1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 2-78178
SOUTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
Michigan 38-2407501
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
51 West Pearl Street
Coldwater, Michigan 49036
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (517) 279-5500
Securities Registered under Section 12(b) of the Act: None
Securities Registered under Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of the registrant's common stock, par value
$2.50 per share (based on the average of the bid and ask prices) held by
non-affiliates of the registrant as of March 1, 2000 was $36,039,382. For
purposes of this computation, all executive officers, directors and 5%
shareholders of the registrant have been assumed to be affiliates. Certain of
such persons may disclaim that they are affiliates of the registrant.
The number of shares outstanding of the registrant's common stock as of
March 1, 2000 was 1,958,498 shares.
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PART I
ITEM 1. BUSINESS
Overview
The registrant, Southern Michigan Bancorp, Inc. (the "Company"), is a
registered bank holding company incorporated under the laws of the State of
Michigan, headquartered in Coldwater, Michigan. The Company was formed in 1982
for the purpose of acquiring all of the outstanding shares of Southern Michigan
National Bank, which it did in November 1982. In December 1992, Southern
Michigan National Bank converted its charter to that of a Michigan state banking
corporation and changed its name to, Southern Michigan Bank & Trust (the
"Bank"), with its main office located at 51 West Pearl Street, Coldwater,
Michigan 49036. The Bank operates twelve (12) branch offices in the primarily
rural areas of Branch, Hillsdale, and Calhoun counties in southwestern Michigan.
In addition to the operations of the Bank described below, the Company owns and
leases certain real estate to the Bank and third parties (see Item 2. Properties
below); and SMB&T Financial Services, Inc., a subsidiary of the Bank, has been
established to provide insurance and investment services, which services are
currently limited to the sale of certain insurance products to the Bank. None of
such activities are significant to the operations of the Company
In February 2000, the Company and Sturgis Bank & Trust Company ("Sturgis")
entered into an Agreement and Plan of Consolidation pursuant to which Sturgis
will become a wholly-owned subsidiary of the Company. Sturgis shareholders will
receive .398 shares of the Company's common stock for each share of Sturgis'
common stock. The transaction is subject to normal regulatory approvals and the
approval of the shareholders of Sturgis. The transaction is expected to close in
the second half of 2000. Sturgis and the Bank will continue to operate as
stand-alone banks.
Banking Services
The Bank offers a full range of banking services to individuals,
businesses, governmental entities and other institutions. These services include
checking, savings, and NOW accounts, time deposits, safe deposit facilities, and
money transfers. The Bank's lending operations provide secured and unsecured
commercial and personal loans, real estate loans, consumer installment loans,
lines of credit and accounts receivable financing.
The Bank's Trust Department offers a wide variety of fiduciary services to
individuals, businesses, not-for-profit organizations and governmental entities,
including services as trustee for personal, corporate, pension, profit sharing,
and other employee benefit trusts. The Bank also provides security custodial
services as an agent, acts as the personal representative for estates and as a
fiscal, paying and escrow agent for corporate customers and governmental
entities.
The Bank also offers securities brokerage services through an unaffiliated
broker. The Bank maintains correspondent banking relationships with several
larger banks, which correspondent relationships concern check clearing
operations, transfer of funds, loan participations, the purchase and sale of
federal funds, and other similar services.
Competition
The banking business in the Bank's market area is highly competitive. The
Bank competes with other banks, savings and loan associations, credit unions and
finance companies. Banks and other financial institutions from surrounding areas
maintain branches within the Bank's service area and offer additional
competition. The Bank is also faced with increasing competition from
non-depository financial intermediaries, such as large retailers, investment
banks and securities brokerage firms.
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Supervision and Regulation
General
Bank holding companies and banks are highly regulated by both state and
federal agencies. As a bank holding company, the Company is subject to
supervision and regulation by the Federal Reserve Board ("FRB") pursuant to the
Bank Holding Company Act of 1956, as amended (the "BHCA"). The BHCA restricts
the product range of a bank holding company by circumscribing the types of
businesses it may own or acquire. The BHCA limits a bank holding company to
owning and managing banks or companies engaged in activities determined by the
FRB to be closely related to banking as to be a proper incident thereto. The
BHCA requires a bank holding company to obtain the prior approval of the FRB
before acquiring a nonbanking company, or substantially all of the assets of a
bank or a bank holding company, or direct or indirect ownership or control of
more than five percent of the voting shares of a bank or a bank holding company.
Under FRB regulations, the Company is required to serve as a source of
financial and managerial strength to the Bank and must conduct its operations in
a safe and sound manner.
The Bank is subject to regulation, supervision, and regular bank
examinations by the Federal Deposit Insurance Corporation (the "FDIC") and the
Michigan Financial Institutions Bureau (the "FIB"). The FIB is the Bank's
chartering authority and primary regulator. Under FIB and FDIC regulations, the
Bank is required to maintain reserves against its deposits and to maintain
certain levels of capital and surplus. In addition, the Bank is subject to
restrictions on the nature and amount of loans which may be made, the types and
amounts of investments it may make, and certain limitations on the payment of
dividends to its sole shareholder, the Company.
Dividend Restrictions
The Company's principal source of income consists of dividends paid by the
Bank on its common stock (all of which is owned by the Company). Michigan law
restricts the Bank's ability to pay dividends to its shareholder. Under the
Michigan Banking Code of 1969, as amended (the "1969 Code") and the Michigan
Banking Code of 1999 (which became effective March 1, 2000 and repealed the 1969
Code), no dividend may be declared by the Bank in an amount greater than net
income then on hand after deducting losses and bad debts. After payment of a
dividend, the Bank must have a surplus amounting to not less than 20% of its
capital. In addition, if the surplus of the Bank is less than the amount of its
capital, before a dividend may be declared, the Bank must transfer to surplus
not less than 10% of the net income of the Bank for the preceding 6 months in
the case of quarterly or semiannual dividends or not less than 10% of its net
profits for the preceding two consecutive 6 month periods in the case of annual
dividends. Dividends cannot be paid from the Bank's capital or surplus. Based on
the Bank's balance sheet as of December 31, 1999, the Bank could pay a dividend
to the Company in the amount of $3,752,000 without prior regulatory approval.
The payment of dividends by the Company and the Bank is also affected by
various regulatory requirements and policies, such as the requirement to
maintain adequate capital above regulatory guidelines. The "prompt corrective
action" provisions of the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") impose further restrictions on the payment of dividends by
insured banks which fail to meet specified capital levels and, in some cases,
their parent bank holding companies. FDICIA generally prohibits a depository
institution from making any capital distribution (including payment of a
dividend) or paying any management fee to its holding company if the depository
institution would thereafter be undercapitalized (see "Capital Requirements").
These regulations and restrictions may limit the Company's ability to obtain
funds
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from the Bank for the Company's cash needs, including funds for acquisitions,
payments of dividends and interest, and the payment of operating expenses.
The FDIC may prevent an insured bank from paying dividends if the bank is
in default of payment of any assessment due to the FDIC. In addition, payment of
dividends by a bank may be prevented by the applicable federal regulatory
authority if such payment is determined, by reason of the financial condition of
such bank, to be an unsafe and unsound banking practice. The Federal Reserve
Board has issued a policy statement providing that bank holding companies and
insured banks should generally only pay dividends out of current operating
earnings.
Federal Regulation
The following is a summary of certain statutes and regulations affecting
the Company and the Bank. This summary is qualified in its entirety by such
statutes and regulations, which are subject to change based on pending and
future legislation and action by regulatory agencies. Proposals to change the
laws and regulations governing the operation of banks and companies which
control banks and other financial institutions are frequently raised in
Congress. The likelihood of any major legislation and the impact such
legislation might have on the Company or the Bank are, however, impossible to
predict.
Gramm-Leach-Bliley
Enacted late in 1999, the Gramm-Leach-Bliley Act ("Gramm-Leach-Bliley"),
broadens the scope of financial services that banks may offer to consumers,
essentially removing the barriers erected during the Depression that separated
banks and securities firms, closes the loophole which permitted commercial
enterprises to own and operate a thrift institution, and provides some new
consumer protections with respect to privacy issues and ATM usage fees.
Gramm-Leach-Bliley permits affiliations between banks, securities firms and
insurance companies (which affiliations were previously prohibited under the
Glass-Steagall Act). Under Gramm-Leach-Bliley, a bank holding company may
qualify as a financial holding company and thereby offer expanded range of
financial oriented products and services which products and services may not be
offered by bank holding companies. To qualify as a financial holding company, a
bank holding company's subsidiary depository institutions must be well-managed,
well-capitalized and have received a "satisfactory" rating on its latest
examination under the Community Reinvestment Act. Gramm-Leach-Bliley provides
for some regulatory oversight by the Securities and Exchange Commission for bank
holding companies engaged in certain activities, and reaffirms that insurance
activities are to be regulated on the state level. States, however, may not
prevent depository institutions and their affiliates from engaging in insurance
activities. Commercial enterprises are no longer able to establish or acquire a
thrift institution and thereby become a unitary thrift holding company. Thrift
institutions may only be established or acquired by financial organizations.
Gramm-Leach-Bliley provides new consumer protections with respect to the
transfer and use of a consumer's nonpublic personal information and generally
enables financial institution customers to "opt-out" of the dissemination of
their personal financial information to unaffiliated third parties. ATM
operators who charge a fee to non-customers for use of its ATM must disclose the
fee on a sign placed on the ATM and before the transaction is made as a part of
the on-screen display or by a paper notice issued by the machine.
Riegle-Neal
Prior to September 29, 1995, the BHCA prohibited a bank holding company
from acquiring shares of any bank located outside the state in which the
operations of the bank holding company's banking subsidiaries were primarily
conducted unless the acquisition was specifically authorized by statute of the
state of the bank whose shares were to be acquired. Under the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"),
the restriction on interstate bank acquisitions was repealed effective September
29, 1995. The FRB is now generally authorized to approve bank acquisitions by
out-of-state bank holding
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companies that are adequately capitalized and managed irrespective of the
permissibility of such acquisition under state law, but subject to any state
requirement that the bank has been organized and operating for a minimum period
of time, not to exceed five (5) years.
Each State is permitted to prohibit interstate branch acquisitions (i.e.,
acquisition of a branch without acquisition of the entire target bank or the
establishment of de novo branches) and to examine acquired and de novo branches
of out-of-state banks with respect to compliance with certain host State laws.
FDICIA
In December 1991, FDICIA was enacted, substantially revising the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and
making revisions to several other federal banking statutes. Among other things,
FDICIA requires the federal banking agencies to take "prompt corrective action"
in respect of depository institutions that do not meet minimum capital
requirements. FDICIA establishes five capital tiers: "well-capitalized,"
"adequately capitalized," "undercapitalized," "significantly under capitalized"
and "critically undercapitalized." A depository institution's capital tier will
depend upon where its capital levels are in relation to various relevant capital
measures, which will include a risk-based capital measure and a leverage ratio
capital measure, and certain other factors. The Bank is considered to be
well-capitalized.
FDICIA also contains a variety of other provisions that may affect the
operations of depository institutions including new reporting requirements,
regulatory standards for real estate lending, "truth in savings" provisions, the
requirement that a depository institution give 90 days prior notice to customers
and regulatory authorities before closing any branch and a prohibition on the
acceptance or renewal of brokered deposits by depository institutions that are
not well capitalized or are adequately capitalized and have not received a
waiver from the FDIC.
FIRREA
Under the Financial Institutions Reform and Recovery and Enforcement Act of
1989 ("FIRREA"), a depository institution insured by the FDIC is liable for any
loss incurred by, or reasonably expected to be incurred by, the FDIC in
connection with (i) the default of a commonly controlled FDIC-insured depository
institution, or (ii) any assistance provided by the FDIC to any commonly
controlled FDIC-insured depository institution "in danger of default." "Default"
is defined generally as the appointment of a conservator or receiver and "in
danger of default" is defined as the existence of certain conditions indicating
that a default is likely to occur in the absence of regulatory assistance.
Transactions with Affiliates and Insiders
The Bank and the Company are affiliates of each other and, as such, are
subject to certain federal restrictions with respect to loans and extensions of
credit to the Company and other Company affiliates, investments in the Company's
and its affiliates' securities, acceptance of such securities as collateral for
loans to any borrowers, and leases, services and other agreements between the
Bank and the Company. Additionally, regulations allow a bank to extend credit to
the bank's and its affiliates' executive officers, directors and principal
shareholders or their related interests, only if the loan is made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with non-insiders, and if
credit underwriting standards are followed that are no less stringent than those
applicable to comparable transactions with non-insiders. Moreover, loans to
insiders must not involve more than the normal risk of repayment or present
other unfavorable features and must in certain circumstances be approved in
advance by a majority of the entire board of directors of the Bank. The
aggregate amount that can be lent to all insiders is limited to the Bank's
unimpaired capital and surplus.
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Deposit Insurance
Deposits held by the Bank are insured, to the extent permitted by law, by
the Bank Insurance Fund ("BIF") administered by the FDIC. As required under
FDICIA, the FDIC has established a system of risk-based deposit insurance
premiums. Under this system each insured institution's assessment is based on
the probability that the BIF will incur a loss related to that institution, the
likely amount of the loss, and the revenue needs of the BIF.
Under the risk-based assessment system, a depository institution pays an
assessment of between 0 cents and 27 cents per $100 of insured deposits based on
its capital level and risk classification. To arrive at a risk based assessment
for an insured institution, the FDIC places it in one of nine risk categories
using a two step analysis based first on capital ratios and then on other
relevant supervisory information. The Bank has been given the designation of
well managed and well capitalized. As a result of such classification, the Bank
pays the lowest assessment rate possible to the FDIC. In 1997, the Bank began
making payments to the FDIC for certain Financing Corporation ("FICO") Bonds
that had been previously issued. Any significant changes in the deposit
insurance assessment rate or FICO bond servicing imposed by the FDIC could have
a material effect on the earnings of the Company.
Capital Requirements
The FRB has imposed risk-based capital guidelines applicable to the
Company. These guidelines require that bank holding companies maintain capital
commensurate with both on and off balance sheet credit and other risks of their
operations. Under the guidelines, a bank holding company must have a minimum
ratio of total capital to risk-weighted assets ("Total Capital") of 8.0 percent.
