slogans that say it all for the new Maximum Checking account. 5 A YEAR OF SUCCESS FOR REAL ESTATE BASED LENDING For Irwin Bank and Trust Company, 2003 was a very good year for consumer and real estate lending. Low interest rates continued to bring a record-level volume of new residential and commercial mortgages, refinancing and construction loans. The resulting increases in interest bearing assets favorably affected the performance of IBT Bancorp Inc.'s subsidiary title company, T/A of Irwin, and the generation of fee income resulting from the secondary sale of conforming mortgages. Consumer loans also posted big gains in 2003. Installment loans increased from $59,321,023 in 2002 to $78,326,069, a 32% increase. Home equity lines of credit grew by 38% in both available and utilized credit lines. At year end, available lines stood at $42,747,765 while lines in use had grown to $21,963,205. [GRAPHIC OMITTED] Irwin Bank and Trust Company is committed to financing both the needs of our neighbors and the dreams of our customers. Pictured above (L-R) Irwin Bank Vice President Scott D. Porterfield, Hot Shots Owners Mike Gerger and Tim Davis, along with Irwin Bank Chief Lending Officer Robert A. Bowell celebrate the completion of Hot Shots, an indoor sports arena in Mount Pleasant, PA. [GRAPHIC OMITTED] Irwin Bank Chief Lending Officer Robert A. Bowell, Doctors Mark Klingensmith and Geoffery Bisignani, building owners, and Irwin Bank Vice President Alan Lazar visit The BK Medical Building, a new professional office building in Greensburg, PA. The project was financed by Irwin Bank & Trust Company. (Not pictured: Dr. Gregory Bisignani) 6 COMMUNITY SPIRIT IS THE SPIRIT OF COMMUNITY BANKING Irwin Bank and Trust Company takes great pride in the financial and human support it provides to the communities it serves. Well over 200 organizations benefit from the Company's sponsorships, donations and the active participation of its employees as volunteers and directors. Recipients range from far reaching institutions including the United Way and the Make-A-Wish Foundation to the very grassroots of local neighborhoods including school boosters, fire companies and service clubs. Community banking is also about understanding local banking needs. The Company's Commercial Relationship Managers and Branch Retail Staff monitor and fulfill those needs, providing customers with the banking solutions demanded by an ever-changing marketplace. [GRAPHIC OMITTED] Irwin Bank and Trust company sponsored the painting of an historical billboard commissioned by the Lincoln Highway Heritage Corridor located on a building in downtown Greensburg. [GRAPHIC OMITTED] President and CEO Charles G. Urtin and Assistant Vice President Sheli Fyock present Irwin Bank and Trust Company's donation to the Make-A-Wish Foundation at a holiday radio-telethon held at Monroeville Mall. Accepting the donation is local broadcast personality Kathy Svilar and Make-A-Wish representative, Ann Fisher. [GRAPHIC OMITTED] Assistant Chief Mike Radakovich and Second Lieutenant Stephan Gongaware show off Manor Borough's newest investment in the safety of its citizens, an Irwin Bank and Trust Company-financed fire engine, to Chief Lending Officer Robert A. Bowell and Vice President Alan Lazar. 7 [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] Douglas P. Arndt Louis C. Bouchat Carolyn Sue Bozzick Jeffrey A. Branthoover Lisa A. Dawson Assistant Vice President/ Vice President / Retail Banking Officer/ Assistant Vice President/ Vice President / Consumer Lending Commercial Lending Branch Mgr. - Haymaker Office Trust Loan Administration Hired October, 2003 Hired March, 2003 Promoted November, 2003 Hired January, 2003 Promoted April, 2003 [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] Mary Ann Ernette Sheli L. Fyock Donald D. Henderson, III Debra S. Hopper Deborah L. Kukic Assistant Vice President/ Assistant Vice Vice President / Vice President / Training Officer UVEST Investment Services President/Marketing Operations Human Resources Promoted April, 2003 Hired August, 2003 Promoted April, 2003 Promoted April, 2003 Promoted April, 2003 [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] [Graphic Omitted] Maurine J. Peer Kristin S. Robertucci Linda D. Shaner Raymond G. Suchta James W. Thompson Assistant Vice President/ Vice President / Assistant Vice President / Sr. Vice President / Vice President / Branch Mgr. - Main Office Accounting Commercial Lending Chief Financial Officer Commercial Lending Promoted April, 2003 Promoted April, 2003 Promoted November, 2003 Promoted April, 2003 Hired November, 2003 [Graphic Omitted] [Graphic Omitted] Kathleen T. Jaquette-Tosh John R. Winter Assistant Vice President / Vice President / Branch Mgr. - Greensburg Branch Commercial Lending Hired April, 2003 Hired April, 2003 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words "believes", "anticipate", "contemplates", "expects", and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, risks associated with the effect of opening a new branch, the ability to control costs and expenses, and general economic conditions. IBT Bancorp, Inc. undertakes no obligation to publicly release the results of any revisions to those forward looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. GENERAL IBT Bancorp, Inc. is a bank holding company headquartered in Irwin, Pennsylvania, which provides a full range of commercial and retail banking services through its wholly owned banking subsidiary, Irwin Bank & Trust Co. (collectively, the "Company"). The Company's stock is traded on the American Stock Exchange under the symbol IRW. The Company opened a new full service branch office in the central Greensburg area of Westmoreland county in November, 2003. The Company now operates out of a main office, six branch offices, a loan center, a trust office, and five supermarket branches located in the Pennsylvania counties of Westmoreland and Allegheny. CRITICAL ACCOUNTING POLICIES The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. The Company's accounting and reporting policies conform with the accounting principles generally accepted in the United States of America and general practices within the financial services industry. The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. Allowance for loan losses: The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors. All of these factors may be susceptible to significant change to the extent actual outcomes differ from management's estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Accounting for stock options: As of January 1, 2003, the Company adopted SFAS 123 as amended by SFAS 148 in regards to the accounting for stock options. As required by this statement, the Company recognized compensation expense in the income statement based on the estimated fair value of the options on the date of the grant. Prior to this date the Company accounted for stock-based compensation in accordance with Accounting Principles Board Opinion (APB) No. 25. Under APB No. 25, no compensation expense is recognized in the income statement related to any options granted under the Company's stock option plans. The pro forma impact to net income and earnings per share that would occur if compensation expense was recognized, based on the estimated fair value of the options on the date of the grant, is disclosed in the notes to the consolidated financial statements. FINANCIAL CONDITION At December 31, 2003, total assets increased $45.5 million, or 7.8%, to $629.5 million from $584.0 million at December 31, 2002. The increase in total assets was primarily the result of a $56.4 million increase in net loans receivable offset by a $15.7 million decrease in securities available 1 for sale. The growth in the loan portfolio was funded by the decrease in securities available for sale, increases in total deposits of $23.9 million and additional FHLB advances of $13.3 million. The increase in the loan portfolio was primarily due to an increase of $34.7 million in real estate secured mortgage loans. Included in this category are multi-family properties and commercial mortgages, which rose $11.7 million and $31.8 million, respectively. Such increases were offset by a decrease of $5.1 million in 1-4 family residential mortgages. This decrease is attributed to customer refinancings, principal repayments, and sales into the secondary mortgage market. The 1-4 family residential mortgage loans originated by the Company are periodically sold to the Pennsylvania Housing Finance Agency ("PHFA") or PHH Mortgage Services to mitigate the interest-rate risk associated with holding long-term, low rate loans in the portfolio. In 2003, loans sold to PHFA and PHH were $1.1 million and $22.1 million, respectively. Consumer installment and home equity credit lines increased $19.0 million and $6.1 million, respectively, offset by a decrease of $4.9 million in loans made to municipalities. Loan growth is attributed to the Company's offering of competitive market interest rates. The decrease in available for sale securities was primarily the result of sales, principal repayments, and maturities of mortgage-backed securities, which had a net decrease of $16.4 million and obligations of state and political sub-divisions, which decreased $1.0 million. Such decreases were offset by an increase of $2.5 million in obligations of U.S. government agencies. Federal Home Loan Bank stock had a net increase of $1.4 million. The Company's investment in this stock is determined by the outstanding borrowings the Company has with the Federal Home Loan Bank and is purchased and sold at its stated value. At December 31, 2003, total liabilities increased $42.0 million, or 8.0%, to $569.9 million from $527.9 million at December 31, 2002. The increase was primarily related to the increase in total deposits, additional FHLB advances, and overnight borrowings of $23.9 million, $13.3 million and $7.9 million, respectively. The change in total deposits was a result of non-interest bearing and interest-bearing deposit increases of $6.8 million and $17.2 million, respectively. The interest-bearing deposit increases were primarily in certificates of deposit and savings accounts, which rose $10.8 million and $4.3 million, respectively. Such increases were attributed to a growing deposit base and competitive pricing. Non-interest bearing deposits increased $6.8 million to $81.1 million at December 31, 2003 from $74.3 million at December 31, 2002. Such increases reflect additions to non-interest bearing deposits of $4.9 million offset by a $1.9 million decrease in investments in repurchase agreements at December 31, 2003. Under the terms of the agreements, deposits in designated demand accounts of the customer are put into an investment vehicle which is used daily to purchase an interest in designated U.S. Government or Agencies' securities. The Company in turn agrees to repurchase these investments on a daily basis and pay the customers the daily interest earned based on the current market rate. See Note 8 to the consolidated financial statements. The Company showed a net increase of $13.3 million in FHLB long-term borrowings. These fixed-rate advances were used to fund the loan originations. At December 31, 2003, total stockholders' equity increased $3.4 million to $59.6 million from $56.2 million at December 31, 2002. The increase was primarily due to net income of $9.6 million for the period offset by a $1.7 million decrease in accumulated other comprehensive income (net of income taxes) and dividends paid of $4.2 million. In addition, surplus (additional paid-in capital) decreased $491,000 due to stock options exercised and increased $102,000 due to stock options granted in accordance with the adoption of FASB 123, as amended by FASB 148. See Note 19 to the consolidated financial statements. Accumulated other comprehensive income decreased as a result of changes in the net unrealized gain on the available for sale securities due to fluctuations in interest rates. Because of interest rate volatility, the Company's accumulated other comprehensive income could materially fluctuate for each interim period and year-end. See Note 2 to the consolidated financial statements. RESULTS OF OPERATIONS Net Income: Net income increased approximately $709,000, or 7.9%, to $9.6 million ($3.19 per diluted share) for the year ended December 31, 2003 from $8.9 million ($2.99 per diluted share) for the year ended December 31, 2002. The increase in net 2 income for fiscal 2003 compared to fiscal 2002 was primarily due to a $1.9 million increase in net interest income, a $574,000 increase in other income and a $500,000 decrease in the provision for loan losses. Net interest income increased primarily because interest expense declined $1.5 million, or 11.8%, while interest income remained relatively stable, declining only $162,000, or ..05%. The Company was able to maintain its levels of interest income due to a $50.0 million increase in the average volume of interest-earning assets, which more than offset a 58-basis point decline in average yield. At December 31, 2002, net income increased approximately $1.4 million, or 19.7%, to $8.9 million ($2.99 per diluted share) from $7.5 million ($2.49 per diluted share) for the year ended December 31, 2001. The increase in net income for fiscal 2002 compared to fiscal 2001 was primarily due to an $1.9 increase in net interest income after provision for loan losses. Such increase was primarily attributable to a $31.0 million increase in the average balances of interest-earning assets offset by a 73-basis point decline in the yield on average interest-earning assets. Net Interest Income: Net interest income is the most significant component of the Company's income from operations. Net interest income is the difference between interest received on interest-earning assets (primarily loans and investment securities) and interest paid on interest-bearing liabilities (primarily deposits and borrowed funds). Net interest income depends on the volume and rate earned on interest-earning assets and the volume and interest rate paid on interest-bearing liabilities. Net interest income before the provision for loan losses increased $1.4 million, or 6.76% to $22.1 million for 2003 compared to $20.7 million for 2002. The increase was primarily due to the increase in average loans of $56.1 million and average investment securities available for sale of $4.1 million offset by a decrease in average other interest-earning assets (primarily federal funds sold) of $10.2 million and a 58-basis point decrease in the yield on average interest earning assets to 5.80% for 2003 from 6.38% for 2002. The decrease in the yield on average interest earning assets was primarily the result of yield decreases in average loans and average investment securities of 68-basis points and 89-basis point, respectively. Average interest-bearing liabilities increased $40.2 million in fiscal 2003 offset by a 58-basis point decrease in the average cost of funds. Net interest income increased $2.5 million, or 13.7% to $20.7 million for 2002 compared to $18.2 million for 2001. The increase was primarily due to the increase in average loans of $33.5 million and average other interest-earning assets (primarily federal funds sold) of $1.2 million offset by a decrease in average investment securities available for sale of $3.8 million and a 73-basis point decrease in the yield on average interest-earning assets to 6.38% for 2002 from 7.11% for 2001. The decrease in the yield on average interest earning assets was primarily the result of yield decreases in average loans and average investment securities of 69-basis points and 86-basis points, respectively. The decrease in the average yields reflects the changes in the interest rate environment including the Federal Reserve easing of interest rates during fiscal 2002. Average interest-bearing liabilities increased $29.5 million in fiscal 2002 offset by a 126-basis point decrease in the average cost of funds. As a result, the interest rate spread for fiscal 2002 increased 53-basis points to 3.4% from 2.9% in fiscal 2001. The following table sets forth certain information relating to the Company's average balance sheet and, reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from daily balances. 3 Year Ended December 31, ----------------------------------------------------------------------------------- 2003 2002 ----------------------------------------------------------------------------------- Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost --------- -------- ---------- -------- -------- ---------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $393,743 $26,097 6.63% $337,600 $24,687 7.31% Investment securities available for sale (2) 177,557 7,244 4.08% 173,472 8,615 4.97% Other interest-earning assets (5) 4,926 57 1.16% 15,086 258 1.71% -------- ------- ------ -------- ------- ------ Total interest earning assets $576,226 $33,398 5.80% $526,158 $33,560 6.38% Non-interest earning assets (8) 31,441 30,550 -------- -------- Total assets $607,667 $556,708 ======== ======== Interest-bearing liabilities: Money market accounts 61,138 645 1.05% 60,735 1,234 2.03% Certificates of Deposit 221,186 7,303 3.30% 208,789 7,935 3.80% Other liabilities (7) 185,117 3,367 1.82% 157,629 3,660 2.32% -------- ------- ------ -------- ------- ------ Total interest-bearing liabilities $467,441 $11,315 2.42% $427,153 $12,829 3.00% Non-interest-bearing liabilities (8) 81,918 76,818 -------- -------- Total liabilities $549,359 $503,971 Retained Earnings (6) 58,308 52,737 -------- -------- Total liabilities and stockholders' equity $607,667 $556,708 ======== ======== Net interest income $22,083 $20,731 ======= ============ Interest rate spread (3) 3.38% 3.38% ====== ====== Net yield on interest-earning assets (4) 3.83% 3.94% ====== ====== Ratio of average interest-earning 123.27% 123.18% assets to average interest-bearing liabilities ====== ====== ------------------------------------------- 2001 ------------------------------------------- Average Average Balance Interest Yield/Cost ------- -------- ---------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $304,080 $24,320 8.00% Investment securities available for sale (2) 177,263 10,337 5.83% Other interest-earning assets (5) 13,850 527 3.81% -------- ------- ------ Total interest earning assets $495,193 $35,184 7.11% Non-interest earning assets (8) 20,404 -------- Total assets $515,597 ======== Interest-bearing liabilities: Money market accounts 55,020 1,751 3.18% Certificates of Deposit 205,242 11,286 5.50% Other liabilities (7) 137,481 3,921 2.85% -------- ------- ------ Total interest-bearing liabilities $397,743 $16,958 4.26% Non-interest-bearing liabilities (8) 69,904 -------- Total liabilities $467,647 Retained Earnings (6) 47,950 -------- Total liabilities and stockholders' equity $515,597 ======== Net interest income $18,226 ======= Interest rate spread (3) 2.85% ====== Net yield on interest-earning assets (4) 3.68% ====== Ratio of average interest-earning 124.50% assets to average interest-bearing liabilities ====== <FN> (1) Average balances include non-accrual loans, and are net of deferred loan fees. (2) Includes interest-bearing deposits in other financial institutions and FHLB stock. (3) Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (4) Net yield on interest-earning assets represents net interest income as a percentage of average interest earning assets. (5) Includes Federal funds sold. (6) Includes capital stock, surplus and unrealized holding gains on SFAS 115 AFS securities. (7) Includes FHLB advances and Federal funds purchased. (8) Includes net deferred income taxes in excess of deferred tax benefits on AFS securities (SFAS 115), stock options (SFAS 123/148) and deferred fees (SFAS109). </FN> 4 The following table shows the effect of changes in volumes and rates on interest income and interest expense. The changes in interest income and interest expense attributable to changes in both volume and rate have been allocated to the changes due to rate. Tax-exempt income was not recalculated on a tax equivalent basis due to the immateriality of the change to the table resulting from a recalculation. Year Ended December 31, Year Ended December 31, 2003 vs. 2002 2002 vs. 2001 ----------------------------- ------------------------------ Increase (Decrease) Increase (Decrease) Due to Due to ----------------------------- ------------------------------ Volume Rate Net Volume Rate Net ------ ------- ------- ------ ------ -------- (In Thousands) Interest income: Loans receivable $ 4,105 $(2,696) $ 1,409 $ 2,681 $(2,314) $ 367 Investment securities available for sale 203 (1,574) (1,371) (221) (1,501) (1,722) Other interest earning assets (174) (27) (201) 47 (316) (269) ------- ------- ------- ------- ------- ------- Total interest-earning assets 4,134 (4,297) (163) 2,507 (4,131) (1,624) ------- ------- ------- ------- ------- ------- Interest expense: Money market accounts 9 (597) (588) 182 (699) (517) Certificates of deposit 471 (1,103) (632) 195 (3,546) (3,351) Other liabilities 642 (936) (294) 574 (836) (262) ------- ------- ------- ------- ------- ------- Total interest-bearing liabilities 1,122 (2,636) (1,514) 951 (5,081) (4,130) ------- ------- ------- ------- ------- ------- Net change in net interest income $ 3,012 $(1,661) $ 1,351 $ 1,556 $ 950 $ 2,506 ======= ======= ======= ======= ======= ======= PROVISION FOR LOAN LOSSES: The Company recorded a provision for loan losses of $600,000, $1.1 million and $500,000 for 2003, 2002, and 2001, respectively. The table below sets forth information with respect to the Company's allowance for loan losses for the years indicated: 5 At December 31, ------------------------------------- 2003 2002 2001 --------- --------- --------- (Dollars in Thousands) Total loans outstanding $ 419,571 $ 362,744 $ 317,246 ========= ========= ========= Average loans outstanding $ 393,743 $ 337,600 $ 304,080 ========= ========= ========= Allowance balances (at beginning of period) $ 2,873 $ 2,114 $ 1,919 Provision (credit): Mortgage 430 930 200 Installment 38 25 100 Commercial 132 145 200 Home equity lines of credit -- -- -- PHEAA -- -- -- Municipal -- -- -- Credit cards -- -- -- Other -- -- -- Net (Charge-offs) recoveries: Mortgage (11) (219) (203) Installment (64) (59) (90) Commercial (113) (63) (14) Home equity lines of credit -- -- -- PHEAA -- -- -- Municipal -- -- -- Credit cards -- -- 2 Other -- -- -- --------- --------- --------- Allowance balance (at end of period) $ 3,285 $ 2,873 $ 2,114 ========= ========= ========= Allowance for loan losses as a percent of 0.78% 0.79% 0.67% total loans outstanding Net loans charged off as a percent of average loans outstanding 0.05% 0.10% 0.10% The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management's best estimate of the losses inherent in the portfolio, based on a monthly review by management of the following factors: o Historical experience o Volume o Type of lending conducted by the Bank o Industry standards o The level and status of past due and non-performing loans 6 o The general economic conditions in the Bank's lending area; and o Other factors affecting the collectability of the loans in the portfolio Large groups of homogeneous loans, such as residential real estate, small commercial real estate loans and home equity and consumer loans are evaluated in the aggregate using historical loss factors and other data. The amount of loss reserve is calculated using historical loss rates, net of recoveries on a five year rolling weighted average, adjusted for environmental, and other qualitative factors such as industry, geographical, economic and political factors that can effect loss rates or loss measurements. Large balance and/or more complex loans such as multi-family and commercial real estate loans may be evaluated on an individual basis and are also evaluated in the aggregate to determine adequate reserves. As specific loans are determined to be impaired, specific reserves are assigned based upon collateral value, market value, if determinable, or the present value of the estimated future cash flows of the loan. The allowance is increased by a provision for loan loss which is charged to expense, and reduced by charge-offs, net of recoveries. Loans are placed on non-accrual status when they are 90 days past due, unless they are adequately collateralized and in the process of collection. The allowance for loan losses is maintained at a level that represents management's best estimate of losses in the portfolio at the balance sheet date. However, there can be no assurance that the allowance for losses will be adequate to cover losses which may be realized in the future and that additional provisions for losses will not be required. Other Income: Total other income increased approximately $574,000, or 10.8% to $5.9 million for the year ended December 31, 2003 from $5.3 million for the year ended December 31, 2002. Such increase was mainly the result of net security gains of $466,000. Other income increased $316,000 primarily due to a gain from the sale of other real estate of $351,000. Total other income increased approximately $1.3 million, or 32.5% to $5.3 million for the year ended December 31, 2002 from $4.0 million for the year ended December 31, 2001. Such increase was the result of $516,000 in additional service fees primarily generated from overdraft fees, $499,000 in increased cash surrender value from bank