At least half of Total Capital must be composed of common shareholder's equity,
qualifying perpetual preferred stock and minority interest in equity accounts of
consolidated subsidiaries, less goodwill and certain other intangible assets
("Tier I Capital"). At December 31, 1999, the Company's Total Capital to
risk-weighted assets was 12.0 percent, which is above the regulatory minimum
requirements.
In addition to risk-based capital requirements, the FRB has also imposed
leverage capital ratio requirements. The leverage ratio requirements establish a
minimum required ratio of Tier I Capital to total assets less goodwill of 3
percent for the bank holding companies having the highest regulatory rating. All
other bank holding companies are required to maintain a minimum Tier I capital
yielding a leverage ratio of 4 percent to 5 percent, depending on the particular
circumstances and risk profile of the institution. The Company's Tier I Capital
leverage ratio at December 31, 1999 was 8.4 percent.
The Bank is also subject to risk-weighted capital standards and leverage
measures which are similar, but in some cases not identical, to the requirements
applicable to bank holding companies. At December 31, 1999, the Bank met all
applicable capital requirements.
Monetary Policy and Economic Conditions
The business of commercial banks, such as the Bank, is affected by monetary
and fiscal policies of various regulatory agencies, including the FRB. Among the
regulatory techniques available to the FRB are open market operations in United
States Government securities, changing the discount rate for member bank
borrowings, and imposing and changing the reserve requirement applicable to
member bank deposits and to certain borrowings by member banks and their
affiliates (including parent companies). These policies influence to a
significant extent the overall growth and distribution of bank loans,
investments and deposits and the interest rates charged on loans, as well as the
interest rates paid on savings and time deposits.
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The monetary policies of the FRB have had a significant effect on the
operating results of commercial banks in the past and are expected to continue
to do so in the future. In view of constantly changing conditions in the
national economy and the money market, as well as the effect of acts by the
monetary and fiscal authorities, including the FRB, no definitive predictions
can be made by the Company or the Bank as to future changes in interest rates,
credit availability, deposit levels, or the effect of any such changes on the
Company's or the Bank's operations and financial condition.
Employees
As of December 31, 1999, 141 persons were employed by the Bank; 123 were
full time employees and 18 were part time employees.
Selected Statistical Information
The following tables describe certain aspects of the Company's business in
statistical form.
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I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL
The following are the average balance sheets for the years ending December 31:
(Dollars in Thousands)
1 9 9 9 1 9 9 8
------------------------------------- --------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
-------- -------- ---- ------- -------- ----
ASSETS
Interest earning assets:
Loans (A) (B) (C) $ 178,906 $ 16,606 9.3% $ 160,666 $ 15,816 $ 9.8%
Taxable investment securities (D) 35,784 2,235 6.2 32,449 2,305 7.1
Tax-exempt investment
securities (A) 22,716 1,715 7.6 22,342 1,657 7.4
Federal funds sold 2,154 107 5.0 4,782 266 5.6
---------- --------- ---------- ------
Total interest earning assets 239,560 20,663 8.6 220,239 20,044 9.1
Non-interest earning assets:
Cash and due from banks 12,679 15,591
Other assets 18,028 16,415
Less allowance for loan loss (2,161) (1,955)
---------- ----------
Total assets $ 268,106 $ 250,290
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits $ 77,664 $ 2,482 3.2% $ 74,154 $ 2,440 3.3%
Savings deposits 45,722 1,496 3.3 44,356 1,509 3.4
Time deposits 73,553 3,760 5.1 68,177 3,673 5.4
Federal funds purchased 2,044 97 4.7 - - -
Other borrowings 9,716 600 6.2 6,146 410 6.7
--------- --------- ---------- ---------
Total interest bearing
liabilities 208,699 8,435 4.0 192,833 8,032 4.2
Non-interest bearing liabilities:
Demand deposits 32,982 30,570
Other 1,261 1,124
Common stock subject to
repurchase obligation 5,009 5,464
Shareholders' equity 20,155 20,299
---------- ----------
Total liabilities and
shareholders' equity $ 268,106 $ 250,290
========== ==========
Net interest earnings $ 12,228 $ 12,012
========= =========
Net yield on interest
earning assets 5.1% 5.5%
===== =====
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---------------------------------------
Average Yield/
Balance Interest Rate
--------- -------- ----
ASSETS
Interest earning assets:
Loans (A) (B) (C) $ 158,193 $ 15,593 9.9%
Taxable investment securities (D) 33,538 2,189 6.5
Tax-exempt investment
securities (A) 16,864 1,253 7.4
Federal funds sold 1,357 74 5.5
----------- ---------
Total interest earning assets 209,952 19,109 9.1
Non-interest earning assets:
Cash and due from banks 10,442
Other assets 14,871
Less allowance for loan loss (1,866)
-----------
Total assets $ 233,399
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits $ 63,856 $ 2,163 3.4%
Savings deposits 43,505 1,485 3.4
Time deposits 67,993 3,612 5.3
Federal funds purchased 784 42 5.4
Other borrowings 1,404 141 10.0
----------- ---------
Total interest bearing
liabilities 177,542 7,443 4.2
Non-interest bearing liabilities:
Demand deposits 30,004
Other 1,355
Common stock subject to
repurchase obligation 4,227
Shareholders' equity 20,271
-----------
Total liabilities and
shareholders' equity $ 233,399
===========
Net interest earnings $ 11,666
=========
Net yield on interest
earning assets 5.6%
=====
(A) Includes tax equivalent adjustment of interest (assuming a 34% tax rate)
for securities and loans of $583,000 and $29,000, respectively for 1999;
$563,000 and $35,000, respectively for 1998; and $392,000 and $48,000
respectively for 1997.
(B) Average balance includes average nonaccrual loan balances of $593,000 in
1999; $815,000 in 1998; and $500,000 in 1997.
(C) Interest income includes loan fees of $663,000 in 1999; $563,000 in 1998;
and $617,000 in 1997.
(D) Average balance includes average unrealized gain (loss) of $(104,000)
in 1999; $128,000 in 1998; and $(13,000) in 1997 on available for sale
securities. The yield was calculated without regard to this average
unrealized gain (loss).
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I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL (CONTINUED)
(Dollars in Thousands)
The following table sets forth for the periods indicated a summary of changes in
interest income and interest expense, based upon a tax equivalent basis,
resulting from changes in volume and changes in rates:
Volume Variance - change in volume multiplied by the previous year's rate.
Rate Variance - change in rate multiplied by the previous year's volume.
Rate/Volume Variance - change in volume multiplied by the change in rate. This
variance was allocated to volume variance and rate variance in proportion to the
relationship of the absolute dollar amount of the change in each.
Interest on non-taxable securities has been adjusted to a fully tax equivalent
basis using a statutory tax rate of 34% in 1999, 1998 and 1997.
1999 Compared to 1998 1998 Compared to 1997
Increase (Decrease) Due To Increase (Decrease) Due To
-------------------------- --------------------------
Interest income on: Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
Loans $ 1,727 $ (937) $ 790 $ 243 $ (20) $ 223
Taxable investment securities 224 (294) (70) (73) 189 116
Tax-exempt investment securities 28 30 58 406 (2) 404
Federal funds sold (133) (26) (159) 190 2 192
-------- ------- ------ ------ ------ ------
Total interest earning assets $ 1,846 $(1,227) $ 619 $ 766 $ 169 $ 935
======== ======= ====== ====== ====== ======
Interest expense on:
Demand deposits $ 113 $ (71) $ 42 $ 340 $ (63) $ 277
Savings deposits 46 (59) (13) 29 (5) 24
Time deposits 281 (194) 87 10 51 61
Federal funds purchased 97 - 97 (42) - (42)
Other borrowings 222 (32) 190 331 (62) 269
--------- --------- ------ ------ ------ ------
Total interest bearing liabilities $ 759 $ (356) $ 403 $ 668 $ (79) $ 589
========= ========= ====== ====== ====== ======
Net interest income $ 1,087 $ (871) $ 216 $ 98 $ 248 $ 346
========= ========= ====== ====== ====== ======
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II. INVESTMENT PORTFOLIO
(Dollars in Thousands)
The following table sets forth the fair value and amortized cost of securities
at December 31:
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
Fair Amortized Fair Amortized Fair Amortized
Value Cost Value Cost Value Cost
----- ---- ----- ---- ----- ----
U.S. Treasury and other
U.S. Government agencies
and corporations $ 15,541 $ 15,885 $ 9,087 $ 9,087 $ 6,262 $ 6,262
States and political subdivisions 28,411 28,529 37,903 37,006 20,885 20,560
Corporate securities 6,172 6,203 15,942 15,902 15,590 15,564
Other securities 4,105 4,201 5,899 5,899 2,688 2,688
--------- --------- --------- -------- -------- ---------
Total investment securities $ 54,229 $ 54,818 $ 68,831 $ 67,894 $ 45,425 $ 45,074
========= ========= ========= ======== ======== =========
The following table sets forth the amortized cost of securities by maturity (or
anticipated call date, if earlier) and weighted average yield for each range of
maturities at December 31, 1999:
-----------------------------------Maturing-----------------------------------
Within One Year 1 to 5 Years 5 to 10 Years After 10 Years
----------------- ------------ ------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
U.S. Treasury and other
U.S. Government agencies
and corporations $ 5,031 5.64% $ 10,854 5.53% $ - -% $ - -%
States and political subdivisions (1) 9,197 5.19 16,183 5.57 3,109 5.85 40 6.10
Corporate securities 2,850 6.26 3,353 6.56
Other securities 654 5.64 2,155 5.36 469 5.73 923 8.63
--------- -------- -------- ------
Total (1) $ 17,732 5.45% $ 32,545 5.63% $ 3,578 5.83% $ 963 8.63%
========= ===== ======== -==== ======== ===== ====== ====
(1) Yields are not presented on a tax-equivalent basis.
The weighted average interest rates are based on coupon rates for securities
purchased at par value and on effective interest rates considering amortization
or accretion if the securities were purchased at a premium or discount.
Except as indicated and for U.S. Treasury and other U.S. Government agencies,
total securities of any state (including all its political subdivisions) were
less than 10% of shareholders' equity. At year-end 1999 and 1998, the amortized
cost of securities issued by the state of Michigan and all its political
subdivisions totaled $13,114,000 and $19,883,000 with an estimated market value
of $13,132,000 and $20,729,000, respectively.
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III. LOAN PORTFOLIO
(Dollars in Thousands)
Types of Loans
The following table sets forth the classification of loans by major category at
December 31:
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Commercial, financial, and
agricultural $ 96,758 $ 82,533 $ 74,819 $ 72,108 $ 51,940
Real estate mortgage (1) 63,423 51,567 50,057 47,561 41,293
Installment 33,190 29,203 33,865 33,009 30,004
----------- ----------- ----------- ----------- -----------
Total loans $ 193,371 $ 163,303 $ 158,741 $ 152,678 $ 123,237
=========== =========== =========== =========== ===========
(1) Includes loans held for sale
Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table sets forth the maturities of the loan portfolio at December
31, 1999. Also provided are the amounts due after one year classified according
to interest rate sensitivity.
Within 1 1 to 5 After 5
Year (A) Years Years Total
-------- ----- ----- -----
Commercial, financial, and agricultural $ 34,461 $ 38,999 $ 23,298 $ 96,758
Real estate mortgages 6,431 1,935 55,057 63,423
Installment 1,816 18,096 13,278 33,190
----------- ----------- ----------- -----------
Total $ 42,708 $ 59,030 $ 91,633 $ 193,371
=========== =========== =========== ===========
Loans maturing after one year with:
Fixed interest rates $ 44,786 $ 23,127
Variable interest rates 14,244 68,506
----------- -----------
Total $ 59,030 $ 91,633
=========== ===========
(A) Amounts include demand loans, loans having no stated schedule of
repayments, or no stated maturity and overdrafts.
11
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III. LOAN PORTFOLIO (CONTINUED)
Non-Performing Loans
Non performing loans include impaired loans, nonaccrual and accruing loans past
due 90 days or more. The following table sets forth the aggregate amount of
non-performing loans in each of the following categories:
December 31
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Non accrual loans:
Commercial, financial and
agricultural $ 306 $ 343 $ 1,026 $ 448 $ 380
Real estate mortgage 23 - - - 24
Installment - - 61 2 40
----------- ----------- ----------- ----------- -----------
329 343 1,087 450 444
Loans contractually past due 90 days
or more:
Commercial, financial, and
agricultural 432 807 1,067 82 353
Real estate mortgage 134 161 630 129 56
Installment 34 120 966 165 4
----------- ----------- ----------- ----------- -----------
600 1,088 2,663 376 413
----------- ----------- ----------- ----------- -----------
Total $ 929 $ 1,431 $ 3,750 $ 826 $ 857
=========== =========== =========== =========== ===========
Percent of total loans outstanding .48% .88% 2.36% .54% .70%
=========== =========== =========== =========== ===========
The accrual of interest income generally is discontinued when a loan becomes
over 90 days past due as to principal or interest. When interest accruals are
discontinued, interest credited to income in the current year and accrued
interest from the prior year is reversed. Management may elect to continue the
accrual of interest when: (1) the estimated net realizable value of collateral
is sufficient to cover the principal balance and accrued interest and; (2) the
loan is in the process of collection.
Interest of $9,000 and $19,000 was realized on nonaccrual loans during 1999 and
1998, respectively. Under original terms for these loans, interest income which
would have been recorded approximates $50,000 and $91,000 in 1999 and 1998,
respectively. There are no loan commitments outstanding to extend credits to
these customers.
Potential Problem Loans
At December 31, 1999, the Company had approximately $2,683,000 in commercial,
financial, agricultural loans for which payments are presently current, but the
borrowers are experiencing certain financial and/or operational difficulties.
These loans are subject to frequent management review and their classification
is reviewed on a monthly basis.
All loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention have been included in the above disclosures.