owned life insurance and other life insurance policies, and $456,000 in other income. The increase in other income resulted primarily from an additional $142,000 in gains generated from loan sales, net gains from the sale of real estate of $104,000 and $186,000 from TA of Irwin, L.P., a partnership formed by the Company in October 2000 to provide title insurance to the general public. Such increases in fiscal 2002 were offset by a decrease of $258,000 in net investment security gains compared to fiscal 2001. Other Expenses: Total other expense increased $1.5 million, or 11.7%, to $14.3 million for 2003 from $12.8 million for 2002. Of this increase, approximately $355,000 is attributed to increased salaries, which reached $5.7 million for 2003 from $5.3 million for 2002. Salary increases were due to additions to staff, annual merit increases, and commissions paid to commission based lenders. Pension and other employee benefits increased $324,000 to $1.6 million for 2003 primarily due to increases in pension costs and health insurance premiums of $96,000 and $129,000, respectively. Occupancy expense increased $221,000 to $1.5 million, for 2003 from $1.3 million for 2002 primarily due to an increase of $153,000 in depreciation expense related to the construction of a new branch and equipment purchases for technological improvements. Rental expense increased $42,000 mainly due to the relocation of the Company's item processing department. Other expenses increased $396,000 to $3.8 million for 2003 from $3.4 million for 2002. This increase was comprised of numerous items related to the normal cost of doing business, non-material in nature. Total other expense increased $1.5 million, or 13.3%, to $12.8 million for 2002 from $11.3 million for 2001. Of this increase, approximately $939,000 was the result of increased salaries, which reached $5.3 million for 2002 from $4.4 million for 2001. The increase in salaries was a combination of additional staff and annual merit increases. Pension and other employee benefits increased $238,000 to $1.3 million for 2002 primarily due to a $117,000 increase in health insurance premiums. Occupancy expense increased $119,000 to $1.3 million, for 2002 from $1.2 million for 2001 predominately due to increased 7 depreciation and real estate tax expense of $77,000 and $17,000, respectively. Other expenses increased $157,000 to $3.4 million for 2002 from $3.2 million for 2001. This increase was mainly due to increased postage, check collection costs, and losses as a result of bad checks and ATM fraud of $29,000, $45,000, and $64,000, respectively. All of these increases were non-material in nature and are due to the normal cost of doing business. Income Taxes: Income tax expense for 2003 was $3.4 million compared to $3.2 million in 2002 and $3.0 million in 2001. The increase in income tax expense was principally attributable to increased earnings in each period. The Company's effective tax rates were 26.2%, 26.2%, and 28.5% for 2003, 2002, and 2001, respectively. The Company's effective tax rate has been below the statutory rate of 34% primarily due to interest earned on obligations of states and political subdivisions, which is exempt from federal taxation. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds include savings, deposits, loan repayments and prepayments, cash from operations and borrowings from the Federal Home Loan Bank. The Company uses its capital resources principally to fund loan originations and purchases, to repay maturing borrowings, to purchase investments, and for short-term liquidity needs. The Company expects to be able to fund or refinance, on a timely basis, its commitments and long-term liabilities. As of December 31, 2003, the Company had commitments to extend credit of $77.0 million. The Company's liquid assets consist of cash and cash equivalents, which include short-term investments. The levels of these assets are dependent on the Company's operating, financing, and investment activities during any given period. At December 31, 2003, cash and cash equivalents totaled $15.8 million. Net cash from operating activities for 2003 totaled $10.1 million, as compared to net cash from operating activities of $8.7 million for 2002. The increase in 2003 was primarily the result of a $709,000 increase in net income offset by a decrease of $921,000 in other assets and $500,000 in provision for loan losses. Net cash from operating activities for 2002 totaled $8.7 million, as compared to net cash used by operating activities of $377,000 for 2001. The decrease in cash due to changes in other assets in 2001 was primarily the result of a $10.0 million purchase of bank owned life insurance. See Note 6 to the consolidated financial statements. Net cash used by investing activities for 2003 totaled $47.9 million, as compared to cash used of $69.1 million for 2002 and $14.7 million for 2001. The decrease of $21.2 million for 2003 was primarily due to a decrease of $48.4 million in securities purchased. The increase of $54.4 million for 2002 was primarily due to an increase in purchases of securities available for sale of $25.4 million, an increase in net loans made to customers of $22.5 million, and a decrease in the proceeds from maturities of securities available for sale of $26.2 million, offset by proceeds from sales of securities available for sale of $23.6 million. Net cash from financing activities for the year ended December 31, 2003 totaled $38.5 million, as compared to net cash from financing activities of $50.3 million for 2002 and $18.5 million for 2001. The $11.8 million decrease in cash from financing activities in 2003 was primarily due to a decrease in the net increase in deposits of $21.9 million. The $31.8 million increase in cash from financing activities for 2002 was primarily the result of a $33.0 million increase in deposits. Liquidity may be adversely affected by unexpected deposit outflows, excessive interest rates paid by competitors, and similar matters. Management monitors projected liquidity needs and determines the level desirable, based in part on the Company's commitment to make loans and management's assessment of the Company's ability to generate funds. The Company is also subject to federal regulations that impose certain minimum capital requirements. The table below sets forth certain information regarding the Company's contractual obligations. See Note 4 and Note 8 to the consolidated financial statements. 8 Payments due by period --------------------------------------------------------------------------- Less than 1-3 3-5 More than Contractual Obligations Total 1 year years years 5 years - --------------------------------------------------------------------------------------------------------------------- Long-Term Debt Obligations 53,308 10,776 1,618 12,914 28,000 Operating Lease Obligations 888 213 254 115 306 MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its lending, investment and deposit taking activities. The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact the Company's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. To that end, management actively monitors and manages its interest rate risk exposure. The principle objective of the Company's interest rate risk management is to evaluate the interest rate risk inherent in certain balance sheet accounts, determine the appropriate level of risk given the Company's business strategy, operating environment, capital and liquidity requirements, performance objectives, and manage the risk consistent with the Board of Directors' approved guidelines. Through such management, the Company seeks to minimize the vulnerability of its operations to changes in interest rates. The Company's Asset/Liability Committee is comprised of the Company's senior management under the direction of the Board of Directors, with senior management responsible for reviewing with the Board of Directors its activities and strategies, the effect of those strategies on the Company's net interest margin, the market value of the portfolio and the effect that changes in interest rates will have on the Company's portfolio and the Company's exposure limits. The Company utilizes the following strategies to manage interest rate risk: o When market conditions permit, to originate and hold in its portfolio adjustable rate loans; o Sell fixed rate mortgage loans that conform to Federal National Mortgage Association guidelines when sales can be achieved on terms favorable to the Company; o Lengthen the maturities of its liabilities when deemed cost effective through the utilization of Federal Home Loan Bank advances; o Purchase mortgage-backed securities for the available for sale securities portfolio with cash flows that can be reinvested in higher earning instruments when interest rates rise; and o Generally, maintain securities in the available for sale portfolio that are short term to offset the risk of long term fixed rate mortgage loans in a rising rate environment. The following table shows the Company's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity or repricing maturity, and the instruments' fair values at December 31, 2003. Market risk sensitive instruments are generally defined as those instruments that can be adversely impacted by changes in market interest rates. The Company currently does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments, but may do so in the future to mitigate interest rate risk. Expected maturities are contractual maturities adjusted for prepayments of principle. The Company uses certain assumptions to estimate fair values and expected maturities. For assets, expected maturities are based upon contractual maturity, call dates and projected repayments of principle. For interest earning assets, no prepayments are assumed. Interest bearing liabilities, such as negotiable order of withdrawal ("NOW") accounts, money market accounts, and similar interest bearing demand accounts are subject to immediate withdrawal or repricing and are therefore presented in the earliest period in the table. 9 Expected Maturity/Principal Repayment at December 31, Total Book Fair 2004 2005 2006 2007 2008 Thereafter Value Value ------- ------- ------- ------- ------- ---------- ------- ------- (Dollars in thousands) Interest-earning assets - ----------------------- Mortgage loans 10,442 10,028 8,958 7,989 6,463 201,043 244,923 248,442 Home equity loans, second mortgage loans, student loans, other loans 35,011 11,594 10,524 9,555 8,033 34,446 109,163 109,597 Commercial loans, municipal loans 12,538 5,524 4,298 2,724 2,208 38,567 65,859 66,247 Investment securities available for sale 2,485 1,498 100 5,751 3,368 153,139 166,341 167,907 Interest-bearing - ----------------- liabilities - ----------------- NOW and other transaction accounts 19,295 - - - - - 19,295 19,295 Money market and other savings accounts 153,100 - - - - - 153,100 153,100 Certificates of deposits 120,642 62,326 9,219 14,427 20,453 11,168 238,235 241,804 Federal Home Loan Bank of Pittsburgh advances 10,776 798 820 2,843 10,071 28,000 53,308 61,145 10 [Letterhead of Edwards Sauer & Owens] INDEPENDENT AUDITORS' REPORT To the Board of Directors IBT Bancorp, Inc. Irwin, Pennsylvania We have audited the accompanying consolidated balance sheets of IBT Bancorp, Inc. (the Bancorp), and subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Bancorp's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IBT Bancorp, Inc. and subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ Edwards Sauer & Owens Pittsburgh, Pennsylvania January 26, 2004 CONSOLIDATED BALANCE SHEETS IBT BANCORP, INC. AND SUBSIDIARY December 31, 2003 2002 ------------- ------------- ASSETS Cash and due from banks $ 15,391,714 $ 12,677,160 Interest-bearing deposits in banks 436,981 760,118 Federal funds sold -- 1,629,000 Certificate of deposit 100,000 100,000 Securities available for sale 167,907,113 183,564,960 Federal Home Loan Bank stock, at cost 4,540,500 3,152,600 Loans, net of allowance for loan losses of $3,284,830 in 2003 and $2,873,067 in 2002 416,286,455 359,871,514 Premises and equipment, net 6,468,749 4,759,015 Other assets 18,398,092 17,520,354 ------------- ------------- TOTAL ASSETS $ 629,529,604 $ 584,034,721 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Non-interest bearing $ 81,053,392 $ 74,339,035 Interest-bearing 411,104,137 393,918,292 ------------- ------------- Total deposits 492,157,529 468,257,327 Federal funds purchased 7,900,000 -- Repurchase agreements 12,610,877 14,525,836 Accrued interest and other liabilities 3,947,390 5,100,380 FHLB advances 53,307,767 40,000,000 ------------- ------------- Total liabilities 569,923,563 527,883,543 STOCKHOLDERS' EQUITY Capital stock, par value $1.25, 50,000,000 shares authorized, 3,023,799 shares issued, 2,977,655 shares outstanding at December 31, 2003 and 2002 3,779,749 3,779,749 Surplus 1,684,258 2,073,102 Retained earnings 54,451,662 48,974,137 Accumulated other comprehensive income 1,033,638 2,667,456 ------------- ------------- 60,949,307 57,494,444 Less: Treasury stock, at cost (1,343,266) (1,343,266) ------------- ------------- Total stockholders' equity 59,606,041 56,151,178 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 629,529,604 $ 584,034,721 ============= ============= The accompanying notes an integral part of these consolidated financial statements. 