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13
IV. SUMMARY OF LOAN LOSS EXPERIENCE
(Dollars in Thousands)
The following table sets forth changes in the allowance for loan losses:
Year Ended December 31
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Balance at beginning of year $ 2,026 $ 1,863 $ 1,814 $ 1,609 $ 1,498
Charge offs:
Commercial, financial and agricultural (505) (227) (122) (13) (87)
Installment (492) (352) (386) (157) (124)
Real estate (53) - - - -
--------- --------- -------- -------- ---------
(1,050) (579) (508) (170) (211)
Recoveries:
Commercial, financial and agricultural 171 41 31 43 43
Installment 132 101 66 62 54
Real estate 1 - - 3 3
--------- --------- -------- -------- ---------
304 142 97 108 100
--------- --------- -------- -------- ---------
Net charge offs (746) (437) (411) (62) (111)
Provision for loan losses 852 600 460 267 222
--------- --------- -------- -------- ---------
Balance at end of year $ 2,132 $ 2,026 $ 1,863 $ 1,814 $ 1,609
========= ========= ======== ======== =========
Average loans outstanding $ 178,906 $ 160,666 $158,193 $137,273 $ 123,684
========= ========= ======== ======== =========
Ratio of net charge offs to average loans outstanding .42% .27% .26% .05% .09%
======= ========= ======== ======== =========
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IV. SUMMARY OF LOAN LOSS EXPERIENCE (CONTINUED)
Allocation of the Allowance for Loan Losses
The Securities and Exchange Commission's guide to the presentation of
statistical information provides for a break down of the allowance for loan
losses into major loan categories. The Company allocates the allowance among the
various categories through an analysis of the loan portfolio composition, prior
loan loss experience, evaluation of those loans identified as being probable
problems in collection, results of examination by regulatory agencies and
current economic conditions. The entire allowance is available to absorb any
losses without regard to the category or categories in which the charged off
loans are classified.
Even though such an allocation has inherent limitations, the Company has
compiled the results of its various reviews and has made estimates of the risk
which might be allocated to the respective loan categories.
The following table sets forth the allocation of the allowance for loan losses
at December 31:
--------1 9 9 9-------- --------1 9 9 8-------- --------1 9 9 7---------
------- ------- -------
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category Category Category
Of Total Of Total Of Total
Allowance Loans Allowance Loans Allowance Loans
Commercial, financial and agricultural $ 924 50.0% $ 777 50.5% $ 628 47.1%
Real estate mortgage 127 32.8 103 31.6 98 31.0
Installment 601 17.2 521 17.9 321 21.9
Unallocated 480 - 625 - 816 -
--------- ------- --------- ------- --------- ------
$ 2,132 100.0% $ 2,026 100.0% $ 1,863 100.0%
========= ======= ========= ======= ========= ======
---------1 9 9 6--------- ---------1 9 9 5---------
------- -------
Percent of Percent of
Loans in Loans in
Each Each
Category Category
Of Total Of Total
Commercial, financial and agricultural Allowance Loans Allowance Loans
Real estate mortgage
Installment $ 351 47.2% $ 313 42.1%
Unallocated 95 31.2 83 33.5
177 21.6 157 24.4
1,191 - 1,056 -
--------- ------- --------- -------
$ 1,814 100.0% $ 1,609 100.0%
========= ======= ========= =======
The allowance for loan losses is maintained at a level which, in management's
opinion, is adequate to absorb loan losses in the portfolio. In assessing the
adequacy of the allowance, management reviews the characteristics of the loan
portfolio in order to determine overall quality and risk profiles. Some factors
considered by management in determining the level at which the allowance is
maintained include a continuing evaluation of those loans identified as being
subject to possible problems in collection, results of examination by regulatory
agencies, current economic conditions, and historical loan loss experience.
The 1996 provision increased from 1995 levels to provide for loan growth. The
1997 provision was increased to provide for loan growth and the increase in
charge-offs and delinquencies. Several customers, including a large commercial
borrower, declared bankruptcy during 1997 resulting in increased charge-offs.
The 1999 and 1998 provisions increased to provide for higher charge-offs and
delinquencies, primarily as a result of increased customer bankruptcies. Net
commercial loan charge-offs totaled $334,000 in 1999; $267,000 of this was
attributable to three commercial borrowers that discontinued business operations
during 1999.
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V. DEPOSITS
(Dollars in Thousands)
The following table sets forth the average amount of deposits and rates paid for
deposits for the years ended December 31:
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
Amount Rate Amount Rate Amount Rate
Non interest bearing demand deposits $ 32,982 $ 30,570 $ 30,004
Interest bearing demand deposits 77,664 3.2% 74,154 3.3% 63,856 3.4%
Savings deposits 45,722 3.3 44,356 3.4 43,505 3.4
Time deposits 73,553 5.1 68,177 5.4 67,993 5.3
--------- --------- ---------
$ 229,921 $ 217,257 $ 205,358
========= ========= =========
The following table sets forth as of December 31, 1999, the aggregate amount of
outstanding deposits (certificates of deposit) of $100,000 or more by maturity
(in thousands of dollars):
Three months or less $ 8,858
Over three months through six months 5,686
Over six months through twelve months 3,850
Over twelve months 4,719
----------
$ 23,113
==========
VI. RETURN ON EQUITY AND ASSETS
The following table sets forth consolidated operating and capital ratios for the
years ended December 31:
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
Return on average assets 1.23% 1.42% 1.30%
Return on average equity (1) 16.37 17.48 14.96
Dividend payout ratio (2) 41.61 35.56 36.58
Average equity to average assets (1) 7.52 8.11 8.69
(1) Average equity used in the above table excludes common stock subject to
repurchase obligation but includes average unrealized appreciation or
depreciation on securities available for sale.
(2) Dividends declared divided by net income.
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ITEM 2. PROPERTIES
The Bank's main office is located at 51 West Pearl Street, Coldwater,
Michigan and is owned by the Bank. This facility, which opened in 1955 and
expanded in 1976, consists of a one story structure comprising 27,945 square
feet. Parking is available for approximately 125 cars and 9 teller windows are
available to serve the Bank's customers. The Bank owns eleven branch offices,
two of which are in Coldwater, two in Union City, Michigan, one in Kinderhook,
Michigan, one in Tekonsha, Michigan, one in Hillsdale, Michigan, one in Camden,
Michigan, one in Athens, Michigan, one in North Adams, Michigan and one in
Pennfield Township (Battle Creek), Michigan. The Bank also leases 1,700 square
feet from a third party for use in its Battle Creek Loan Production Office. In
addition, the Company owns a 15,000 square foot building in Battle Creek,
Michigan and a 14,000 square foot building in Coldwater, Michigan. 6,000 square
feet of the Battle Creek building is leased to the Bank for use by one of its
Battle Creek branches. 3,500 square feet is leased to a local college, 2,300
square feet is leased as office space to local businesses and the remaining
space is presently unoccupied. 7,446 square feet of the Coldwater building is
leased to the Bank for use as a Consumer Loan center, 3,420 square feet is
leased to a local title office, 762 square feet is leased to a local insurance
company and 394 square feet is leased to community nonprofit organizations. The
Bank's branch offices range in size from 465 square feet to 6,000 square feet,
with nine of the branch offices having drive-in facilities and seven of the
branches having automated teller machines.
All of the Company's and the Bank's facilities are maintained in good
condition and are adequately insured. Management of Company believes the present
facilities are adequate to meet both current and future needs.
ITEM 3. LEGAL PROCEEDINGS
The Bank is frequently engaged in litigation, both as plaintiff and
defendant, which is incident to its business. In certain proceedings, claims or
counterclaims may be asserted against the Bank. Based on the facts known to it
to date, management of the Company does not currently anticipate that the
ultimate liability, if any, arising out of any such litigation will have a
material effect on the consolidated financial statements of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
17
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is regularly quoted on the OTC Bulletin
Board (OTCBB). The bid prices described below are quotations reflecting
inter-dealer prices, without retail markup, markdown or commissions, and may not
necessarily represent actual transactions. There were 469 shareholders of record
at February 29, 2000.
The following table sets forth the range of high and low bid
information and dividends declared for the Company's two most recent fiscal
years:
1999 1998
------------------------------------------ -------------------------------------------
BID PRICE CASH BID PRICE CASH
------------------------- DIVIDENDS ------------------------ DIVIDENDS
HIGH BID LOW BID DECLARED HIGH BID LOW BID DECLARED
Quarter Ended
- -------------------------------------------------------------------------------------------------------------------------
March 31 $ 33.08 $ 27.00 $ .16 $ 37.80 $ 30.60 $ .13
June 30 32.40 27.23 .17 46.13 37.13 .13
September 30 29.70 26.10 .17 40.50 37.13 .15
December 31 30.60 27.23 .18 37.80 29.48 .19
There are restrictions that currently limit the Company's ability to pay cash
dividends. Information regarding dividend payment restrictions is described in
Note L to the consolidated financial statements for the year ended December 31,
1999.
All market price per share amounts have been adjusted for a 10% stock dividend
declared in 1999.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31
1999 1998 1997 1996 1995
----------------------------------------------------------------------------
Total interest income $ 20,051 $ 19,446 $ 18,669 $ 16,787 $ 15,476
Net interest income 11,616 11,414 11,226 10,183 9,096
Provision for loan losses 852 600 460 267 222
Net income 3,300 3,549 3,032 3,058 2,615
Per share data:
Basic and diluted earnings per share 1.64 1.70 1.44 1.46 1.27
Cash dividends .68 .60 .52 .48 .45
Balance sheet data:
Other borrowings 15,000 5,000 3,000 - -
Capital note - - - - 1,000
Common stock subject to repurchase 3,990 6,029 4,899 3,555 2,232
Equity 19,990 19,345 20,590 19,616 18,497
Total assets 275,825 266,851 238,531 235,562 209,977
Return on average assets 1.23% 1.42% 1.30% 1.45% 1.31%
Return on average equity 16.37% 17.48% 14.96% 16.09% 14.64%
All per share amounts have been adjusted for a 10% stock dividend declared in
1999, a 1997 stock split effected in the form of a 100% stock dividend and a 2
for 1 stock split in 1995.
17
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion provides information about the Company's
financial condition which supplements the Consolidated Financial Statements. The
analysis should be read in conjunction with such financial statements.
FINANCIAL CONDITION
The Company functions as a financial intermediary and, as such, its
financial condition should be examined in terms of trends in its sources and
uses of funds.
The Company uses its funds primarily to support its lending activities.
Loans increased by 18.4% in 1999 and 2.9% in 1998. The loan growth occurred in
all loan categories and is the result of continued good economic conditions
within the Company's market area. Commercial loans increased 17.2% as local
businesses expanded to meet the growth demands of the region. Consumer loans
increased 13.7% as the Bank competitively priced its boat and recreational
vehicle loans and offered dealer incentives to obtain such loans. Real estate
mortgage loans increased 23.0% as the Bank engaged in a home equity loan
promotion and offered an attractive short-term fixed rate mortgage loan product.
Gains recognized on the sale of real estate mortgage loans to the
secondary market decreased in 1999 from $1,085,000 in 1998 to $758,000. The
secondary market loan activity declined in 1999 as mortgage rates increased and
the refinancing activity of 1998 declined. Loans held for sale at December 31,
1999 were $991,000. The real estate portfolio largely consists of residential
mortgages within the local area with a low risk of loss.
The loan growth in 1998 occurred in commercial loans, which increased
by 10.3% as local businesses expanded and took advantage of lower interest
rates. Consumer loans declined in 1998 as a result of competition from both
financial and non-financial companies which offer borrowers other low cost
financing options. The real estate portfolio increased primarily due to the
offering of competitive home equity products.
Loan commitments, consisting of unused credit card and home equity
lines, available amounts on revolving lines of credit and other approved loans
which have not been funded, were $37,949,000 and $31,175,000 at December 31,
1999 and 1998, respectively. Most of these commitments are priced at a variable
interest rate thus minimizing the Bank's risk in a changing interest rate
environment.
There were no significant concentrations in any loan category as to
borrower or industry. However, substantially all loans are granted to customers
primarily in Southern Michigan.
Another significant component of cash flow is the securities portfolio.
Total securities decreased by 20.1% in 1999 and increased by 50.6% in 1998. The
funds received from maturing securities were used to fund the 1999 loan growth
since the Bank was not able to fund this growth with deposits. The 1998 increase
is the result of a significant increase in deposits.
The available-for-sale portfolio had net unrealized losses of $589,000
in 1999 and gains of $394,000 in 1998. During 1999, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities" and transferred the entire
portfolio of held to maturity securities to available for sale. The transfer was
done so that the securities would be available to sell should the Company's
liquidity needs require it. None of these securities were sold during 1999.
There is no concentration of securities in the portfolio which would constitute
an unusual risk except at year-end 1999 and
18
19
1998, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $13,114,000 and $19,883,000 with an estimated
market value of $13,132,000 and $20,729,000, respectively.
Deposits traditionally represent the Company's principal source of
funds. Total deposits remained stable in 1999 and increased 12.7% in 1998. The
Bank was not able to increase its deposit base in 1999 because of increased
competition within the Bank's market area. Local competitors have offered
premium rates for deposits and the Bank has chosen not to match such rates. Also
contributing to the lack of deposit growth was an increase in customer cash
withdrawals late in the year in preparation for the Year 2000 rollover. The 1998
increase in deposits is the result of a complete overhaul of the Bank's personal
checking accounts which allowed the Bank to increase the number of deposit
accounts. The Bank experienced an increase not only in demand deposit accounts,
but in other deposit accounts as well as customers opened secondary accounts to
supplement their new checking accounts.
Attracting and keeping traditional deposit relationships will continue
to be a challenge to the Bank, particularly with the increased competition from
nondeposit products. As an alternate funding source, the Bank obtains putable
advances from the Federal Home Loan Bank (FHLB) of Indianapolis. The advances
are secured by a blanket collateral agreement with the FHLB giving the FHLB an
unperfected security interest in the Bank's one-to-four family whole mortgage
loans, U.S. Treasury and Government agencies and highly rated private
mortgage-backed securities. FHLB advances can be a less expensive way to obtain
longer term funds than paying a premium for long term deposits.
Premises and equipment decreased by 4.7% in 1999 and increased by 25.9%
in 1998. The 1999 decrease was due to a lack of significant additions and
increased depreciation because of the high level of additions in 1998. The Bank
opened a new branch office in Hillsdale in October 1998 at an approximate cost
of $2,000,000. The Bank made this significant investment because of the growth
potential in Hillsdale. In 2000, the Bank will spend approximately $2,300,000 to
renovate the Coldwater main office and the Beckley Road office.
On February 15, 2000, the Company announced that it had agreed to merge
with Sturgis Bank & Trust Company of Sturgis, Michigan ("Sturgis"). The
transaction is anticipated to be a tax-free exchange. It is subject to
regulatory approvals and approval by the shareholders of Sturgis, and is
anticipated to be effective the second half of 2000. The exchange ratio is .398
shares of the Company's common stock for one share of Sturgis' common stock.
CAPITAL RESOURCES
The Company maintains a strong capital base to take advantage of
business opportunities while ensuring that it has resources to absorb the risks
inherent in the business.
The Federal Reserve Board (FRB) has imposed risk-based capital
guidelines applicable to the Company. These guidelines require that bank holding
companies maintain capital commensurate with both on and off balance sheet
credit risks of their operations. Under the guidelines, a bank holding company
must have a minimum ratio of total capital to risk-weighted assets of 8 percent.
In addition, a bank holding company must maintain a minimum ratio of Tier 1
capital equal to 4 percent of risk-weighted assets. Tier 1 capital includes
common shareholders' equity, qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries less goodwill.
As a supplement to the risk-based capital requirements, the FRB has
also adopted leverage capital ratio requirements. The leverage ratio
requirements are intended to insure that adequate capital is maintained against
risk other than credit risk. The leverage ratio requirements establish a minimum
ratio of Tier 1 capital to total assets of 3 percent for the most highly rated
bank holding companies and banks that do not anticipate and are
19
20
not experiencing significant growth. All other bank holding companies are
required to maintain a ratio of Tier 1 capital to assets of 4 to 5 percent,
depending on the particular circumstances and risk profile of the institution.
Regulatory agencies have determined that the capital component created
by the adoption of FASB Statement 115 should not be included in Tier 1 capital.
As such, the net unrealized appreciation or depreciation on available-for-sale
securities is not included in the ratios listed in Note O to the financial
statements. The ratios include the common stock subject to repurchase obligation
in the Company's employee stock ownership plan (ESOP) and the unearned ESOP
shares. As seen in Note O, the Company exceeds the well capitalized
requirements.
In addition to these regulatory requirements, a certain level of
capital growth must be achieved to maintain appropriate levels of equity to
total assets. During 1999 and 1998, total average assets grew 7.1% and 7.2%. At
the same time, average equity (including common stock held by the ESOP)
decreased 2.3% in 1999 and increased 5.2% in 1998. Equity grew at lower levels
than assets in both 1999 and 1998 because of the repurchase and retirement of
common stock shares (82,442 shares in 1999 and 51,079 in 1998). Future growth
opportunities will focus on maintaining the existing customer base and growing
within selected other markets identified as providing significant growth
potential.
LIQUIDITY AND INTEREST RATE SENSITIVITY
The primary functions of asset/liability management are to assure
adequate liquidity and maintain an appropriate balance between interest-earning
assets and interest-bearing liabilities. Liquidity management involves the
ability to meet the cash flow requirements of customers who may be either
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. Interest rate
sensitivity management seeks to avoid fluctuating net interest margins and
enhance consistent growth of net interest income through periods of changing
interest rates.
Maturing loans and investment securities are the principal sources of
asset liquidity. Securities maturing or callable within 1 year were $17,732,000
at December 31, 1999 representing 32.7% of the amortized cost of the investment
securities portfolio, a decrease from the 43.4% level of 1998. Loans maturing
within 1 year were $42,708,000 at December 31, 1999 representing 22.1% of the
loan portfolio, a slight decrease from the 23.2% level of 1998.
Financial institutions are subject to prepayment risk in falling rate
environments. Prepayments of assets carrying higher rates reduce the Company's
interest income and overall asset yields. Certain portions of an institution's
liabilities may be short-term or due on demand, while most of its assets may be
invested in long-term loans or investments. Accordingly, the Company seeks to
have in place sources of cash to meet short-term demands. These funds can be
obtained by increasing deposits, borrowing, or selling assets. Also, Federal
Home Loan Bank advances and short-term borrowings provide additional sources of
liquidity for the Company.
During the year ended December 31, 1999, there was a net decrease in
cash and cash equivalents of $4,182,000. The major sources of cash in 1999 were
loan sales and maturing securities. The major uses of cash in 1999 were loan
growth and loans originated for sale.
During the year ended December 31, 1998, there was a net decrease in
cash and cash equivalents. of $620,000. The major sources of cash in 1998 were
loan sales and the increase in deposits. The major uses of cash in 1998 were the
purchase of investment securities and loans originated for sale.
During the year ended December 31, 1997, there was a net increase in
cash and cash equivalents of $3,328,000. The major sources of cash in 1997 were
loan sales and maturing securities. The major uses of cash in 1997 were loan
growth and loans originated for sale.
20
21
Federal law places restrictions on extensions of credit from banks to
their parent holding company and, with certain exceptions, to other affiliates,
on investments in stock or other securities thereof, and on taking of such
securities as collateral for loans. State law also places restrictions on the
payment of dividends by the Bank to the Company. Note L to the Consolidated
Financial Statements discusses these dividend limitations.
Interest rate risk arises when the maturity or repricing
characteristics of assets differ significantly from the maturity or the
repricing characteristics of liabilities. Accepting this risk can be an
important source of profitability and shareholder value, however excessive
levels of interest rate risk could pose a significant threat to the Company's
earnings and capital base. Accordingly, effective risk management that maintains
interest rate risk at prudent levels is essential to the Company's safety and
soundness.
The Company measures the impact of changes in interest rates on net
interest income through a comprehensive analysis of the Bank's interest rate
sensitive assets and liabilities. Interest rate sensitivity varies with
different types of interest-earning assets and interest-bearing liabilities.
Overnight federal funds and mutual funds on which rates change daily and loans
which are tied to the prime rate or a comparable index differ considerably from
long-term investment securities and fixed-rate loans. Similarly, certificates of
deposit and money market investment accounts are much more interest sensitive
than passbook savings accounts. The shorter term interest rate sensitivities are
key to measuring the interest sensitivity gap, or excess interest-earning assets
over interest-bearing liabilities. In addition to reviewing the interest
sensitivity gap, the Company also analyzes projected changes in market interest
rates and the resulting effect on net interest income.
The following table shows the interest sensitivity gaps for five
different time intervals as of December 31, 1999:
0-30 31-90 91-365 1-5 Over 5
Days Days Days Years Years
---- ---- ---- ----- -----
Interest-earning assets $ 54,348 $ 6,439 $ 56,815 $ 108,904 $ 21,749
Interest-bearing liabilities 53,968 84,526 42,013 25,260 10,000
----------------------------------------------------------------------
Interest sensitivity gap $ 380 $ (78,087) $ 14,802 $ 83,644 $ 11,749
======================================================================
The primary interest sensitive assets in the one year repricing range
are commercial loans and adjustable rate mortgage loans. The primary interest
sensitive liabilities in the one year repricing range are money market
investment accounts, certificates of deposit and interest bearing checking
accounts. This analysis indicates that growth in rate sensitive liabilities has
outpaced the growth in rate sensitive assets in the one year range. This has
occurred primarily as a result of the inclusion of interest bearing checking
accounts and savings accounts in a repricing period of one year or less as these
accounts have become rate sensitive as interest rates have fluctuated. The
long-term interest sensitivity gap indicates that the Company's net interest
margin would improve with an increase in interest rates and decline with further
declines in interest rates. Trying to minimize the interest sensitivity gap is a
continual challenge in a changing rate environment and one of the objectives of
the Company's asset/liability strategy.
RESULTS OF OPERATIONS
Net interest income is an effective measurement of how well management
has balanced the Company's interest rate sensitive assets and liabilities. Net
interest income increased by 1.8% in 1999, 1.7% in 1998 and 10.2% in 1997. The
1999 increase is due to the reinvestment of funds held in the investment
securities portfolio
21
22
into the higher yielding loan portfolio, partially offset by increased interest
expense as a result of increased FHLB advances. The 1998 increase is due to the
reinvestment of funds held in overnight federal funds accounts into higher
yielding investment securities. The 1997 net interest income increased as a
result of the reinvestment of funds received from maturing investment securities
into the higher yielding loan portfolio, along with the stability of the
Company's cost of funds.
The uncertain economic environment and potential fluctuations in
interest rates are expected to continue to impact the Company and the industry
in 2000. Depending on these interest rate fluctuations, there may be continued
market pressure to raise deposit rates in 2000 and to lower loan rates. The
Company monitors deposit rates on a weekly basis and adjusts deposit rates as
the market dictates. Loan rates are subject to change as the national prime rate
changes and are also influenced by competitor's rates. An increase in deposit
rates occurring at the same time as loan rate decreases would cause the
Company's net interest income to decline.
The provision for loan losses is based on an analysis of the required
additions to the allowance for loan losses. The allowance for loan losses is
maintained at a level believed adequate by management to absorb potential losses
in the loan portfolio. Some factors considered by management in determining the
level at which the allowance is maintained include specific credit reviews, past
loan loss experience, current economic conditions and trends, results of
examinations by regulatory agencies and the volume, growth and composition of
the loan portfolio.
The provision for loan losses was $852,000 in 1999, $600,000 in 1998
and $460,000 in 1997. The 1999 provision increase occurred to provide for loan
growth and increased charge-offs, primarily as a result of increased customer
bankruptcies. Net commercial loan charge-offs totaled $334,000 in 1999; $267,000
of this was attributable to three commercial borrowers that discontinued
business operations during 1999. The 1998 provision was increased to provide for
increased charge-offs and delinquencies, primarily as a result of increased
customer bankruptcies. The 1997 provision was increased to provide for loan
growth and the increase in charge-offs and delinquencies. Several customers,
including a large commercial borrower, declared bankruptcy during 1997 resulting
in increased charge-offs. It is anticipated that the Company will continue to
experience higher than normal losses in 2000. The provision will be adjusted
quarterly, if necessary, to reflect actual charge-off experience and any known
future losses.
Non-interest income, excluding security gains and losses, decreased by
5.4% in 1999 and increased by 30.2% in 1998 and 15.2% in 1997. The 1999 decrease
is due primarily to a decline in gains recognized on the sale of real estate
mortgage loans to the secondary market. In order to reduce the risk associated
with changing interest rates, the Bank regularly sells fixed rate real estate
mortgage loans on the secondary market. The Bank recognizes a profit at the time
of the sale and receives a fee in order to service the loans. As fixed rate
mortgage rates increased in 1999, the number of new loans and refinancing
activities declined.
The 1998 increase is due to increased service charge income, increased
gains recognized on the sale of secondary market real estate mortgage loans and
increased income from the Bank's automatic teller machines (ATMs). The Bank
increased its deposit base by 12.7% in 1998 and generated additional service
charges as a result of the growth. During this period of relatively low interest
rates, the Bank generated large volumes of fixed rate mortgage loans which were
sold to the secondary market. During 1998, the Bank began assessing a fee to
noncustomers who use the Bank's ATMs and thus increased fees generated.
The 1997 increase is due to increased service charges on deposit
accounts as a result of the additional deposits purchased in connection with the
acquisition of two branches late in 1996, increased gains recognized on the sale
of secondary market real estate mortgage loans in 1997 due to an increase in
activity, increased fees from the sale of nondepository investment products in
1997 due to an increase in activity and unrecognized losses on real estate
mortgage loans held for sale recorded in 1996. These increases were partially
offset by a
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decline in trust income due to a decline in trust assets and a decline in
earnings on Bank owned life insurance policies due to an increase in premium
payments.
Security gains of $5,000 were recognized in 1997. No sales occurred in
1999 or 1998.
Non-interest expense increased by 2.2% in 1999, 1.8% in 1998 and 16.0%
in 1997. In 1999, salaries and benefit expenditures increased as additional loan
department employees were added to assist with the increased loan volume.
Occupancy and equipment costs were higher in 1999 as a result of the addition of
the new Hillsdale branch and its equipment additions, increasing maintenance on
the Bank's older properties and technological upgrades to the Bank's mainframe
and personal computers. Professional and outside services were higher in 1999 as
a result of increased usage of consultants for general bank consulting purposes.
Advertising and marketing expenses were down for 1999 as a result of higher
expenses paid to promote the Bank's new checking product in 1998.
The primary expense categories that increased in 1998 were occupancy
and equipment and professional and outside services. Occupancy and equipment
costs increased as a result of the opening of the new Hillsdale branch and
continued upgrades to the Bank's technology base. Professional and outside
services increased as a result of increased usage of consultants for general
bank consulting purposes.
The 1997 increase was due to additional personnel costs, occupancy and
equipment costs, advertising and marketing expenditures, training costs and
intangible asset amortization as a result of the acquisition of two branches
late in 1996. Trust department expenses also increased in 1997 as professional
consultants and new trust administrators were added in order to increase the
trust department's market share. Equipment costs increased in 1997 as the
Company invested in significant technological upgrades.
Income tax expense was $1,005,000 in 1999, $1,185,000 in 1998 and
$1,085,000 in 1997. Tax-exempt income continues to have a major impact on the
Company's tax expense. The lower coupon rate on municipal instruments is offset
by the nontaxable feature of the income earned on such instruments. This
resulted in a lower effective tax rate and reduced federal income tax expense by
approximately $358,000 in 1999, $350,000 in 1998 and $254,000 in 1997.
Results of operations can be measured by various ratio analyses. Two
widely recognized performance indicators are the return on equity and the return
on assets. The Company's return on average equity was 16.4% in 1999, 17.5% in
1998 and 15.0% in 1997. The return on average assets was 1.2% in 1999, 1.4% in
1998 and 1.3% in 1997.
The majority of assets and liabilities of a financial institution are
monetary in nature and therefore differ greatly from most commercial and
industrial companies that have significant investments in fixed assets or
inventories. However, inflation does have an important impact on the growth of
total assets in the banking industry and the resulting need to increase equity
capital at higher than normal rates in order to maintain an appropriate
equity-to-assets ratio. Another significant effect of inflation is on other
expenses, which tend to rise during periods of general inflation.
Management believes the most significant impact on financial results is
the Company's ability to react to changes in interest rates. As discussed
previously, management is attempting to maintain an essentially balanced
position between interest sensitive assets and liabilities in order to protect
against wide interest rate fluctuations.
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YEAR 2000
The Company had a successful Year 2000 rollover. The Company has not
experienced any significant Year 2000 problems as a result of the rollover, and
is not aware of any customers that have experienced material Year 2000 problems.