2 CONSOLIDATED STATEMENTS OF INCOME IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ INTEREST INCOME Loans, including fees $ 26,096,559 $ 24,687,048 $ 24,320,407 Investment securities 7,244,174 8,614,876 10,337,309 Federal funds sold 57,110 258,302 527,021 ------------ ------------ ------------ Total interest income 33,397,843 33,560,226 35,184,737 INTEREST EXPENSE Deposits 8,666,938 10,537,258 14,773,560 Federal funds purchased 25,933 193 -- FHLB advances 2,487,363 2,113,678 1,833,212 Repurchase agreements 134,546 177,464 351,473 ------------ ------------ ------------ Total interest expense 11,314,780 12,828,593 16,958,245 ------------ ------------ ------------ NET INTEREST INCOME 22,083,063 20,731,633 18,226,492 PROVISION FOR LOAN LOSSES 600,000 1,100,000 500,000 ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 21,483,063 19,631,633 17,726,492 OTHER INCOME (LOSSES) Service fees 2,370,065 2,370,568 1,854,595 Investment security gains 533,155 158,670 452,890 Investment security losses (67,636) (24,925) (60,792) Increase in cash surrender value 513,066 584,847 85,914 of life insurance Debit card fees 614,475 615,517 520,393 Other income 1,927,933 1,612,378 1,155,822 ------------ ------------ ------------ Total other income 5,891,058 5,317,055 4,008,822 OTHER EXPENSES Salaries 5,653,310 5,297,750 4,359,468 Pension and other employee benefits 1,642,651 1,318,944 1,081,027 Occupancy expense 1,549,532 1,329,170 1,209,779 Data processing expense 843,074 729,548 750,896 Advertising expense 412,702 406,898 340,513 Pennsylvania shares tax 446,041 391,557 341,823 Other expenses 3,752,672 3,357,211 3,200,650 ------------ ------------ ------------ Total other expenses 14,299,982 12,831,078 11,284,156 ------------ ------------ ------------ INCOME BEFORE INCOME TAXES 13,074,139 12,117,610 10,451,158 PROVISION FOR INCOME TAXES 3,427,893 3,180,311 2,985,824 ------------ ------------ ------------ NET INCOME $ 9,646,246 $ 8,937,299 $ 7,465,334 ============ ============ ============ BASIC EARNINGS PER SHARE $ 3.24 $ 3.00 $ 2.49 ============ ============ ============ DILUTED EARNINGS PER SHARE $ 3.19 $ 2.99 $ 2.49 ============ ============ ============ The accompanying notes an integral part of these consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, 2003, 2002 and 2001 ACCUMULATED OTHER CAPITAL RETAINED COMPREHENSIVE TREASURY STOCK SURPLUS EARNINGS INCOME STOCK TOTAL ---------- ---------- ----------- ------------ ------------ ------------ BALANCE AT DECEMBER 31, 2000 $3,779,749 $2,073,102 $39,261,880 $ 189,326 $ (689,476) $44,614,581 Comprehensive Income Net income 7,465,334 7,465,334 Other comprehensive income, net of tax: Change in net unrealized holding gains on securities available for sale, net of deferred income tax of $747,292 1,450,626 1,450,626 Reclassification adjustment, net of deferred income tax benefit of ($153,144) (297,280) (297,280) ------------ 1,153,346 ------------ Total Comprehensive Income 8,618,680 Cash dividends ($1.04) (3,113,278) (3,113,278) Purchase of Treasury Stock (395,277) (395,277) ---------- ---------- ----------- ---------- ----------- ----------- BALANCE AT DECEMBER 31, 2001 $3,779,749 $2,073,102 $43,613,936 $1,342,672 $(1,084,753) $49,724,706 ========== ========== =========== ========== =========== =========== The accompanying notes an integral part of these consolidated financial statements. 4 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, 2003, 2002 and 2001 ACCUMULATED OTHER CAPITAL RETAINED COMPREHENSIVE TREASURY STOCK SURPLUS EARNINGS INCOME STOCK TOTAL ---------- ---------- ----------- ------------ ------------ ------------ BALANCE AT DECEMBER 31, 2001 $3,779,749 $2,073,102 $43,613,936 $1,342,672 $(1,084,753) $49,724,706 Comprehensive Income Net income 8,937,299 8,937,299 Other comprehensive income, net of tax: Change in net unrealized holding gains on securities available for sale, net of deferred income tax of $718,036 1,393,742 1,393,742 Reclassification adjustment, net of deferred income tax benefit of ($34,532) (68,958) (68,958) ----------- 1,324,784 ----------- Total Comprehensive Income 10,262,083 Cash dividends ($1.20) (3,577,098) (3,577,098) Purchase of Treasury Stock (258,513) (258,513) ---------- ---------- ----------- ---------- ----------- ----------- BALANCE AT DECEMBER 31, 2002 $3,779,749 $2,073,102 $48,947,137 $2,667,456 $(1,343,266) $56,151,178 ========== ========== =========== ========== =========== =========== The accompanying notes an integral part of these consolidated financial statements. 5 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, 2003, 2002 and 2001 ACCUMULATED OTHER CAPITAL RETAINED COMPREHENSIVE TREASURY STOCK SURPLUS EARNINGS INCOME STOCK TOTAL ---------- ---------- ----------- ------------ ------------ ------------ BALANCE AT DECEMBER 31, 2002 $3,779,749 $2,073,102 $48,974,137 $2,667,456 $(1,343,266) $56,151,178 Comprehensive Income Net income 9,646,246 9,646,246 Other comprehensive income, net of tax: Change in net unrealized holding gains on securities available for sale, net of deferred income tax of ($739,040) (1,434,608) (1,434,608) Reclassification adjustment, net of deferred income tax benefit of ($102,624) (199,210) (199,210) ----------- (1,633,818) ----------- Total Comprehensive Income 8,012,428 Cash dividends ($1.40) (4,168,721) (4,168,721) Stock options granted 102,154 102,154 Exercise of stock options (490,998) (490,998) Purchase of Treasury Stock - - ---------- ---------- ----------- ---------- ----------- ----------- BALANCE AT DECEMBER 31, 2003 $3,779,749 $1,684,258 $54,451,662 $1,033,638 $(1,343,266) $59,606,041 ========== ========== =========== ========== =========== =========== The accompanying notes an integral part of these consolidated financial statements. 6 CONSOLIDATED STATEMENTS OF CASH FLOWS IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, ----------------------------------------------- 2003 2002 2001 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 9,646,246 $ 8,937,299 $ 7,465,334 Adjustments to reconcile net cash from operating activities: Depreciation 832,770 684,731 607,993 Increase in cash surrender value of insurance (513,066) (584,847) (85,914) Net amortization/accretion of premiums and discounts 1,129,046 429,379 102,482 Net investment security gains (465,519) (133,745) (392,098) Provision for loan losses 600,000 1,100,000 500,000 Stock options granted 102,154 -- -- Increase (decrease) in cash due to changes in assets and liabilities: Other assets (921,069) (540,772) (8,527,117) Accrued interest and other liabilities (311,325) (1,232,409) (48,024) ------------- ------------- ------------- Net Cash From (Used By) Operating Activities 10,099,237 8,659,636 (377,344) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of certificates of deposit (100,000) -- (2,606,400) Proceeds from maturity of certificates of deposit 100,000 -- 5,206,400 Proceeds from sales of securities available for sale 34,800,655 31,725,398 8,128,240 Proceeds from maturities of securities available for sale 54,553,305 72,493,575 98,681,479 Purchase of securities available for sale (76,835,123) (125,205,572) (99,729,469) Net loans made to customers (56,458,544) (46,265,045) (23,829,098) Purchases of premises and equipment (2,542,504) (788,236) (363,726) Proceeds from Federal Home Loan Bank stock 1,772,400 -- -- Purchase of Federal Home Loan Bank stock (3,160,300) (1,050,800) (137,500) ------------- ------------- ------------- Net Cash Used By Investing Activities (47,870,111) (69,090,680) (14,650,074) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 23,900,202 45,795,234 12,823,631 Net (decrease) increase in securities sold under agreements to repurchase (1,914,959) 3,318,764 2,184,882 Net increase in federal funds purchased 7,900,000 -- -- Dividends (4,168,721) (3,577,098) (3,113,278) Proceeds from FHLB advances 16,000,000 7,000,000 9,000,000 Repayment of FHLB advances (2,692,233) (2,000,000) (2,000,000) Purchase of treasury stock -- (258,513) (395,277) Exercised stock options (490,998) -- -- ------------- ------------- ------------- Net Cash From Financing Activities 38,533,291 50,278,387 18,499,958 ------------- ------------- ------------- Net Change in Cash and Cash Equivalents 762,417 (10,152,657) 3,472,540 Cash and Cash Equivalents at Beginning of Year 15,066,278 25,218,935 21,746,395 ------------- ------------- ------------- Cash and Cash Equivalents at End of Year $ 15,828,695 $ 15,066,278 $ 25,218,935 ============= ============= ============= The accompanying notes an integral part of these consolidated financial statements. 7 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, ---------------------------------------- 2003 2002 2001 ----------- ----------- ----------- SUPPLEMENTAL DISCLOSURES Cash payments for: Interest $11,446,828 $13,225,782 $18,089,680 Income taxes $ 3,671,847 $ 3,543,379 $ 3,003,600 NON CASH TRANSACTIONS Recorded unrealized gains on securities available for sale $ 1,566,116 $ 4,041,600 $ 2,034,303 at December 31 Deferred income taxes on recorded unrealized gains on securities available for sale at December 31 $ 532,479 $ 1,374,144 $ 691,631 Loans transferred to foreclosed real estate during the year $ 301,284 $ 857,681 $ 432,376 Recorded nonmonetary gain on securities available for sale at December 31 $ 11,960 $ 1,986 $ 81,092 The accompanying notes an integral part of these consolidated financial statements. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS: IBT Bancorp, Inc. (the Bancorp), is a bank holding company whose principal activity is the ownership and management of its wholly owned subsidiary, Irwin Bank and Trust Company (the Bank). The Bank is a full service state chartered commercial banking institution and provides a variety of financial services to individuals and corporate customers through its six branch offices, a loan center, a trust division, five supermarket branches and main office located in Southwestern Pennsylvania. The Bank's primary deposit products are non-interest and interest-bearing checking accounts, savings accounts and certificates of deposit. Its primary lending products are single-family and multi-family residential loans, installment loans and commercial loans. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Bancorp and the Bank. All significant intercompany accounts have been eliminated in the consolidation. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and foreclosed real estate, management obtains independent appraisals for significant properties. INVESTMENT SECURITIES: All investments in debt and equity securities are to be classified into three categories. Securities which management has positive intent and ability to hold until maturity are classified as held to maturity. Securities held to maturity are stated at cost, adjusted for amortization of premium and accretion of discount computed on a level yield basis. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities. All other securities are classified as available for sale securities. Unrealized holding gains and losses for trading securities are included in earnings. Unrealized holding gains and losses for available for sale securities are excluded from earnings and reported net of income taxes as a separate component of stockholders' equity until realized. At this time, management has no intention of establishing a trading securities classification. Interest and dividends on securities are reported as interest income. Gains and losses realized on sales of securities represent the differences between net proceeds and carrying values determined by the specific identification method. ADVERTISING COSTS: Advertising costs are expensed as incurred. Advertising expense totaled $412,702 for 2003, $406,898 for 2002 and $340,513 for 2001. LOANS AND ALLOWANCE FOR LOAN LOSSES: Loans are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status. The allowance for loan losses is maintained at a level which, in management's judgement, is adequate to absorb potential losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Large groups of smaller balance homogeneous loans are valued collectively for impairment. The amount of loss reserve is calculated using historical loss rates, net of recoveries, adjusted for environmental, and other qualitative factors such as industry, geographical, economic and politcal factors that can affect loss rates or loss measurements. Allowances for losses on specifically identified loans that are determined to be impaired are calculated based upon collateral value, market value, if determinable, or the present value of the estimated future cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Loans are placed on nonaccrual status when they are 90 days past due, unless they are adequately collateralized and in the process of collection. PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less accumulated depreciation computed on both the straight-line and accelerated methods over the estimated useful lives of the assets. Costs for maintenance and repairs are expensed currently. Costs of major additions or improvements are capitalized. OTHER REAL ESTATE OWNED (OREO): Real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the lower of the Bank's carrying amount or fair value less estimated selling cost at the date of foreclosure. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, these assets are carried at the lower of their new cost basis or fair value less cost to sell. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. Valuations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its cost or fair value less cost to sell. INCOME TAXES: The Bancorp uses an asset and liability approach to financial accounting and reporting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. The Bancorp files consolidated Federal income tax returns with its subsidiary. EARNINGS PER SHARE: Earnings per share are calculated on the basis of the weighted average number of shares outstanding. The weighted average shares outstanding was 2,977,655, 2,980,282 and 2,993,693 for the years ended December 31, 2003, 2002 and 2001, respectively. 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CASH EQUIVALENTS: For purposes of the Statements of Cash Flows, the Bancorp considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The Bancorp considers all cash and amounts due from depository institutions, interest-bearing deposits in other banks, except certificates of deposit with maturities of more than three months, and federal funds sold to be cash equivalents for purposes of the statements of cash flows. Reclassification of Prior Year's Statements: Certain previously reported items have been reclassified to conform to the current year's classifications. The reclassifications have no effect on total assets, total liabilities and stockholders' equity, or net income. NOTE 2 -- INVESTMENT SECURITIES Investment securities available for sale consist of the following: DECEMBER 31, 2003 --------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------- ------------- ------------- ------------- Obligations of U.S. Government Agencies $ 82,462,153 $ 824,768 $ (318,174) $ 82,968,747 Obligations of State and political sub-divisions 35,863,808 2,057,452 -- 37,921,260 Mortgage-backed securities 37,012,318 735,791 (91,604) 37,656,505 Other securities 710,005 29,553 -- 739,558 Equity securities 10,292,713 140,507 (1,812,177) 8,621,043 ------------- ------------- ------------- ------------- $ 166,340,997 $ 3,788,071 $ (2,221,955) $ 167,907,113 ============= ============= ============= ============= DECEMBER 31, 2002 --------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------- ------------- ------------- ------------- Obligations of U.S. Government Agencies $ 78,956,706 $ 1,547,905 $ (1,852) $ 80,502,759 Obligations of State and political sub-divisions 37,252,772 1,668,700 (31,994) 38,889,478 Mortgage-backed securities 52,300,534 1,803,446 -- 54,103,980 Other securities 706,015 44,506 -- 750,521 Equity securities 10,307,333 102,647 (1,091,758) 9,318,222 -------------- ------------- ------------- ------------- $ 179,523,360 $ 5,167,204 $ (1,125,604) $ 183,564,960 ============== ============= ============= ============= 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 2 -- INVESTMENT SECURITIES (CONTINUED) Gross realized gains and losses on calls and sales of available-for-sale securities were: YEARS ENDED DECEMBER 31, ------------------------------ 2003 2002 2001 -------- -------- -------- Gross realized gains: Obligations of U.S. Government Agencies $ 75,646 $ 42,922 $358,639 Obligations of state and political sub-divisions 26,250 760 5,348 Mortgage-backed securities 279,457 113,002 606 Equity securities 151,802 1,986 88,297 -------- -------- -------- $533,155 $158,670 $452,890 ======== ======== ======== Gross realized losses: Obligations of U.S. Government Agencies $ -- $ -- $ 2,616 Mortgage-backed securities 67,636 24,925 58,176 -------- -------- -------- $ 67,636 $ 24,925 $ 60,792 ======== ======== ======== The amortized cost and estimated market value of the investment securities available for sale at December 31, 2003, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Market Cost Value ------------ ------------ Due in one year or less $ 2,484,522 $ 2,550,439 Due after one year through five years 10,717,749 11,057,213 Due after five years through ten years 85,468,227 86,358,100 Due after ten years, includes equity securities 67,670,499 67,941,361 ------------ ------------ $166,340,997 $167,907,113 ============ ============ As a member of the Federal Home Loan Bank of Pittsburgh (FHLB), the Bank is required to maintain a minimum amount of FHLB stock. The minimum amount is calculated based on level of assets, residential real estate loans and outstanding FHLB advances. The Bank held $4,540,500 and $3,152,600 of FHLB stock at December 31, 2003 and 2002, respectively. 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 2 -- INVESTMENT SECURITIES (CONTINUED) Temporarily impaired investments consist of the following: DECEMBER 31, 2003 ------------------------------------------------------ -------------------------- LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL -------------------------- ------------------------ -------------------------- MARKET UNREALIZED MARKET UNREALIZED MARKET UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES ----------- ------------ ---------- ----------- ----------- ------------ Obligations of U.S. Government Agencies $21,875,290 $ (318,174) $ -- $ -- $21,875,290 $ (318,174) Mortgage-backed securities 13,826,675 (91,604) -- -- 13,826,675 (91,604) Equity securities -- -- 8,180,000 (1,812,177) 8,180,000 (1,812,177) ----------- ----------- ----------- ----------- ----------- ----------- Total temporarily impaired securities $35,701,965 $ (409,778) $ 8,180,000 $(1,812,177) $43,881,965 $(2,221,955) =========== =========== =========== =========== =========== =========== Investments are reviewed for declines in value on a quarterly basis. Common stocks currently have market values that are in excess of carrying values. All other investments are interest rate sensitive. These investments earn interest at fixed or adjustable rates. The adjustable rate instruments are generally linked to an index, such as the 3 month libor rate, plus or minus a variable. The value of these instruments fluctuates with interest rates, therefore the changes in value are deemed to be temporary. NOTE 3 -- LOANS Major classifications of loans are as follows: DECEMBER 31, -------------------------------- 2003 2002 ------------ ------------ Mortgage $244,923,121 $210,244,046 Home equity credit 21,963,205 15,832,462 Installment 78,326,060 59,321,023 Commercial 59,591,433 58,633,722 PHEAA 7,833,861 6,899,585 Municipal 6,267,974 11,190,265 Credit cards 37,890 32,445 Other 965,493 1,147,661 ------------ ------------ 419,909,037 363,301,209 Less: Allowance for loan losses 3,284,830 2,873,067 Deferred loan fees 337,752 556,628 ------------ ------------ $416,286,455 $359,871,514 ============ ============ 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 3 -- LOANS (CONTINUED) The aggregate amount of demand deposit accounts with overdrawn balances that were reclassified as loan balances at December 31, 2003 and 2002 amounted to $407,581 and $490,961, respectively and are included in other loans. The total recorded investment in impaired loans amounted to $567,564 at December 31, 2003 and $619,326 at December 31, 2002. The allowance for loan losses related to impaired loans amounted to $283,782 and $309,663 at December 31, 2003 and 2002, respectively. Changes in the allowance for loan losses were as follows: YEARS ENDED DECEMBER 31, ----------------------------------------- 2003 2002 2001 ----------- ----------- ------------ Balance, beginning of year $ 2,873,067 $ 2,113,806 $ 1,919,327 Provision charged to operations 600,000 1,100,000 500,000 Loans charged off (242,711) (440,728) (344,909) Recoveries 54,474 99,989 39,388 ----------- ----------- ------------ Balance, end of year $ 3,284,830 $ 2,873,067 $ 2,113,806 =========== =========== ============ NOTE 4 -- PREMISES AND EQUIPMENT Premises and equipment which are stated at cost are as follows: DECEMBER 31, ----------------------------- 2003 2002 ----------- ----------- Land $ 791,559 $ 450,466 Buildings and improvements 5,889,215 5,053,222 Furniture and equipment 7,298,169 5,932,751 ----------- ----------- 13,978,943 11,436,439 Less: Accumulated depreciation 7,510,194 6,677,424 ----------- ----------- $ 6,468,749 $ 4,759,015 =========== =========== During 2003, the Bank purchased land and built a new branch at a cost of approximately $1,050,000. Depreciation expense was $832,770 in 2003, $684,731 in 2002 and $607,993 in 2001. Eight of the Bank's commercial branch office buildings and/or land, the Bank's trust division office and an operations facility are leased by the Bank. These leases have initial terms of 1 to 20 years, and all contain renewal options for additional years. 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 4 -- PREMISES AND EQUIPMENT (CONTINUED) The following is a summary of the future minimum lease payments under these operating leases: For the year ended December 31, 2004 $ 212,953 2005 166,618 2006 87,532 2007 56,140 2008 59,116 2009 and thereafter 305,960 --------- $ 888,319 ========= Rental expense under these operating leases was $220,981, $183,005 and $178,437 for the years ended December 31, 2003, 2002 and 2001, respectively. NOTE 5 -- JOINT VENTURE The Bancorp has an 85% limited partnership interest in T.A. of Irwin, L.P. This partnership provides title insurance to the general public. The Bancorp uses the equity method to account for its investment in the partnership. As of December 31, 2003 and 2002, the partnership is reflected in the other assets section of the balance sheet at $21,309 and $82,140, respectively. NOTE 6 -- BANK OWNED LIFE INSURANCE In 2001, the Bank purchased single premium life insurance policies on officers of the Bank at a cost of $10,000,000. At December 31, 2003 and 2002, the cash surrender value of these policies was $11,068,593 and $10,584,859, respectively, and is included in the other assets section of the balance sheet. The increase in cash surrender value of these policies is recorded as other income. NOTE 7 -- DEPOSITS Time deposits maturing in years ending December 31, as of December 31, 2003 are summarized as follows: 2004 $ 120,642,479 2005 62,325,950 2006 9,219,357 2007 14,426,491 2008 20,452,960 2009 and thereafter 11,167,981 ------------- $ 238,235,218 ============= 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 7 -- DEPOSITS (CONTINUED) The Bank held related party deposits of approximately $2,750,000 and $3,600,000 at December 31, 2003 and 2002, respectively. The Bank held time deposits that exceeded $100,000 of $42,550,077 and $47,748,416 at December 31, 2003 and 2002, respectively. NOTE 8 -- REPURCHASE AGREEMENTS The Bank offers its corporate customers an investment product fashioned in the form of a repurchase agreement. Under the terms of the agreement, deposits in designated demand accounts of the customer are put into an investment vehicle which is used daily to purchase an interest in designated U.S. Government or Agencies' securities owned by the Bank. The Bank in turn agrees to repurchase these investments on a daily basis and pay the customer the daily interest earned on them. The amount of repurchase agreements was $12,610,877 and $14,525,836 at December 31, 2003 and 2002, respectively. NOTE 9 -- PLEDGED ASSETS At December 31, 2003 and 2002, U.S. Government Agency obligations carried at approximately $25,500,000 and $42,800,000 respectively, were pledged to qualify for fiduciary powers, to secure public monies and for other purposes required or permitted by law. At December 31, 2003 and 2002, the carrying amount of securities pledged to secure repurchase agreements was approximately $9,300,000 and $27,900,000 respectively. NOTE 10 -- FHLB ADVANCES At December 31, 2003 and 2002, the Bank had the following advances from the Federal Home Loan Bank (FHLB). 2003 2002 Interest Rate Maturity Date ------------ ------------ ------------------------ ----------------- $ 10,000,000 $ 10,000,000 5.86% Fixed w/Strike Rate July 22, 2004 2,000,000 2,000,000 3.67% Fixed September 5, 2007 3,307,767 - 2.79% Amortizing-Fixed January 28, 2008 5,000,000 5,000,000 5.63% Fixed to Float July 21, 2008 5,000,000 5,000,000 4.86% Fixed to Float October 23, 2008 4,000,000 4,000,000 5.18% Fixed w/Strike Rate February 23, 2011 4,000,000 4,000,000 4.98% Fixed to Float March 23, 2011 5,000,000 5,000,000 4.947% Fixed w/Strike Rate August 29, 2011 5,000,000 5,000,000 4.6% Fixed w/Strike Rate January 30, 2012 5,000,000 - 3.51% Fixed w/Strike Rate January 28, 2013 5,000,000 - 3.47% Fixed w/Strike Rate March 18, 2013 ------------ ------------ $ 53,307,767 $ 40,000,000 ============ ============ Interest only is payable until maturity on all FHLB advances except for the FHLB advance with a maturity date of January 28, 2008. Collateral for all advances includes all qualifying mortgages. 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 10 -- FHLB ADVANCES (CONTINUED) The following is a summary of the principal payments due on the FHLB advance of $4,000,000. The advance is payable in 60 monthly payments of $71,502 including interest at 2.79%, maturing Janaury 28, 2008. The outstanding balance at December 31, 2003 was $3,307,767; Principal payments due December 31: 2004 $ 775,607 2005 797,525 2006 820,063 2007 843,237 2008 71,335 ----------- $ 3,307,767 =========== On May 27, 2003, the Bank obtained a line of credit from the Federal Home Loan Bank in the amount of $20,000,000. The interest rate is variable and was 1.06% at December 31, 2003. The line of credit has an expiration date of May 25, 2004. There was no balance outstanding on the line of credit as of December 31, 2003. The Bank had maximum borrowing capacity with FHLB of approximately $282,428,000 and $261,519,000 at December 31, 2003 and 2002, respectively. NOTE 11 -- INCOME TAXES The provision for income taxes consists of: YEARS ENDED DECEMBER 31, --------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Currently payable $ 3,424,374 $ 3,527,269 $ 3,072,885 Deferred tax (benefit) 3,519 (346,958) (87,061) ----------- ----------- ----------- Total $ 3,427,893 $ 3,180,311 $ 2,985,824 =========== =========== =========== The significant components of temporary differences for 2003, 2002 and 2001 are as follows: Years Ended December 31, ------------------------------------------ 2003 2002 2001 --------- --------- --------- Provision for loan losses $(201,201) $(299,256) $ (86,543) Depreciation 143,959 32,400 (30,397) Pension 28,457 28,461 37,532 Deferred loan fees 74,418 (96,222) (32,695) Other (42,114) (12,341) 25,042 --------- --------- --------- Total $ 3,519 $(346,958) $ (87,061) ========= ========= ========= 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 11 -- INCOME TAXES (CONTINUED) A reconciliation of the federal statutory tax rate to the effective tax rate applicable to income before income taxes is as follows: Years Ended December 31, ------------------------------- % of Pretax Income ------------------------------- 2003 2002 2001 ------ ----- ----- Provision at statutory rate 34.0% 34.0% 34.0% Effect of tax free income (5.2) (5.4) (4.3) Other (2.6) (2.4) (1.2) ---- ---- ---- Effective tax rate 26.2% 26.2% 28.5% ==== ==== ==== The deferred tax assets and deferred tax liabilities recorded on the balance sheet as of December 31, 2003 and 2002 are as follows: 2003 2002 -------------------------------------------------- Deferred Tax Deferred Tax ------------------------ ------------------------ Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Provision for loan losses $1,035,069 $ -- $ 833,868 $ -- Depreciation -- 309,018 -- 165,059 Pension expense -- 150,957 -- 122,499 Other 269,437 -- 301,741 -- SFAS 115 -- 532,479 -- 1,374,144 ---------- ---------- ---------- ---------- $1,304,506 $ 992,454 $1,135,609 $1,661,702 ========== ========== ========== ========== NOTE 12 -- SHAREHOLDER RIGHTS PLAN On November 18, 2003, the Board of Directors of the Bancorp adopted a Shareholder Rights Plan. The Board declared a dividend distribution of one Right for each outstanding share of common stock to stockholders of record at the close of business on December 1, 2003. Each Right initially entitled the registered holder to purchase from the Bancorp common stock worth $410 on the date of exercise, for a purchase price of $205, subject to adjustment. Initially, the Rights will be attached to all common stock certificates representing shares then outstanding, and no separate Rights certificate will be distributed. The Rights will separate from the common stock and a distribution date will occur upon the earlier of (i) 10 business days following a public announcement that a person or group of affiliated or associated persons (an "Acquiring Person"), has acquired, or obtained the Right to acquire, beneficial ownership of 10% or more of the outstanding shares of common stock ("stock acquisition date") or (ii) 10 business days following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 10% or more of such outstanding shares of common stock. The Rights are not exercisable until the distribution date and will expire at the close of business on December 1, 2013, unless earlier redeemed or exchanged by the Bancorp. 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 12 -- SHAREHOLDER RIGHTS PLAN (CONTINUED) In the event that at any time following the Rights dividend declaration date, a person becomes the beneficial owner of 10% or more of the then-outstanding shares of common stock, each holder of a Right (other than Rights held by the party triggering the Rights and certain transferees which are voided) will thereafter have the right to receive, upon exercise, common stock (or, in certain circumstances, cash, property, or other securities of the Bancorp subject to certain limitations) having a value equal to two times the exercise price of the Right. However, Rights are not exercisable following the occurrence of the event set forth above until such time as the Rights are no longer redeemable by the Bancorp. NOTE 13 -- COMMITMENTS AND CONTINGENCIES In the normal course of business, there are various outstanding commitments and certain contingent liabilities which are not reflected in the accompanying financial statements. These commitments and contingent liabilities represent financial instruments with off-balance-sheet risk. The contract or notional amounts of those instruments were comprised of commitments to extend credit approximating $76,971,000 and $75,521,000 as of December 31, 2003 and 2002, respectively, and approximate fair value. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The same credit policies are used in making commitments and conditional obligations as for on-balance-sheet instruments. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the counterparty. The terms are typically for a one year period, with an annual renewal option subject to prior approval by management. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. These commitments are comprised primarily of available commercial and personal lines of credit. The exposure to loss under these commitments is limited by subjecting them to credit approval and monitoring procedures. Substantially all of the commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of the loan funding. Since many of the commitments are expected to expire without being drawn upon, the total contractual amounts do not necessarily represent future funding requirements. The Bancorp and Bank are involved in various legal actions from normal business activities. Management believes that the liability, if any, arising from such actions will not have a material adverse effect on the financial position of the Bancorp and Bank. NOTE 14 -- CONCENTRATION OF CREDIT The Bank primarily grants loans to customers in Western Pennsylvania, and maintains a diversified loan portfolio and the ability of its debtors to honor their contracts is not substantially dependent on any particular economic business sector. A substantial portion of the Bank's investments in municipal securities are obligations of state or political subdivisions located within Pennsylvania. As a whole, the Bank's loan and investment portfolios could be affected by the general economic conditions of Pennsylvania. In addition, at December 31, 2003 and 2002, a significant portion of the Bank's "due from banks" and "federal funds sold" is maintained with two large financial institutions located in Southwestern Pennsylvania. The Bank maintains a cash balance and federal funds sold at financial institutions that exceed the $100,000 amount that is insured by the FDIC. Amounts in excess of insured limits, per the institutions' records, were approximately $1,201,000 and $2,756,000 at December 31, 2003 and 2002, respectively. 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 15 -- EMPLOYEE BENEFIT PLANS DEFINED BENEFIT PLANS The Bank maintained one non-contributory defined benefit pension plan for its employees prior to 1995 (Plan #1). In 1995, various plan assumptions were changed which resulted in a reduction in benefits for older and long-standing employees. To compensate for this, a supplemental non-qualified plan was installed for those employees so affected (Plan #2). The Bank's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes for Plan #1. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Assets for the plans are primarily invested in U.S. Government obligations, corporate obligations and equity securities whose valuations are subject to fluctuations of the securities' market. The actuarial measurement period of October 15, through October 14, was used to determine the components of the net periodic pension cost and the financial disclosures for both plans. The actuarial measurement date of October 15 was used in determining the plans' liabilities and asset information. The following is a combined summary of the plans' components as of December 31, 2003, 2002 and 2001, even though the information has been compiled on the basis of the actuarial measurement period. 2003 2002 2001 ----------- ----------- ----------- Change in Projected Benefit Obligation: Benefit obligation at beginning of year $ 2,739,116 $ 2,253,576 $ 1,840,408 Service cost 210,043 179,307 151,433 Interest cost 184,275 162,431 141,430 Benefits paid (35,897) (161,570) (68,612) Other - net 233,819 305,372 188,917 ----------- ----------- ----------- Benefit obligation at end of year $ 3,331,356 $ 2,739,116 $ 2,253,576 =========== =========== =========== Change in Fair Value of Plan Assets: Plan assets at estimated fair value at beginning of year $ 2,201,346 $ 2,350,244 $ 2,215,142 Actual return on plan assets, net of expenses 305,653 (207,196) 4,280 Benefits paid (35,897) (161,570) (68,612) Employer contributions 264,969 219,868 199,434 ----------- ----------- ----------- Fair value of plan assets at end of year $ 2,736,071 $ 2,201,346 $ 2,350,244 =========== =========== =========== Funded status $ (595,285) $ (537,770) $ 96,668 Unrecognized net loss from actuarial experience 1,115,107 1,057,676 377,432 Unrecognized prior service cost (183,700) (201,962) (220,224) Unamortized net asset existing at date of adoption of SFAS No. 87 (27,075) (31,173) (35,271) ----------- ----------- ----------- Prepaid pension cost $ 309,047 $ 286,771 $ 218,605 =========== =========== =========== 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 15 -- EMPLOYEE BENEFIT PLANS (CONTINUED) DEFINED BENEFIT PLANS (CONTINUED) Net periodic pension cost included the following components: Years Ended December 31, ----------------------------------- 2003 2002 2001 --------- --------- --------- Service cost $ 210,043 $ 179,307 $ 151,433 Interest cost 184,275 162,431 141,430 Expected return on plan assets (167,906) (175,875) (165,293) Amortization of prior service cost (18,262) (18,262) (18,262) Amortization of transition asset (4,098) (4,098) (4,098) Recognized net actuarial loss 44,196 8,199 -- --------- --------- --------- Net periodic pension cost $ 248,248 $ 151,702 $ 105,210 ========= ========= ========= December 31, Amounts recognized in the consolidated -------------------------------------- balance sheets consist of: 2003 2002 2001 -------- -------- -------- Prepaid benefit cost $536,653 $500,022 $406,868 ======== ======== ======== In the months of December 2003, 2002 and 2001, the Bank contributed $293,275, $264,969 and $219,868 respectively, to the plans subsequent to the actuarial measurement dates of October 15, 2003, 2002 and 2001. Because these employer contributions were paid after the actuarial measurement period ended, the Bank's prepaid pension cost at December 31, 2003, 2002 and 2001 was $536,653, $500,022 and $406,868, respectively. The combined accumulated benefit obligation for both plans was $2,417,536 and $1,970,893 at December 31, 2003, and 2002, respectively. Weighted-average assumptions used to determine YEARS ENDED DECEMBER 31, both the benefit obligations and net periodic pension ------------------------------------------------------ costs were as follows: 2003 2002 2001 ------------- ------------- ------------- Plan #1 Discount rate 6.50% 6.75% 7.25% Expected long-term return on plan assets 7.00% 7.00% 7.00% Rate of compensation increase 3.50% - 5.50% 3.50% - 5.50% 3.50% - 5.50% Plan #2 Discount rate 7.00% 7.00% 7.00% Expected long-term return on plan assets 7.00% 7.00% 7.00% Rate of compensation increase 3.50% 3.50% 3.50% The interest rate assumption utilized for the plan valuation methods is 7%. The interest rate assumption is reasonable considering historical rates of return and the asset allocation mix of the plan. 