This success can be attributed to the fact that the Company began addressing
Year 2000 issues in mid 1997. The Company followed a plan to identify all
critical business processes and established a priority schedule for assessment
of each process. As the Company worked through its Year 2000 plan, any hardware,
software, equipment or vendor provided services that were identified as not Year
2000 compliant were either upgraded or retired. While no Year 2000 problems have
been identified to date, monitoring will continue for most of 2000 to assure
that all Year 2000 issues have been addressed.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, accruing loans past due
90 days or more, and other real estate which includes foreclosures and deeds in
lieu of foreclosure.
A loan generally is classified as nonaccrual when full collectibility
of principal or interest is doubtful or a loan becomes 90 days past due as to
principal or interest, unless management determines that the estimated net
realizable value of the collateral is sufficient to cover the principal balance
and accrued interest. When interest accruals are discontinued, unpaid interest
credited to income in the current year is reversed, and unpaid interest accrued
in prior years is charged to the allowance for loan losses. Nonperforming loans
are returned to performing status when the loan is brought current and has
performed in accordance with contract terms for a period of time.
The following table sets forth the aggregate amount of nonperforming
loans in each of the following categories:
December 31
1999 1998 1997
-------------------------------------
(Dollars in thousands)
Nonaccrual loans:
Commercial, financial and agricultural $ 306 $ 343 $ 1,026
Real estate mortgage 23 - -
Installment - - 61
---------------------------------------------
329 343 1,087
Loans contractually past due 90 days or more:
Commercial, financial and agricultural 432 807 1,067
Real estate mortgage 134 161 630
Installment 34 120 966
---------------------------------------------
600 1,088 2,663
---------------------------------------------
Total nonperforming loans 929 1,431 3,750
Other real estate owned 4 166 103
---------------------------------------------
Total nonperforming assets $ 933 $ 1,597 $ 3,853
---------------------------------------------
Nonperforming loans to year-end loans .48% .88% 2.36%
=== === ====
Nonperforming assets to year-end loans
and other real estate owned .48% .98% 2.43%
=== === ====
Nonperforming loans are subject to continuous monitoring by management
and are specifically reserved for in the allowance for loan losses where
appropriate.
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At December 31, 1999, the Company had approximately $2,683,000 in
commercial, financial and agricultural loans for which payments are presently
current but the borrowers are experiencing certain financial and/or operational
difficulties. These loans are subject to frequent management review and their
classification is reviewed on a monthly basis.
In management's evaluation of the loan portfolio risks, any significant
future increases in nonperforming loans is dependent to a large extent on the
economic environment. In a deteriorating or uncertain economy, management
applies more conservative assumptions when assessing the future prospects of
borrowers and when estimating collateral values. This may result in a higher
number of loans being classified as nonperforming.
REGULATORY MATTERS
Representatives of the Financial Institutions Bureau, a division of the
Department of Commerce of the State of Michigan, completed an examination at the
Company's subsidiary bank using financial information as of May 24, 1999. The
purpose of the examination was to determine the safety and soundness of the
Bank.
Examination procedures require individual judgments about a borrower's
ability to repay loans, sufficiency of collateral values and the effects of
changing economic circumstances. These procedures are similar to those employed
by the Company in determining the adequacy of the allowance for loan losses and
in classifying loans. Judgments made by regulatory examiners may differ from
those made by management. The Company's level and classification of identified
potential problem loans was not revised significantly as a result of this
regulatory examination process.
Management and the Board of Directors evaluate existing practices and
procedures on an ongoing basis. In addition, regulators often make
recommendations during the course of their examination that relate to the
operations of the Company and the Bank. As a matter of practice, management and
the Board of Directors consider such recommendations promptly.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk and to
a lesser extent liquidity risk. See Liquidity and Interest Rate Sensitivity,
above. Business is transacted in U.S. dollars with no foreign exchange rate risk
or any direct exposure to changes in commodity prices.
The following tables provide information about the Company's financial
instruments that are sensitive to changes in interest rates as of December 31,
1999 and 1998. The Company had no derivative financial instruments, or trading
portfolio, at either date. The expected maturity date values for loans
receivable, mortgage-backed securities and investment securities were calculated
without adjusting the instrument's contractual maturity date for expectations of
prepayments. Expected maturity date values for interest-bearing core deposits
were not based upon estimates of the period over which the deposits would be
outstanding, but rather the opportunity for repricing. Similarly, with respect
to its variable rate instruments, the Company believes that repricing dates, as
opposed to expected maturity dates may be more relevant in analyzing the value
of such instruments and are reported as such in the following table. Company
borrowings are also reported based on conversion or repricing dates.
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1999 Principal Amount Maturing in: Fair Value
2000 2001 2002 2003 2004 Thereafter Total 12/31/99
---- ---- ---- ---- ---- ---------- ----- --------
Rate sensitive assets:
Fixed interest rate loans $11,510 $ 5,997 $ 10,769 $ 11,439 $ 16,581 $ 23,127 $ 79,423 $ 78,477
Average interest rate 8.98 9.01 9.03 9.52 9.72 9.31 9.12
Variable interest rate loans 84,171 5,636 4,514 6,928 10,934 1,765 113,948 113,948
Average interest rate 8.65 8.92 8.89 9.03 8.90 9.17 8.75
Fixed interest rate securities 9,638 7,985 11,546 11,217 2,902 10,941 54,229 54,229
Average interest rate 5.45 5.57 5.64 5.87 5.44 5.32 5.60
Other interest bearing assets 655 655 655
Average interest rate 5.14% 5.14%
Rate sensitive liabilities
Interest bearing demand
deposits 82,498 82,498 82,498
Average interest rate 3.19 3.19
Passbook savings 30,793 30,793 30,793
Average interest rate 2.40 2.40
Time deposits 57,453 8,044 5,765 574 29 71,865 71,959
Average interest rate 5.11 5.65 5.55 5.15 5.14 5.23
Other deposits 6,482 2,792 1,265 234 4,250 15,023 14,911
Average interest rate 4.87 5.25 5.29 5.30 5.31 5.11
Fixed interest rate
borrowings 13,588 2,000 15,588 15,588
Average interest rate 5.32 5.77 5.38
1998 Principal Amount Maturing in: Fair Value
1999 2000 2001 2002 2003 Thereafter Total 12/31/98
---- ---- ---- ---- ---- ---------- ----- --------
Rate sensitive assets:
Fixed interest rate loans $ 9,887 $ 6,679 $ 8,478 $ 10,259 $ 11,483 $ 11,582 $ 58,368 $ 58,653
Average interest rate 10.81 9.98 10.25 10.50 9.79 9.01 10.02
Variable interest rate loans 77,513 5,190 4,157 6,380 10,069 1,626 104,935 104,935
Average interest rate 8.75 8.63 8.65 8.79 9.00 8.72 8.70
Fixed interest rate securities 21,933 11,304 7,962 5,327 2,971 18,397 67,894 68,831
Average interest rate 4.71 4.62 4.59 4.64 4.58 4.71 4.60
Other interest bearing assets 6,610 6,610 6,610
Average interest rate 4.84% 4.84%
Rate sensitive liabilities
Interest bearing demand
deposits 79,255 79,255 79,255
Average interest rate 3.05 3.05
Passbook savings 31,797 31,797 31,797
Average interest rate 2.30 2.30
Time deposits 54,704 10,774 5,164 1,797 72,439 72,899
Average interest rate 5.11 4.83 4.74 4.81 5.00
Other deposits 6,461 2,825 1,282 235 4,289 15,092 16,209
Average interest rate 4.35 5.81 5.72 5.65 5.60 5.40
Fixed interest rate
borrowings 3,588 2,000 5,588 5,588
Average interest rate 5.47 5.47 5.47
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the Section
entitled "Quantitative and Qualitative Disclosures about Market Risk" included
under Item 7 of this report and is incorporated herein by reference.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See consolidated financial statements of the Company which are included
in Item 14., Exhibits, Financial Statement Schedules and Reports on Form 8-K,
and begin on page FS-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table lists the names of the directors and their ages as
of February 29, 2000, their principal occupations and the year in which each
became a director. Mr. Grohalski is the only executive officer of the Company.
YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR PAST 5 DIRECTOR OF THE COMPANY
NAME OF DIRECTOR AGE YEARS(1)
----------------------------------- --------- ---------------------------------------- ---------------------------
James P. Briskey 66 Owner - Pittsford Grain Incorporated 1982
(grain elevator operator)
H. Kenneth Cole 51 Treasurer - Hillsdale College 1998
William E. Galliers 57 Co-Owner and Chief Executive Officer - 1993
G & W Display Fixtures, Inc.
(manufacturer of display fixtures)
James T. Grohalski 59 President and Chief Executive Officer 1982
of the Company and the Bank since
December 31, 1998; Executive Vice
President and Chief Financial Officer
of the Company and President of the
Bank from January 1, 1984 until
December 31, 1998; Mr. Grohalski
joined the Bank in 1967.
Nolan E. Hooker 48 Owner - Hooker Oil Co. (distributor of 1991
heating oil)
Gregory J. Hull 51 Farmer 1955
Thomas E. Kolassa 52 Owner - The Planning Group (insurance) 1995
James J. Morrison 52 Owner - Morrison & Associates 1991
(insurance)
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YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR PAST 5 DIRECTOR OF THE COMPANY
NAME OF DIRECTOR AGE YEARS(1)
----------------------------------- --------- ---------------------------------------- ---------------------------
Jane L. Randall 78 Owner - Dally Tire Co. (tire 1982
distributor)
Freeman E. Riddle 67 Owner - Spoor & Parlin, Inc. (farm 1982
equipment)
Jerry L. Towns 65 President and Chief Executive Officer 1982
of the Company and Chairman and Chief
Executive Officer of the Bank until
retirement on December 31, 1998
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth compensation paid by the Company and the
Bank with respect to the fiscal year ended December 31, 1999 to the Company's
Chief Executive Officer. Mr. Grohalski is the only executive officer of the
Company.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
-------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($)(1) COMPENSATION ($)(2)
-----------------------------------------------------------------------------------------------------------
James T. Grohalski
President and Chief Executive
Officer of the 1999 $140,570 $7,344
Company and the
Bank 1998 $133,813 $7,400
1997 $135,225 $7,202
(1) The amounts shown include amounts deferred under the 401(k)
provisions of the ESOP and the Bank's Executives' Deferred
Compensation Plan.
(2) The amounts shown include the following for 1999: (i) employer
contributions to accounts in the ESOP and the Deferred
Compensation Plan of $4,000 and $3,000 respectively for Mr.
Grohalski; and (ii) $344 constituting the value of insurance
premiums paid by the Bank for term life insurance for Mr.
Grohalski's benefit.
Retirement Benefits
Officers of the Company participate in the Southern Michigan Bank &
Trust Retirement Plan (the "Retirement Plan") which has been adopted by the
Bank. Under the terms of the Retirement Plan, a normal monthly retirement
benefit is provided to covered employees who attain the age of 65. It provides
for a normal retirement benefit after 30 years of credited service equal to 35%
of a participant's actual monthly compensation based on the participant's
highest consecutive five year average compensation (see column captioned
"Remuneration"). For participants with less than 30 years credited service,
reduced benefits are available in an amount equal to the normal retirement
benefit reduced by 1/30 for each year of service less than 30. Participants are
100% vested after five years of credited service, and are subject to forfeiture
upon termination of employment with credited service less than five years. The
following table represents estimated normal
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annual benefits payable on a straight-life annuity basis upon retirement at age
65 and are not subject to deduction for social security benefits:
PENSION PLAN TABLE
YEARS OF SERVICE
-------------------------------------------------------------
REMUNERATION 25 30 35
-----------------------------------------------------------------------------------------------
$110,000 $32,100 $38,500 $38,500
$120,000 $35,000 $42,000 $42,000
$130,000 $37,900 $45,500 $45,500
$140,000 $40,800 $49,000 $49,000
$150,000 $43,750 $52,500 $52,500
James T. Grohalski has 32 years of credited service and $132,500 current covered
remuneration.
The Bank also has in effect supplemental retirement arrangements in the
form of Executive Employee Salary Continuation Agreements with Messrs. Grohalski
and Towns under which a specified annual benefit, in addition to that provided
under the Retirement Plan, is payable to the participant upon retirement at age
65. The participant is entitled to a reduced benefit if his retirement occurs
between the ages of 62 and 65. No benefit is payable if the participant
voluntarily terminates his employment or is discharged for cause prior to the
age of 62. However, the specified benefit is payable beginning at age 65, if the
participant's employment is terminated after a "change in control" of the
Company, and in connection with such change, his title, responsibility or
compensation is significantly lessened or the status of his employment is
changed without his consent. The specified annual benefit, when added to the
benefit under the Retirement Plan, is intended to be approximately equal to the
benefit the participant would have received under the Retirement Plan but for a
plan amendment which changed the Retirement Plan's benefit formula to comply
with changes in pension laws and which substantially reduced the participants'
benefits. For James T. Grohalski, the specified benefit payable upon retirement
at age 65 under the supplemental retirement arrangement is $22,060 per year for
15 years. The Board of Directors may increase the benefit by not more than 2%
per year prior to retirement.
The Bank also has an Executives' Deferred Compensation Plan (the
"Deferred Compensation Plan") for directors and certain officers. Under the
Deferred Compensation Plan, participants elect to defer a portion of their
compensation (in the case of directors, their fees) on a pretax basis. Upon
retirement at or after age 65, the participant or his or her designated
beneficiary is entitled to a benefit equal to the amount of the participant's
deferrals to the Deferred Compensation Plan plus earnings on such deferrals at a
specified rate of interest compounded annually, payable in equal monthly amounts
for not less than 180 months. Upon the participant's termination of employment
or retirement before age 65, the benefit payable to the participant at age 65 is
determined by multiplying the amount deferred under the Deferred Compensation
Plan by the ratio of the number of months for which the participant made
deferrals to the number of months from the time the participant began making
deferrals to the participant's reaching age 65. The amounts shown in the summary
compensation table above include amounts deferred as contributions under the
Deferred Compensation Plan.
Compensation Committee Report on Executive Compensation
Executive Compensation Policies.
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30
The Company's executive compensation policies are designed to support
the corporate objective of maximizing the long-term value of the Company to its
shareholders and employees. To achieve this objective, the Compensation
Committee believes it is important to provide competitive levels of compensation
to attract and retain the most qualified executives, to recognize individuals
who exceed expectations and to link closely overall corporate performance and
executive pay.