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 15 -- EMPLOYEE BENEFIT PLANS (CONTINUED) DEFINED BENEFIT PLANS (CONTINUED) DECEMBER 31, Pension plan weighted-average asset allocations ------------------------------ by investment category are as follows: 2003 2002 2001 ---- ---- ---- Cash and cash equivalents 17% 9% 15% Stocks 24% 32% 37% Bonds 16% 13% 9% Mutual funds 30% 29% 29% Government securities 13% 17% 10% --- --- --- Total 100% 100% 100% === === === The Bank's pension plan funds are managed and held in trust by the Bank's Trust Division. The investment objective and strategy for investing plan assets calls for a "Moderate Growth Income Objective". This objective provides for a preservation of the principal's purchasing power and moderate income. The range of equity exposure is from 40 to 80 percent and fixed income maturities to 30 years. The targeted asset allocation percentages for each category of plan assets would reveal a strategy to acquire a higher position in equities to a level of between 50 to 55 percent over the course of the next one to two year period. The investment policies of the plan trustees prohibit the use of derivatives. In addition, the plan assets are diversified appropriately across different sections and the plan trustees have further diversified plan assets by maintaining an investment in mutual funds. OTHER EMPLOYEE BENEFIT PLANS The Bank also maintains non-qualified deferred compensation plans for certain directors, which are generally funded by life insurance. Prior to 2002, premiums on those policies were paid for by the Bank. In 2002, the Bank elected to pay those premiums with dividends accruing on the insurance policies. The present value of these benefits to be paid under the programs is being accrued over the estimated remaining service period of the participants. The liability for these future obligations was $473,567 and $477,164 at December 31, 2003 and 2002, respectively. In addition, the Bank maintains a qualified 401(k) - deferred compensation plan for eligible employees. The plan is designed to provide a predetermined matching contribution by the Bank based on compensation deferrals by participants in the plan. The Bank contributions, including administrative fees, for 2003, 2002 and 2001 amounted to $68,479, $57,304 and $53,404, respectively. NOTE 16 -- RELATED-PARTY TRANSACTIONS At December 31, 2003 and 2002, certain officers and directors of the Bancorp and the Bank, and companies in which they have beneficial ownership, were indebted to the Bank in the aggregate amount of approximately $10,810,000 and $12,630,000 respectively. During 2003, new loans to such related parties were approximately $1,770,000 and repayments approximated $3,590,000. 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 17 -- DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. Cash and cash equivalents: The carrying amount is a reasonable estimate of fair value. Certificates of deposit: The carrying amounts of these short term investments approximate their fair value. Investment securities: The fair value of securities is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. Federal Home Loan Bank stock: The carrying value of the FHLB stock is a reasonable estimate of fair value due to restrictions on the securities. Loans receivable: For certain homogeneous categories of loans, fair value is estimated using the quoted market prices for securities backed by similar loans adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities. Deposit liabilities: The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Short-term borrowings: The carrying amounts of federal funds purchased and borrowings under repurchase agreements are short-term borrowings and approximate their fair values. FHLB advances: The fair value of FHLB advances was determined using a discounted cash flow analysis based on current FHLB advance rates for advances with similar maturities. The estimated fair value of the Bancorp's financial instruments as of December 31, 2003 are as follows: CARRYING FAIR AMOUNT VALUE Financial Assets: Cash and cash equivalents $ 15,828,695 $ 15,828,695 Certificate of deposit $ 100,000 $ 100,000 Investment securities $167,907,113 $167,907,113 Federal Home Loan Bank stock $ 4,540,500 $ 4,540,500 Loans receivable $416,286,455 $420,626,455 Financial liabilities: Deposits $492,157,529 $495,726,529 Short-term borrowings $ 20,510,877 $ 20,510,877 FHLB advances $ 53,307,767 $ 61,144,767 The market values of investments, which are based upon quoted market prices, are contained in Note 2. 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 18 -- REGULATORY MATTERS The Bank is subject to legal limitations on the amount of dividends that can be paid to the Bancorp. The Pennsylvania Banking Code restricts the payment of dividends, generally to the extent of its retained earnings. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, as set forth below, of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2003 and 2002, that the Bank meets all capital adequacy requirements to which it is subjected. The Bank's actual capital ratios as of December 31, 2003 and 2002, the minimum ratios required for capital adequacy purposes, and the ratios required to be considered well capitalized under the Federal Deposit Insurance Corporation Improvement Act of 1991 provisions are as follows: December 31, Minimum Well ----------------------- Capital Capitalized 2003 2002 Requirements Requirements ------- ------- ------------ --------------- Risk-based capital ratio 15.1% 15.2% 8.0% 10.0% or higher Leverage capital ratio 9.1% 8.9% 3.0% to 4.0% 5.0% or higher Tier 1 risk-based capital ratio 14.3% 14.4% 4.0% 6.0% or higher Included in cash and due from banks are required federal reserves of $4,740,000 and $4,358,000 at December 31, 2003 and 2002, respectively, for facilitating the implementation of monetary policy by the Federal Reserve System. The required reserves are computed by applying prescribed ratios to the classes of average deposit balances. These reserves are held in the form of due from banks. NOTE 19 -- STOCK OPTION PLAN The Bank's Stock Option Plan authorizes the granting of stock options to Bank directors and employees for up to 300,000 shares of common stock. The stock option plan provides for a term of ten years, after which no awards can be made. Under the plan, the exercise price of each option equals the closing market price of the Bank's stock on the grant date, and an option's maximum term is ten years. Options constitute both incentive and non-incentive stock options and are generally granted annually in the month of May. Options granted to directors are vested immediately and are exercisable six months from the grant date and options granted to employees generally vest over three years. As of December 31, 2003, a total of 150,000 stock options have been granted, of which, 73,887 are vested and exercisable, 44,167 have not vested, 27,779 have been exercised and 4,167 have been forfeited. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 19 -- STOCK OPTION PLAN (CONTINUED) A summary of the status of the Bank's stock option plan is presented below: DECEMBER 31, ------------------------------------------------------------------------- 2003 2002 2001 ------------------- ------------------- ------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ -------- ------ -------- ------ -------- Outstanding at beginning of year 119,709 $ 26.53 94,000 $ 23.97 61,000 $ 24.50 Granted 20,500 $ 51.40 35,500 $ 32.88 33,000 $ 23.00 Forfeitures (1,001) $ 29.58 (3,166) $ 23.79 - - Exercised (21,154) $ 25.85 (6,625) $ 25.58 - - ------- ------- ------ Outstanding at December 31, 118,054 $ 30.94 119,709 $ 26.53 94,000 $ 23.97 ======= ======= ====== Exercisable at December 31, 73,887 $ 25.54 66,513 $ 25.70 41,333 $ 24.17 ======= ======= ====== The options outstanding at December 31, 2003, 2002 and 2001 had a weighted-average contractual maturity of 7.66 years, 8.2 years, and 8.73 years, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: DECEMBER 31, ------------------------------------------- 2003 2002 2001 --------- -------- --------- Dividend yield 2.72% 3.79% 3.59% Expected life 7 years 7 years 7 years Expected volatility 20% 19% 18% Risk-free interest rate 4.00% 3.75% 4.95% Weighted-average fair value $10.75 $7.46 $4.19 Prior to 2003, the Bank accounted for stock-based compensation under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in either 2002 or 2001 net income, as all options granted during 2002 and 2001 had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, the Bank adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation, prospectively to all employee awards granted in 2003. Awards under the plan vest over periods ranging from six months to three years. Therefore, the cost related to stock-based compensation included in the determination of net income for 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of Statement 123. 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 19 -- STOCK OPTION PLAN (CONTINUED) The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each year. YEARS ENDED DECEMBER 31, ------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Net income, as reported $ 9,646,246 $ 8,937,299 $ 7,465,334 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 67,422 -- -- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 151,518 327,483 114,219 ------------ ------------ ------------ Pro-forma net income $ 9,562,150 $ 8,609,816 $ 7,351,115 ============ ============ ============ Earnings per share: Basic-as reported $ 3.24 $ 3.00 $ 2.49 ============ ============ ============ Basic-pro forma $ 3.21 $ 2.84 $ 2.45 ============ ============ ============ Diluted-as reported $ 3.19 $ 2.99 $ 2.49 ============ ============ ============ Diluted-pro forma $ 3.17 $ 2.84 $ 2.45 ============ ============ ============ Weighted-average number of shares outstanding assuming dilution of exercisable stock options using the treasury stock method was 3,020,075, 2,991,043 and 2,994,088 for the years ended December 31, 2003, 2002 and 2001, respectively. NOTE 20 -- TREASURY STOCK In 2002 and 2001, the Bancorp repurchased 8,040 and 16,228 shares of its stock for $258,513 and $395,277, respectively, and is being held as treasury stock. The Bancorp did not repurchase any shares of its own stock during 2003. NOTE 21 -- RECENT ACCOUNTING PRONOUNCEMENTS In 2003, the Bank adopted the disclosure provisions as required by SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits", as revised by the FASB. This statement retains the disclosure requirements contained in the original Statement 132, the revised Statement requires additional disclosures about plan assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The revised Statement does not change the measurement or recognition of those plans as originaly required by SFAS No. 87, "Employers' Accounting for Pensions". The provisions of the revised statement are effective for fiscal years ending after December 15, 2003. Management has included the additional disclosures in the notes to the financial statements and believes that this statement has no financial impact on the Bank or its operations. In 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (effective for contracts entered into or modified after June 30, 2003, with specified exceptions). Management does not believe the statement will have a material impact on the Bank or its operations. Also in 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" (effective for financial instruments entered into or modified after May 31, 2003, with limited exceptions). Management does not believe the statement will have a material impact on the Bank or its operations. 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY Years Ended December 31, 2003, 2002 and 2001 NOTE 22 -- PARENT COMPANY FINANCIAL INFORMATION The condensed financial information for IBT Bancorp, Inc. as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001 is as follows: BALANCE SHEETS DECEMBER 31 ------------------------- 2003 2002 ----------- ----------- ASSETS Cash in bank $ 60,813 $ 401,584 Investment in subsidiary 58,771,455 54,926,513 Securities available for sale 578,603 554,207 Other assets 242,943 303,774 ----------- ----------- Total Assets $59,653,814 $56,186,078 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 47,773 $ 34,900 Stockholders' Equity 59,606,041 56,151,178 ----------- ----------- Total Liabilities and Stockholders' Equity $59,653,814 $56,186,078 =========== =========== STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, ----------------------------------- 2003 2002 2001 --------- --------- --------- Income Dividends from subsidiary 3,600,000 4,000,000 3,650,000 Other dividends 14,156 14,069 16,978 Investment security gains 151,802 1,986 88,297 Income from joint ventures 218,307 185,541 102,124 Expenses Professional fees 167,658 72,371 87,923 Loss on joint venture -- -- 27,471 Miscellaneous 62,954 33,203 16,880 ---------- ---------- ---------- Income Before Income Taxes and Equity in Undistributed Earnings of Subsidiary 3,753,653 4,096,022 3,725,125 Equity in Undistributed Earnings of Subsidiary 5,892,593 4,841,277 3,740,209 ---------- ---------- ---------- Net Income $9,646,246 $8,937,299 $7,465,334 ========== ========== ========== 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 22 -- PARENT COMPANY FINANCIAL INFORMATION (CONTINUED) STATEMENTS OF CASH FLOWS Years Ended December 31, ----------------------------------------- 2003 2002 2001 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 9,646,246 $ 8,937,299 $ 7,465,334 Adjustments to reconcile net income to net cash provided by operating activities: Net undistributed earnings of joint ventures (218,307) (185,541) (74,652) Investment security gains (151,802) (1,986) (88,297) Decrease in cash due to changes in assets and liabilities: Equity in undistributed earnings of subsidiary (5,892,593) (4,841,277) (3,740,209) ----------- ----------- ----------- NET CASH FROM OPERATING ACTIVITIES 3,383,544 3,908,495 3,562,176 CASH FLOWS FROM INVESTING ACTIVITIES Distributions from joint ventures 279,137 157,105 79,095 Proceeds from sale of securities available for sale 166,846 -- 478,554 Purchase of securities available for sale (1,577) (74,095) (369,062) ----------- ----------- ----------- NET CASH FROM INVESTING ACTIVITIES 444,406 83,010 188,587 CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (4,168,721) (3,577,098) (3,113,278) Purchase of Treasury Stock -- (258,513) (395,277) ----------- ----------- ----------- NET CASH USED BY FINANCING ACTIVITIES (4,168,721) (3,835,611) (3,508,555) ----------- ----------- ----------- NET CHANGE IN CASH AND CASH EQUIVALENTS (340,771) 155,894 242,208 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 401,584 245,690 3,482 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 60,813 $ 401,584 $ 245,690 =========== =========== =========== 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) IBT BANCORP, INC. AND SUBSIDIARY YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 NOTE 23 -- CONDENSED CONSOLIDATED SELECTED QUARTERLY FINANCIAL DATA (Unaudited) QUARTERS ENDED 2003 -------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ---------- ---------- ------------ ----------- Interest income $8,493,556 $8,338,858 $8,381,878 $8,183,551 Interest expense 2,973,791 2,826,082 2,736,619 2,778,289 ---------- ---------- ---------- ---------- Net interest income 5,519,765 5,512,776 5,645,259 5,405,262 Provision for loan losses 150,000 150,000 150,000 150,000 Non-interest income 1,440,540 1,686,128 1,581,936 1,182,452 Non-interest expense 3,246,494 3,744,055 3,581,862 3,727,570 ---------- ---------- ---------- ---------- Income before income taxes 3,563,811 3,304,849 3,495,333 2,710,144 Income tax expense 934,406 849,268 933,405 710,813 ---------- ---------- ---------- ---------- Net income $2,629,405 $2,455,581 $2,561,928 $1,999,331 ========== ========== ========== ========== Net income per Share of Capital Stock $ 0.88 $ 0.82 $ 0.86 $ 0.67 ========== ========== ========== ========== QUARTERS ENDED 2002 -------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ---------- ---------- ------------ ----------- Interest income $8,207,972 $8,343,506 $8,523,469 $8,485,279 Interest expense 3,207,376 3,161,028 3,234,016 3,226,173 ---------- ---------- ---------- ---------- Net interest income 5,000,596 5,182,478 5,289,453 5,259,106 Provision for loan losses 250,000 250,000 300,000 300,000 Non-interest income 1,335,340 1,253,906 1,307,726 1,420,083 Non-interest expense 2,849,710 3,264,057 3,171,255 3,546,056 ---------- ---------- ---------- ---------- Income before income taxes 3,236,226 2,922,327 3,125,924 2,833,133 Income tax expense 805,240 779,597 834,259 761,215 ---------- ---------- ---------- ---------- Net income $2,430,986 $2,142,730 $2,291,665 $2,071,918 ========== ========== ========== ========== Net income per Share of Capital Stock $ 0.81 $ 0.72 $ 0.77 $ 0.70 ========== ========== ========== ========== 29 IBT BANCORP, INC. CORPORATE PROFILE IBT Bancorp, Inc. (the "Company"), a Pennsylvania corporation, is the bank holding company for Irwin Bank & Trust Company ("Irwin Bank"). Irwin Bank is the principal subsidiary of the Company. Irwin Bank & Trust Company was incorporated in 1922 under the laws of Pennsylvania as a commercial bank. The Bank is headquartered in Irwin, Pennsylvania and conducts business through 7 full service branches, 5 supermarket branches, a loan office, and a trust office, in the Pennsylvania counties of Westmoreland and Allegheny. Irwin Bank is a diversified financial services institution providing a broad range of commercial and retail banking services, as well as trust services to consumers and businesses. Deposits in Irwin Bank are insured by the Federal Deposit Insurance Corporation ("FDIC") to applicable limits. Stock Market Information The Company's common stock is listed on the American Stock Exchange ("AMEX") under the symbol "IRW". As of March 2, 2004 IBT Bancorp, Inc. had approximately 700 shareholders of record and 2,977,655 shares of common stock outstanding. The number of stockholders does not reflect persons or entities who hold their stock in nominee or "street" name through various brokerage firms. For 2003 the following table sets forth high and low trade prices per share for the common stock for the calendar quarters indicated, based upon information obtained from the AMEX. For 2002 the following the following table sets forth high and low bid prices per share for the common stock for the calendar quarters indicated, based upon information obtained from the OTC Bulletin Board. All such bid prices reflect inter-dealer prices, without retail mark-downs or commissions and may not necessarily represent actual transactions. Price Range Cash Dividends High ($) Low ($) Declared Per Share ($) -------- ------- ---------------------- 2003 First Quarter 41.41 37.25 .35 Second Quarter 50.05 41.00 .35 Third Quarter 52.25 44.09 .35 Fourth Quarter 62.48 49.65 .35 2002 First Quarter 33.00 27.30 .30 Second Quarter 33.00 30.50 .30 Third Quarter 35.00 31.90 .30 Fourth Quarter 39.95 34.15 .30 The ability of the Company to pay dividends is dependent upon the ability of Irwin Bank to pay dividends to the Company. Because Irwin Bank is a depository institution insured by the FDIC it may not pay dividends or distribute capital assets if it is in default on any assessment due the FDIC. Additionally, Irwin Bank is also subject to certain state banking regulations. Under Federal Reserve Policy, the Company is required to maintain adequate regulatory capital and is expected to act as a source of financial strength to Irwin Bank and to commit resources to support Irwin Bank in circumstances where it might not do so absent such a policy. This policy could have the effect of reducing the amount of dividends declarable by the Company. ANNUAL SHAREHOLDERS MEETING The annual meeting of shareholders of IBT Bancorp, Inc. will be held on Tuesday April, 20, 2004 at 2:00 PM local time, at the Irwin Masonic Hall, located at 417 Main Street, Irwin, Pennsylvania 15642. FORM 10-K The Annual Report for the year ended December 31, 2003 filed with the Securities and Exchange Commission on Form 10-K, is available without charge upon written request. For a copy of the Form 10-K please contact: Raymond G. Suchta, Senior Vice President and Chief Financial Officer, IBT Bancorp, Inc., 309 Main Street, Irwin, PA 15642. TRANSFER AGENT INDEPENDENT AUDITORS Registrar and Transfer Company Edwards, Sauer & Owens Investor Relations 500 Warner Center 10 Commerce Drive Pittsburgh, PA 15222 Cranford, New Jersey 07016-3572 1-800-368-5948 SPECIAL COUNSEL Malizia, Spidi & Fisch, PC 1100 New York Avenue, NW Suite 340 West Washington, D.C. 20005 IRWIN BANK & Trust Company Officers J. Curt Gardner, Chairman of the Board Mary Ann Ernette, Assistant Vice President-Uvest Charles G. Urtin, President/CEO Keith Frid, Assistant Vice President/Auditor Robert A. Bowell, Executive Vice President/ Sheli L. Fyock, Assistant Vice President- Secretary-Treasurer/CLO Marketing/Assistant Secretary David A. Finui, Senior Vice President/COO Beverly A. Hahn, Assistant Vice President/ Raymond G. Suchta, Senior Vice President/CFO Branch Manager - Penn Township Leslie F. Petras, Senior Vice President-Commercial Loans Nancy J. McCullough, Assistant Vice President/ Louis C. Bouchat, Vice President-Commercial Loans Branch Manager - Route 30 Lisa A. Dawson, Vice President-Loan Administration Robert G. Michaud, Assistant Vice President-Marketing Scott J. Fisher, Vice President-Trust Maurine J. Peer, Assistant Vice President/ Jay Gordon, Vice President-Commercial Loans Branch Manager - Main Office Donald D. Henderson III, Vice President-Operations Darwin H. Poole, Assistant Vice President- Debra S. Hopper, Vice President-Human Resources Data Processing Alan Lazar, Vice President-Commercial Loans Nancy A. Smith, Assistant Vice President- Joseph A. Mignogna, Vice President-Compliance Officer Mortgage Lending John J. Minkel, Vice President-Consumer Loans Linda D. Shaner, Assistant Vice President- Scott D. Porterfield, Vice President- Commercial Loans Branch Administration / Business Development Thomas R. Stephenson, Assistant Vice President- Kristin S. Robertucci, Vice President-Accounting Loan Review James W. Thompson, Vice President-Commercial Loans Kathleen T. Jaquette-Tosh, Assistant Vice President/ Stacey G. Winfield, Vice President-Commercial Loans Branch Manager - Greensburg John R. Winter, Vice President-Commercial Loans Gene Bender, Assistant Trust Officer Douglas P. Arndt, Assistant Vice President-Consumer Loans Carolyn Sue Bozzick, Retail Banking Officer/Manager - Jeffrey A. Branthoover, Assistant Vice President- Haymaker Village Trust Administration Deborah L. Kukic, Training Officer Barbara A. Burzio, Assistant Vice President-Commercial Loans Denise Y. Poole, Operations Officer Barbara DelBene, Assistant Vice President/ Sandra L. Schwaderer, Retail Banking Officer/ Branch Manager - White Oak Manager - Pitcairn IRWIN BANK & Trust Company Locations Main Office Branch Offices Irwin Bank Extra Locations 309 Main Street Greensburg Ft. Allen Irwin, PA 15642 4 Triangle Drive Inside Hempfield Shop N' Save 724-863-3100 Greensburg, PA 15601 Greensburg, PA 15601 724-837-5000 724-853-8540 Loan Center Monroeville Irwin-North Huntingdon 319 Main Street Haymaker Village Inside Scozio's Shop N' Save Irwin, PA 15642 4580 Broadway Blvd. Norwin Hills Shopping Center 724-863-3100 Monroeville, PA 15146 8775 Norwin Avenue 412-858-4450 North Huntingdon, PA 15642 724-861-8701 Trust Division Suite 204 Penn Township Monroeville 20 N. Pennsylvania Avenue 4021 Route 130 Inside Haymaker Village Giant Eagle Greensburg, PA 15601 Irwin, PA 15642 4548 Broadway Blvd. 724-836-2010 724-744-2176 Monroeville, PA 15146 412-856-5330 UVest Investments Pitcairn 319 Main Street 512 Broadway Blvd. Penn Crossing Irwin, PA 15642 Pitcairn, PA 15140 Inside Scozio's Festival Foods 724-978-2751 412-372-3838 2000 Penny Lane Jeannette, PA 15644 Route 30 724-744-6111 9570 Route 30 Irwin, PA 15642 White Oak 724-863-2510 Inside Scozio's Shop N' Save Oak Park Mall White Oak 2001 Lincoln Way Oak Park Mall White Oak, PA 15131 2003 Lincoln Way 412-664-0984 White Oak, PA 15131 412-678-3000