The Company has established two primary components of the Company's
executive compensation plan. The two components are: (a) base compensation; and
(b) stock-based performance compensation through stock option grants, subject to
the shareholders' approval of the Southern Michigan Bancorp, Inc. 2000 Stock
Option Plan described below.
Base Compensation.
The Compensation Committee annually reviews base salaries of executive
officers. Factors which influence decisions made by the Compensation Committee
regarding base salaries are levels of responsibility and potential for future
responsibilities, salary levels offered by competitors and overall performance
of the Company. The Compensation Committee's practice in establishing salary
levels is based in part upon overall Company performance and is not based upon
any specific objectives or policies, but reflects the subjective judgment of the
Compensation Committee. However, specific annual performance goals are
established for each executive officer. Based on the Compensation Committee's
comparison of the Company's overall compensation levels as a percent of revenues
and net income to comparable companies in the industry, the Compensation
Committee believes its overall compensation levels are in the middle of the
range.
Stock Option Grants.
Executive compensation to reward past performance and to motivate
future performance will also be provided through stock options granted under the
Southern Michigan Bancorp, Inc. 2000 Stock Option Plan if approved by the
shareholders. The purpose of the plan is to encourage executive officers to
maintain a long-term stock ownership position in the Company in order that their
interests are aligned with those of the Company's shareholders. The Board of
Directors, in its discretion, has the authority to determine participants in the
plan, the number of shares to be granted and the option price and term.
Consideration for stock option awards are evaluated on a subjective basis and
granted to participants until an ownership position exists which is consistent
with the participant's current responsibilities.
Chief Executive Officer Compensation.
The Compensation Committee established Mr. Grohalski's base salary
based primarily on a subjective evaluation of the Company's prior year's
financial results, past salary levels and compensation paid to other chief
executive officers in the Company's industry. Based on the Compensation
Committee's comparison of the Company's overall compensation level for Mr.
Grohalski as a percent of revenue and net income to comparable companies in the
industry, the Compensation Committee believes his overall compensation level is
in the middle of the range.
RESPECTFULLY SUBMITTED BY THE MEMBERS OF THE COMPENSATION COMMITTEE, James J.
Morrison, H. Kenneth Cole and James P. Briskey.
Director Compensation
Currently, each director of the Company whose principal occupation is
not with the Company or the Bank receives an annual fee of $6,200 which will be
indexed for inflation in 2000. In addition, outside directors are compensated
$150 for each committee meeting attended and participate in a bonus program
based upon the
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achievement of growth and profitability goals. No bonus was paid to outside
directors for 1999. Subject to approval by the shareholders as described below,
the directors will be eligible to receive stock options under the Southern
Michigan Bancorp, Inc. 2000 Stock Option Plan.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 29, 2000, the names and
addresses of all beneficial owners of 5% or more of the Common Stock showing the
amount and nature of such beneficial ownership:
NAME & ADDRESS OF AMOUNT & NATURE OF PERCENT
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP(1) OF CLASS
-----------------------------------------------------------------------------------------------------------
Common Stock Southern Michigan Bank 169,500(a) 8.65%
& Trust
51 West Pearl Street
Coldwater, MI 49036
Common Stock Harvey B. Randall 146,075(b) 7.46%
8391 Old U.S. 27 South
Marshall, MI 49068
(1) Based upon information furnished to the Company by the beneficial
owners named above. The nature of beneficial ownership for shares
shown is sole voting and investment power, except as set forth
below. Shares have been rounded to the nearest whole share.
(a) Shares are held by the Trust Department of Southern Michigan
Bank & Trust (the "Bank") in various fiduciary capacities.
16,270 of such shares are voted by the Bank with no
investment power.
(b) Includes 146,022 shares held by Mr. Randall as trustee.
The following table sets forth, as of February 29, 2000, the total
number of shares of the Common Stock beneficially owned, and the percent of such
shares so owned, by each director and by all directors and executive officers of
the Company as a group.
NAME OF BENEFICIAL OWNER OR AMOUNT AND NATURE OF TOTAL PERCENT OF
NUMBER OF PERSONS IN GROUP BENEFICIAL OWNERSHIP(1) CLASS
----------------------------------------------------------------------------------------
James P. Briskey 10,648 21,296 1.09
10,648 (a)
H. Kenneth Cole 169 169 (2)
William E. Galliers 2,260 (a) 2,260 (2)
James T. Grohalski(3) 21,868 (b) 21,868 1.12
Nolan E. Hooker 950 (a) 950 (2)
Gregory J. Hull 1,099 (a) 1,099 (2)
Thomas E. Kolassa 1,527 (a) 1,527 (2)
James J. Morrison 346 2,904 (2)
2,558 (a)
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NAME OF BENEFICIAL OWNER OR AMOUNT AND NATURE OF TOTAL PERCENT OF
NUMBER OF PERSONS IN GROUP BENEFICIAL OWNERSHIP(1) CLASS
----------------------------------------------------------------------------------------
Jane L. Randall 5,774 (c) 5,774 (2)
Freeman E. Riddle 4,554 7,000 (2)
2,446 (a)
Jerry L. Towns (4) 126 (a) 7,048 (2)
6,922 (d)
All directors and executive 71,895 71,895 3.67%
officers as a group (11 persons)
(1) Based upon information furnished to the Company by the individual
named and the members of the designated group. The nature of
beneficial ownership for shares shown is sole voting and
investment power except as set forth below. Shares have been
rounded to the nearest whole share.
(a) Shared voting and investment power.
(b) Includes 19,385 shares held by the Bank's Employee Stock
Ownership Plan (the "ESOP") as to which Mr. Grohalski has
voting power only.
(c) Shares indicated are held as trustee.
(d) Shares are voted by the Bank as IRA custodian unless
otherwise directed by Mr. Towns.
(2) Less than one percent (1%).
(3) Mr. Grohalski is the only executive officer of the Company.
(4) Mr. Towns served on the Board of Directors since 1982 and is
retiring as a director effective April 17, 2000. Mr. Towns' three
year term as a director expires as of the 2000 Annual Meeting.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Directors and officers of the Company and their associates were
customers of, and had transactions with the Bank in the ordinary course of
business during 1999. All loans and commitments included in such transactions
were made in the ordinary course of business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons and did not involve more than the
normal risk of collectibility or present other unfavorable features.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)The following consolidated financial statements of the Company
are filed as a part of this report and are included herewith
beginning on page FS-1:
- Report of Crowe, Chizek and Company LLP, independent
auditors
- Consolidated Balance Sheets - December 31, 1999 and 1998
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33
- Consolidated Statements of Changes in Shareholders' Equity -
Years ended December 31, 1999, 1998 and 1997
- Consolidated Statements of Income - Years ended December 31,
1999, 1998 and 1997
- Consolidated Statements of Cash Flows - Years ended December
31, 1999, 1998 and 1997
- Notes to Consolidated Financial Statements - December 31,
1999
(a)(2)Not applicable.
(a)(3)Exhibits (Numbered in accordance with Item 601 of Regulation
S-K).
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 2 Agreement and Plan of Consolidation dated February
15, 2000 by and between the Company and Sturgis
Bank & Trust Company, a Michigan savings bank.
Exhibit 3(i) Articles of Incorporation incorporated by reference
to Exhibit 3 to the Company's Annual Report on Form
10-K for the year ended December 31, 1991 and
Exhibit 3 to Form S-3D filed April 30, 1998.
Exhibit 3(ii) Amended and Restated By-Laws are incorporated by
reference to Exhibit 3 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997.
Exhibit 4 Instruments Defining the Rights of Security Holders
of the Company are the Articles of Incorporation
and By-Laws (see Exhibits 3(i) and (ii) above).
Exhibit 9 Not applicable.
Exhibit 10(a) Material Contracts - Executive Compensation Plans
and Arrangements: (1) Master Agreements for
Directors' Deferred Income Plan; (2) Composite form
of Executive Employee Salary Continuation
Agreement, as amended; and (3) Master Agreements
for Executives' Deferred Compensation Plan, as
amended, are incorporated by reference to Exhibit
10 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994.
Exhibit 10(b) Southern Michigan Bancorp, Inc. 2000 Stock Option
Plan.
Exhibit 11 Not applicable.
Exhibit 12 Not applicable.
Exhibit 13 Not applicable.
Exhibit 16 Not applicable.
Exhibit 18 Not applicable.
Exhibit 19 Not applicable.
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34
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 21 Subsidiaries of the Company.
Exhibit 22 Not applicable.
Exhibit 23 Consent of Independent Auditors.
Exhibit 27 Financial Data Schedule.
(b) No reports on Form 8-K were filed in the last Quarter of the
period covered by this report.
(c) Exhibits - See Item 14(a)(3) above.
(d) Financial Statement Schedules - Omitted due to inapplicability or
because required information is shown in the Financial Statements
and Notes thereto.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO
SECTION 12 OF THE ACT
(a) On March 24, 2000, the Company delivered to the Commission via
EDGAR its proxy statement dated March 24, 2000 which was prepared
for its 2000 Annual Meeting of Shareholders and, which proxy
statement included, in Appendix B, the information required in
its 2000 Annual Report.
(The remainder of this page is intentionally blank. The next page is FS-1).
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REPORT OF INDEPENDENT AUDITORS
[CROWE CHIZEK LOGO]
Shareholders and Board of Directors
Southern Michigan Bancorp, Inc.
Coldwater, Michigan
We have audited the accompanying consolidated balance sheets of Southern
Michigan Bancorp, Inc. as of December 31, 1999 and 1998 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our 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 Southern Michigan
Bancorp, Inc. as of December 31, 1999 and 1998 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999 in conformity with generally accepted accounting principles.
As disclosed in Note C, on July 1, 1999 the Company changed its method of
accounting for derivative instruments and hedging activities to comply with new
accounting guidance.
Crowe, Chizek and Company LLP
South Bend, Indiana
February 11, 2000
FS-1
36
CONSOLIDATED BALANCE SHEETS
(In thousands, except number of shares)
December 31,
1999 1998
---------------------------
ASSETS
Cash $ 4,217 $ 3,021
Due from banks 7,829 13,207
---------------------------
Cash and cash equivalents 12,046 16,228
Federal funds sold 4,000
Securities available for sale 54,229 36,138
Securities held to maturity (fair value $32,693 - 1998) 31,756
Loans, net of allowance for loan losses $2,132 - 1999 ($2,026 - 1998) 191,239 161,277
Premises and equipment 6,705 7,036
Accrued interest receivable 2,442 2,418
Net cash surrender value of life insurance 5,251 5,026
Other assets 3,913 2,972
---------------------------
TOTAL ASSETS $ 275,825 $ 266,851
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 33,124 $ 34,778
Interest bearing 200,179 198,583
---------------------------
Total deposits 233,303 233,361
Accrued expenses and other liabilities 3,542 3,116
Other borrowings 15,000 5,000
---------------------------
TOTAL LIABILITIES 251,845 241,477
Common stock subject to repurchase obligation in
Employee Stock Ownership Plan, shares outstanding - 130,502 in 1999
(150,727 in 1998) 3,990 6,029
Shareholders' equity
Preferred stock, 100,000 shares authorized; none issued or outstanding
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 1,969,259 shares in 1999 (1,872,677 in 1998)
Outstanding - 1,838,757 shares in 1999 (1,721,950 in 1998) 4,597 4,305
Additional paid-in capital 8,421 3,863
Retained earnings 7,949 11,505
Accumulated other comprehensive income (loss), net of tax $200 - 1999,
$(134) - 1998 (389) 260
Unearned Employee Stock Ownership Plan shares (588) (588)
---------------------------
TOTAL SHAREHOLDERS' EQUITY 19,990 19,345
---------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 275,825 $ 266,851
===========================
See accompanying notes to consolidated financial statements.
FS-2
37
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except number of shares and per share data)
Accumulated
Other
Comprehensive
Additional Income, Unearned
Common Paid-In Retained (Loss) ESOP
Stock Capital Earnings Net of Tax Shares TOTAL
----------------------------------------------------------------------------
BALANCE AT JANUARY 1, 1997 $ 2,174 $ 2,734 $ 14,687 $ 21 $ $ 19,616
Net income for 1997 3,032 3,032
Cash dividends declared - $.52 per share (1,109) (1,109)
Common stock issued under dividend
reinvestment plan (9,879 shares) 25 365 390
100% stock dividend issued (956,695
shares) 2,392 (2,392)
Change in common stock subject
to repurchase (159) (1,185) (1,344)
Net change in unrealized gain on
available for sale securities, net of tax 5 5
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 4,432 1,914 14,218 26 20,590
Net income for 1998 3,549 3,549
Cash dividends declared - $.60 per share (1,262) (1,262)
Common stock issued under dividend
reinvestment plan (6,835 shares) 18 233 251
Common stock repurchased and
retired (51,079 shares) (128) (2,171) (2,299)
Transfer from retained earnings to
additional paid-in capital 5,000 (5,000)
Change in common stock subject
to repurchase (17) (1,113) (1,130)
Purchase of shares by ESOP
(14,000 shares) (588) (588)
Net change in unrealized gain on
available for sale securities, net of tax 234 234
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 4,305 3,863 11,505 260 (588) 19,345
Net income for 1999 3,300 3,300
Cash dividends declared - $.68 per share (1,373) (1,373)
10% stock dividend issued (179,024
shares) 447 5,036 (5,483)
Common stock repurchased and
retired (82,442 shares) (206) (2,466) (2,672)
Change in common stock subject
to repurchase 51 1,988 2,039
Net change in unrealized gain (loss) on
available for sale securities, net of tax (649) (649)
-----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 $ 4,597 $ 8,421 $ 7,949 $ (389) $ (588) $ 19,990
=============================================================================
See accompanying notes to consolidated financial statements.
FS-3
38
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Year ended December 31,
1999 1998 1997
------------------------------------------
Interest income:
Loans, including fees $ 16,577 $ 15,781 $ 15,545
Securities:
Taxable 2,235 2,305 2,189
Tax-exempt 1,132 1,094 861
------------------------------------------
3,367 3,399 3,050
Other 107 266 74
------------------------------------------
Total interest income 20,051 19,446 18,669
Interest expense:
Deposits 7,738 7,622 7,260
Other 697 410 183
------------------------------------------
Total interest expense 8,435 8,032 7,443
------------------------------------------
NET INTEREST INCOME 11,616 11,414 11,226
Provision for loan losses 852 600 460
------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,764 10,814 10,766
Non-interest income:
Service charges on deposit accounts 1,064 978 835
Trust fees 486 500 528
Securities gains 5
Net gains on loan sales 758 1,085 550
Earnings on life insurance assets 208 220 181
Other 509 413 360
------------------------------------------
3,025 3,196 2,459
Non-interest expense:
Salaries and employee benefits 4,569 4,528 4,508
Occupancy 854 781 697
Equipment 979 872 762
Printing, postage and supplies 385 466 419
Advertising and marketing 287 417 444
Professional and outside services 428 326 242
Other 1,982 1,886 2,036
------------------------------------------
9,484 9,276 9,108
------------------------------------------
Income before income taxes 4,305 4,734 4,117
Federal income taxes 1,005 1,185 1,085
------------------------------------------
NET INCOME 3,300 3,549 3,032
Other comprehensive income:
Unrealized gains (losses) on securities arising during the year (1,599) 355 13
Net cumulative effect of adopting new accounting principle 616
Reclassification adjustment for accumulated (gains) losses
included in net income (5)
Tax effect 334 (121) (3)
------------------------------------------
Other comprehensive income (loss) (649) 234 5
------------------------------------------
COMPREHENSIVE INCOME $ 2,651 $ 3,783 $ 3,037
==========================================
BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 1.64 $ 1.70 $ 1.44
==========================================
See accompanying notes to consolidated financial statements.
FS-4
39
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended December 31,
1999 1998 1997
------------------------------------------
OPERATING ACTIVITIES
Net income $ 3,300 $ 3,549 $ 3,032
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 852 600 460
Depreciation 711 599 527
Net amortization of investment securities 206 182 138
Net realized gain on sales of investment securities (5)
Loans originated for sale (27,348) (34,550) (17,175)
Proceeds on loans sold 27,773 35,167 17,489
Net gains on loan sales (758) (1,085) (550)
Net change in:
Accrued interest receivable (24) (342) (161)
Other assets (607) 60 124
Accrued expenses and other liabilities 481 (459) 160
------------------------------------------
Net cash from operating activities 4,586 3,721 4,039
INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold 4,000 500 (4,500)
Activity in available-for-sale securities:
Sales 255
Maturities and calls 19,238 9,522 12,187
Purchases (19,387) (32,808) (1,167)
Activity in held-to-maturity securities:
Maturities and calls 12,625 6,852 4,355
Purchases (6,213) (4,230)
Increase in net cash surrender value of life insurance (225) (612) (432)
Loan originations and payments, net (30,481) (4,531) (6,230)
Additions to premises and equipment (380) (2,047) (888)
------------------------------------------
Net cash from investing activities (14,610) (29,337) (650)
FINANCING ACTIVITIES
Net change in deposits (58) 26,296 (2,402)
Proceeds from other borrowings 10,000 2,000 3,000
Common stock issued 251 390
Cash dividends paid (1,428) (1,252) (1,049)
Repurchase of common stock (2,672) (2,299)
------------------------------------------
Net cash from financing activities 5,842 24,996 (61)
------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (4,182) (620) 3,328
Beginning cash and cash equivalents 16,228 16,848 13,520
------------------------------------------
ENDING CASH AND CASH EQUIVALENTS $ 12,046 $ 16,228 $ 16,848
==========================================
Transfers of securities from held to maturity
to available for sale $ 19,747 $ - $ -
See accompanying notes to consolidated financial statements.
FS-5
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND INDUSTRY SEGMENTS: Southern Michigan Bancorp, Inc. is a
bank holding company. The Company's business is concentrated in the banking
industry segment. The business of commercial and retail banking accounts for
more than 90% of its revenues, operating income and assets. While the Company's
chief decision makers monitor the revenue stream of various company products and
services, operations are managed and financial performance is evaluated on a
company-wide basis. Accordingly, all of the Company's banking operations are
considered by management to be aggregated into one operating segment. The Bank
offers individuals, businesses, institutions and government agencies a full
range of commercial banking services primarily in the southern Michigan
communities in which the Bank is located and in areas immediately surrounding
these communities. The Bank grants commercial, real estate and consumer loans to
customers. The majority of loans are secured by business assets, commercial and
residential real estate, and consumer assets. There are no foreign loans.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Southern Michigan Bancorp, Inc. (the Company) and its wholly owned
subsidiary, Southern Michigan Bank & Trust (the Bank), after elimination of
significant intercompany balances and transactions.
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, liabilities and
disclosure of contingent 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. Estimates that are more
susceptible to change in the near term include the allowance for loan losses,
deferred income tax provisions, fair values of certain securities and other
financial instruments and the actuarial present value of pension benefit
obligations, net periodic pension expense and prepaid pension costs.
SECURITIES: Management determines the appropriate classification of securities
at the time of purchase. If management has the intent and the Company has the
ability at the time of purchase to hold securities until maturity, they are
classified as held to maturity and carried at amortized historical cost.
Securities to be held for indefinite periods of time and not intended to be held
to maturity are classified as available for sale and carried at fair value, with
unrealized gains and losses reported in other comprehensive income and
shareholders' equity, net of tax. Securities classified as available for sale
include securities that management intends to use as part of its asset/liability
management strategy and that may be sold in response to changes in interest
rates, resultant prepayment risk, and other factors.
Premiums and discounts on securities are recognized in interest income using the
level yield method over the estimated life of the security. Gains and losses on
the sale of available for sale securities are determined using the specific
identification method. Securities are written down to fair value when a decline
in fair value is not temporary.
LOANS: Loans are reported at the principal balance outstanding, net of unearned
interest, deferred loan fees and costs, and an allowance for loan losses.
Interest income is reported on the interest method and includes amortization of
net deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation
allowance for probable credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Estimating the risk of loss and
the amount of loss on any loans is necessarily subjective. Accordingly,
management estimates the allowance balance required based on past loan loss
experience, known and inherent risks in the portfolio, information about
specific borrower situations and estimated collateral values, economic
conditions, and other factors. Allocations of the allowance may be made for
specific loans, but the entire allowance is available for any loan that, in
management's judgment, should be charged-off. A problem loan is charged-off by
management as a loss when deemed uncollectible, although collection efforts
continue and future recoveries may occur.
FS-6
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated in total for smaller-balance loans of similar
nature such as residential mortgage and consumer loans and on an individual loan
basis for other loans. If a loan is impaired, a portion of the allowance is
allocated so that the loan is reported, net, at the present value of estimated
future cash flows using the loan's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Loans are
evaluated for impairment when payments are delayed, typically 90 days or more,
or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
accumulated depreciation. Depreciation is computed principally using accelerated
methods over their estimated useful lives. These assets are reviewed for
impairment when events indicate their carrying amount may not be recoverable
from future undiscounted cash flows. Maintenance, repairs and minor alterations
are charged to current operations as expenditures occur. Major improvements are
capitalized.
SERVICING RIGHTS: Servicing rights represent both purchased rights and the
allocated value of servicing rights retained on loans sold. Servicing rights are
expensed in proportion to, and over the period of, estimated net servicing
revenues.
Impairment is evaluated based on the fair value of the rights, using groupings
of the underlying loans as to interest rates and then, secondarily, as to
geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance.
GOODWILL AND CORE DEPOSIT INTANGIBLES: Goodwill is the excess of purchase price
over identified net assets in business acquisitions. Goodwill is amortized on
the straight-line method over 15 years. Identified intangibles represent the
value of depositor relationships purchased and are amortized on accelerated
methods over 10 years. Goodwill and identified intangibles are assessed for
impairment based on estimated undiscounted cash flows, and written down if
necessary. Goodwill was $745,000 and $807,000 and core deposit intangibles were
$376,000 and $464,000 at December 31, 1999 and 1998, respectively. These
balances are included in other assets.
OTHER REAL ESTATE: Other real estate was $161,000 and $166,000 at December 31,
1999 and 1998 and is included in other assets. Other real estate is comprised of
properties acquired through a foreclosure proceeding or acceptance of a deed in
lieu of foreclosure. These properties are initially recorded at fair value at
the date of foreclosure, establishing a new cost basis by a charge to the
allowance for loan losses. After foreclosure, valuations are periodically
performed by management and real estate is carried at the lower of cost or fair
value less estimated cost of disposal.
INCOME TAXES: Income tax expense is the total of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts for the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
EARNINGS AND DIVIDENDS PER COMMON SHARE: Basic earnings per common share is
based on net income divided by the weighted average number of common shares
outstanding during the period. ESOP shares are considered outstanding for this
calculation unless unearned. Diluted earnings per common share reflects the
dilutive effect of any additional potential common shares. Earnings and
dividends per share are restated for all stock splits and stock dividends
through the date of issue of the financial statements.
CASH FLOW INFORMATION: For purposes of the consolidated statements of cash
flows, the Company considers cash and due from banks as cash and cash
equivalents. The Company reports net cash flows for customer loan and deposit
transactions.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes the net change in
unrealized gains and losses on securities available for sale, net of tax, which
is also recognized as a separate component of shareholders' equity.
FS-7
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions. Fair value
estimates involve uncertainties and matters of significant judgment regarding
interest rates, credit risk, prepayments and other factors, especially in the
absence of broad markets for particular items. Changes in assumptions or in
market conditions could significantly affect such estimates.
CONCENTRATIONS OF CREDIT RISK: The Company grants commercial, real estate and
installment loans to customers mainly in Southern Michigan. Commercial loans
include loans collateralized by commercial real estate, business assets and
agricultural loans collateralized by crops and farm equipment. Commercial,
financial and agricultural loans make up approximately 50% of the loan portfolio
and the loans are expected to be repaid from cash flow from operations of
businesses. Residential mortgage loans make up approximately 33% of the loan
portfolio and are collateralized by mortgages on residential real estate.
Consumer loan loans make up approximately 17% of the loan portfolio and are
primarily collateralized by consumer assets.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: The Company, in the normal
course of business, makes commitments to extend credit which are not reflected
in the consolidated financial statements.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there are such matters that will have a
material effect on the consolidated financial statements at December 31, 1999
and 1998.
RECLASSIFICATIONS: Some items in the prior year consolidated financial
statements have been reclassified to conform with the current year presentation.
NOTE B - BASIC AND DILUTED EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators of the computations of basic
and diluted earnings per common share for the years ended December 31, 1999,
1998 and 1997 is presented below:
Year Ended December 31,
1999 1998 1997
---- ---- ----
BASIC EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,300 $ 3,549 $ 3,032
==========================================
Weighted average common shares outstanding 2,027,015 2,084,821 2,101,494
Less: Unallocated ESOP shares (15,400) (2,566) -
------------------------------------------
Weighted average common shares outstanding for basic
earnings per common share 2,011,615 2,082,255 2,101,494
==========================================
Basic earnings per common share $ 1.64 $ 1.70 $ 1.44
==========================================
DILUTED EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,300 $ 3,549 $ 3,032
==========================================
Weighted average common and dilutive
potential common shares outstanding 2,011,615 2,082,255 2,101,494
==========================================
Diluted earnings per common share $ 1.64 $ 1.70 $ 1.44
==========================================
FS-8
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - SECURITIES
Year end investment securities were as follows (in thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE, 1999 COST GAINS LOSSES VALUE
---------------------------------------------------------
U.S. Treasury and Government agencies $ 15,885 $ $ (344) $ 15,541
States and political subdivisions 28,529 106 (224) 28,411
Corporate securities 6,203 1 (32) 6,172
Mortgage-backed securities 3,278 (96) 3,182
---------------------------------------------------------
Total debt securities 53,895 107 (696) 53,306
Equity securities 923 923
---------------------------------------------------------
TOTAL $ 54,818 $ 107 $ (696) $ 54,229
=========================================================
There were no securities held to maturity as of December 31, 1999.
AVAILABLE FOR SALE, 1998
U.S. Treasury and Government agencies $ 9,019 $ 68 $ $ 9,087
States and political subdivisions 20,236 315 (5) 20,546
Corporate securities 1,302 8 1,310
Mortgage-backed securities 2,677 8 2,685
---------------------------------------------------------
Total debt securities 33,234 399 (5) 33,628
Equity securities 2,510 2,510
---------------------------------------------------------
TOTAL $ 35,744 $ 399 $ (5) $ 36,138
=========================================================
HELD TO MATURITY, 1998
States and political subdivisions $ 16,460 $ 897 $ $ 17,357
Corporate securities 14,592 49 (9) 14,632
---------------------------------------------------------
Total debt securities 31,052 946 (9) 31,989
Equity securities 704 704
---------------------------------------------------------
TOTAL $ 31,756 $ 946 $ (9) $ 32,693
=========================================================
Sales of available for sale securities were (in thousands):
1999 1998 1997
------------------------------------------
Proceeds $ 0 $ 0 $ 255
Gross gains 0 0 5
Gross losses 0 0 0
Contractual maturities of debt securities at year-end 1999 were as follows (in
thousands). Securities not due at a single maturity date, primarily
mortgage-backed securities, are shown separately. Expected maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
---------------------------
Due in one year or less $ 8,994 $ 8,991
Due from one to five years 31,906 31,571
Due from five to ten years 7,057 6,863
Due after ten years 2,660 2,699
Mortgage-backed securities 3,278 3,182
---------------------------
$ 53,895 $ 53,306
===========================
FS-9
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - SECURITIES (CONTINUED)
Investment securities with an amortized cost of $2,911,000 and $3,303,000 were
pledged as collateral for public deposits and for other purposes in 1999 and
1998.
Except as indicated, total securities of any state (including all its political
subdivisions) were less than 10% of shareholders' equity. At year-end 1999 and
1998, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $13,114,000 and $19,883,000 with an estimated
market value of $13,132,000 and $20,729,000, respectively.
As of July 1, 1999, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities." Under SFAS No. 133, all derivative instruments are recorded at
their fair values. If derivative instruments are designated as hedges of fair
values, both the change in the fair value of the hedge and the hedged item are
included in current earnings. Fair value adjustments related to cash flow hedges
are recorded in other comprehensive income and reclassified to earnings when the
hedged transactions are reflected in earnings. Ineffective portions of hedges
are reflected in income currently. The Company does not have any derivative
instruments nor does the Company have any hedging activities. As permitted by
SFAS No. 133, the Company transferred securities with an amortized cost of
$19,131,000 and a fair value of $19,747,000 from the held to maturity portfolio
to the available for sale portfolio. None of these securities were sold during
1999.
NOTE D - LOANS
Loans at year-end were as follows (in thousands):
1999 1998
---------------------------
Commercial $ 96,758 $ 82,533
Consumer 33,190 29,203
Real estate mortgage 62,432 50,909
Loans held for sale, net of valuation allowance of $-0- in 1999 and 1998 991 658
---------------------------
193,371 163,303
Less allowance for loan losses (2,132) (2,026)
---------------------------
LOANS, NET $ 191,239 $ 161,277
===========================
Certain directors and executive officers of the Company and the Bank, including
their associates and companies in which they are principal owners, were loan
customers of the Bank. The following is a summary of loans (in thousands)
exceeding $60,000 in the aggregate to these individuals and their associates.
1999 1998
---------------------------
Balance at January 1 $ 3,923 $ 3,722
New loans 6,222 7,767
Repayments (5,487) (7,624)
Other changes, net (156) 58
---------------------------
BALANCE AT DECEMBER 31 $ 4,502 $ 3,923
===========================
The unpaid principal balance of mortgage loans serviced for others, which are
not included on the consolidated balance sheet, was $69,880,000 and $51,462,000
at December 31, 1999 and 1998, respectively. Related escrow deposit balances
were approximately $11,000 and $2,000 at December 31, 1999 and 1998,
respectively.
Activity for capitalized mortgage servicing rights was as follows (in
thousands):
1999 1998
---------------------------
Balance at January 1 $ 595 $ 327
Additions 377 468
Amortized to expense (176) (200)
---------------------------
BALANCE AT DECEMBER 31 $ 796 $ 595
===========================
No valuation allowance for capitalized mortgage servicing rights was necessary
at December 31, 1999 or 1998.
FS-10
45
NOTE E - ALLOWANCES FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31 were as
follows (in thousands):
1999 1998 1997
------------------------------------------
Balance at January 1 $ 2,026 $ 1,863 $ 1,814
Provision for loan losses 852 600 460
Loans charged off (1,050) (579) (508)
Recoveries 304 142 97
------------------------------------------
Net charge-offs (746) (437) (411)
------------------------------------------
BALANCE AT DECEMBER 31 $ 2,132 $ 2,026 $ 1,863
==========================================
1999 1998
---------------------------
Information regarding impaired loans follows:
Year end loans with allowance for loan losses allocated $ 1,543 $ 1,259
Year end loans with no allowance for loan losses allocated 700 0
---------------------------
Total impaired loans $ 2,243 $ 1,259
===========================
Amount of allowance allocated to these loans $ 275 $ 367
Average balance of impaired loans during the year $ 2,415 $ 1,566
Cash basis interest income recognized during the year $ 191 $ 73
Interest income recognized during the year $ 200 $ 102
NOTE F - PREMISES AND EQUIPMENT
Premises and equipment consist of (in thousands):
1999 1998
---------------------------
Land $ 786 $ 786
Buildings and improvements 7,685 7,625
Equipment 3,442 3,157
---------------------------
11,913 11,568
Less accumulated depreciation (5,208) (4,532)
---------------------------
TOTALS $ 6,705 $ 7,036
===========================
Depreciation and amortization expense charged to operations was approximately
$711,000, $599,000 and $527,000 in 1999, 1998 and 1997, respectively.
NOTE G - DEPOSITS
The carrying amount of domestic deposits at year end follows (in thousands):
1999 1998
---------------------------
Non-interest bearing checking $ 33,124 $ 34,778
Interest bearing checking 38,927 37,055
Passbook savings 30,793 31,797
Money market accounts 43,571 42,200
Time deposits 71,865 72,439
Individual retirement accounts and other deposits 15,023 15,092
---------------------------
TOTALS $ 233,303 $ 233,361
===========================
FS-11
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - DEPOSITS (CONTINUED)
The carrying amount of time deposits over $100,000 was $23,113,000 and
$21,058,000 at December 31, 1999 and 1998, respectively. Interest expense on
time deposits over $100,000 was $1,198,000, $1,084,000 and $1,025,000 at
December 31, 1999, 1998 and 1997, respectively.
At year end, scheduled maturities of time deposits were as follows for the years
ending December 31 (in thousands):
2000 $ 57,453
2001 8,044
2002 5,765
2003 574
2004 29
-----------
TOTALS $ 71,865
===========
Related party deposits were $2,061,000 and $1,374,000 at December 31, 1999 and
1998, respectively.
Cash paid for interest was $8,397,000, $8,054,000 and $7,464,000 for the years
ended December 31, 1999, 1998 and 1997, respectively.
NOTE H - OTHER BORROWINGS
Other borrowings represents putable advances obtained by the Bank from the
Federal Home Loan Bank (FHLB) of Indianapolis. The advances have fixed interest
rates ranging from 5.31% to 5.71% until the stated call date ranging from
February 22, 2000 to June 29, 2009. On the stated call date, the FHLB will have
the option to convert the advances to a periodic adjustable rate and will
continue to have this option quarterly thereafter. The advances may not be
prepaid by the Bank prior to the FHLB exercising its option to convert the
advances to an adjustable rate. The advances are secured by a blanket collateral
agreement with the FHLB which gives the FHLB an unperfected security interest in
the Bank's one-to-four family mortgage loans, U.S. Treasury and Government
agencies, and highly rated private mortgage-backed securities.
At year-end 1999, scheduled principal reductions on these advances were as
follows for the years ending December 31 (in thousands):
2000 $ -
2001 -
2002 3,000
2003 2,000
2004 -
Thereafter 10,000
-----------
TOTAL FHLB ADVANCES $ 15,000
===========
NOTE I - INCOME TAXES
Income tax expense consists of:
1999 1998 1997
------------------------------------------
Current $ 1,021 $ 1,226 $ 1,066
Deferred (16) (41) 19
------------------------------------------
TOTALS $ 1,005 $ 1,185 $ 1,085
==========================================
Income tax expense calculated at the statutory federal income tax rate of 34%
differs from actual income tax expense as follows (in thousands):
1999 1998 1997
------------------------------------------
Statutory rates $ 1,464 $ 1,610 $ 1,400
Tax-exempt interest income (358) (350) (254)
Increase in net cash surrender value of life insurance policies (77) (82) (65)
Other items, net (24) 7 4
------------------------------------------
TOTALS $ 1,005 $ 1,185 $ 1,085
==========================================
FS-12
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - INCOME TAXES (CONTINUED)
Year end deferred tax assets and liabilities consist of (in thousands):
1999 1998
---------------------------
Deferred tax assets:
Net unrealized depreciation on available-for-sale securities $ 200 $
Allowance for loan losses 497 461
Deferred compensation liability 502 470
Pension liability 99 65
Other 185 175
---------------------------
Totals 1,483 1,171
Deferred tax liabilities:
Net unrealized appreciation on available-for-sale securities 134
Mortgage servicing rights 271 202
Other 41 14
---------------------------
Totals 312 350
---------------------------
NET DEFERRED TAX ASSET $ 1,171 $ 821
===========================
The Company made income tax payments of $1,160,000 in 1999, $1,165,000 in 1998
and $1,130,000 in 1997. An allowance against the net deferred tax asset was not
considered necessary at December 31, 1999 or 1998.
NOTE J - RETIREMENT PLANS
The defined benefit pension plan covers substantially all full-time employees.
The benefits are based on years of service and the employee's average highest
compensation during five consecutive years of employment. The funding policy is
to contribute annually an amount sufficient to meet the minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974,
plus additional amounts as may be appropriate from time to time. 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.
Information about the pension plan was as follows (in thousands):
1999 1998
---------------------------
Change in benefit obligation:
Beginning benefit obligation $ (2,326) $ (1,715)
Service cost (133) (140)
Interest cost (134) (115)
Actuarial (gain) loss 511 (435)
Benefits paid 667 79
---------------------------
Ending benefit obligation (1,415) (2,326)
Change in plan assets, at fair value:
Beginning plan assets 2,266 1,856
Actual return 144 335
Employer contribution 29 154
Benefits paid (667) (79)
---------------------------
Ending plan assets 1,772 2,266
---------------------------
Funded status 357 (60)
Unrecognized net actuarial gain (650) (185)
Unrecognized transition obligation 13 17
Unrecognized prior service cost 37 49
---------------------------
ACCRUED PENSION COST $ (243) $ (179)
===========================
FS-13
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - RETIREMENT PLANS (CONTINUED)
The components of pension expense and related actuarial assumptions were as
follows:
1999 1998 1997
------------------------------------------
Service cost $ 133 $ 140 $ 130
Interest cost 134 115 113
Actual return on plan assets (153) (345) (330)
Net amortization and deferral 16 188 205
------------------------------------------
NET $ 130 $ 98 $ 118
==========================================
Discount rate on benefit obligation 7.0% 7.0% 7.0%
Long-term expected rate of return on plan assets 8.0% 8.0% 8.0%
Rate of compensation increase 3.0% 3.0% 3.5%
The Company has an employee stock ownership plan (ESOP) for substantially all
full-time employees. The Board of Directors determines the Company's
contribution level annually. Assets of the plan are held in trust by the Bank
and administrative costs of the plan are borne by the plan sponsor. Costs
charged to operations for contributions to the plan totaled $78,000, $90,000 and
$66,000 in 1999, 1998 and 1997. During 1999, the Company amended its ESOP plan
to adopt 401(k) provisions allowing for employee salary deferrals to purchase
either Company stock or mutual funds. Company matching is provided in Company
stock. Substantially all employees have converted their ESOP accounts to the
amended plan.
During 1998, the ESOP borrowed $588,000 to purchase 14,000 shares of company
stock which are currently held as unallocated ESOP shares.
Shares held by the ESOP at year-end are as follows:
1999 1998
---------------------------
Allocated shares 130,502 150,727
Unallocated shares 15,400 14,000
---------------------------
TOTAL ESOP SHARES 145,902 164,727
===========================
The fair value of the allocated shares held by the ESOP is approximately
$3,990,000 and $6,029,000 at December 31, 1999 and 1998, respectively. Upon
distribution of shares to a participant, the participant has the right to
require the Company to purchase shares at their fair value in accordance with
terms and conditions of the plan. As such these shares are not classified in
shareholders' equity as permanent equity.
As an incentive to retain key members of management and directors, the Bank has
a deferred compensation plan whereby participants defer a portion of current
compensation. Benefits are based on salary and length of service and are vested
as service is provided from the date of participation through age 65. A
liability is recorded on a present value basis and discounted at current
interest rates. This liability may change depending upon changes in long-term
interest rates. Deferred compensation expense was $218,000, $229,000 and
$206,000 in 1999, 1998 and 1997. The liability for vested benefits was
$1,476,000 and $1,382,000 at December 31, 1999 and 1998, respectively.
FS-14
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - COMMITMENTS
There are various commitments which arise in the normal course of business, such
as commitments under commercial letters of credit, standby letters of credit and
commitments to extend credit. Generally accepted accounting principles recognize
these transactions as contingent liabilities and accordingly, they are not
reflected in the accompanying financial statements. These arrangements have
credit risk essentially the same as that involved in extending loans to
customers and are subject to the Bank's normal credit policies. Collateral
generally consists of receivables, inventory and equipment and is obtained based
on management's credit assessment of the customer.
At December 31, 1999 and 1998, respectively, the Bank had commitments under
commercial letters of credit, used to facilitate customers' trade transactions,
of $414,000 and $133,000.
Under standby letter of credit agreements, the Bank agrees to honor certain
commitments in the event that its customers are unable to do so. At December 31,
1999 and 1998, respectively, commitments under outstanding standby letters of
credit were $626,000 and $385,000.
Loan commitments outstanding to extend credit are detailed below (in thousands):
1999 1998
---------------------------
Fixed rate $ 4,570 $ 1,616
Variable rate 33,379 29,559
----------------------------
TOTALS $ 37,949 $ 31,175
============================
The fixed rate commitments have stated interest rates ranging from 8.5% to
17.0%. The terms of the above commitments range from 1 to 60 months.
Management does not anticipate any losses as a result of the above related
transactions; however, the above amount represents the maximum exposure to
credit loss for loan commitments and commercial and standby letters of credit.
At December 31, 1999, the Bank had line of credit agreements with the Federal
Home Loan Bank, Bank One and Fifth Third Bank for $3,000,000, $5,000,000 and
$750,000 respectively. The balances on all three of these lines was $0 at
December 31, 1999.
NOTE L - RESTRICTIONS ON TRANSFERS FROM SUBSIDIARY
Banking laws and regulations restrict the amount the Bank may transfer to the
Company in the form of cash dividends, loans and advances. In 2000, the Bank is
permitted to pay the Company an amount equal to $3,752,000 plus the Bank's 2000
net income, as dividends without prior regulatory approval.
FS-15
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION
Condensed financial statements of Southern Michigan Bancorp, Inc. follow (in
thousands):
Balance Sheets December 31,
1999 1998
-----------------------
ASSETS
Cash $ 97 $ 16
Securities available for sale 3,273 3,170
Securities held to maturity 250
Investment in subsidiary 19,107 20,422
Premises and equipment 1,196 1,231
Other 704 700
---------------------------
TOTAL ASSETS $ 24,377 $ 25,789
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 340 $ 393
Other liabilities 57 22
Common stock subject to repurchase obligation in ESOP 3,990 6,029
Shareholders' equity 19,990 19,345
---------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,377 $ 25,789
===========================
Statements of Income Year ended December 31,
1999 1998 1997
------------------------------------------
Dividends from Bank $ 3,718 $ 3,620 $ 1,109
Interest income 154 167 137
Other income 269 226 206
Other expenses (98) (33) (49)
------------------------------------------
4,043 3,980 1,403
Federal income tax expense (35) (85) (68)
------------------------------------------
4008 3,895 1,335
Equity in undistributed/(excess) distributed net income of subsidiary (708) (346) 1,697
------------------------------------------
NET INCOME 3,300 3,549 3,032
------------------------------------------
Net change in unrealized gains (losses) on securities available for sale (649) 234 5
------------------------------------------
Other comprehensive income (649) 234 5
------------------------------------------
COMPREHENSIVE INCOME $ 2,651 $ 3,783 $ 3,037
==========================================
Statements of Cash Flows Year ended December 31,
1999 1998 1997
------------------------------------------
OPERATING ACTIVITIES
Net income $ 3,300 $ 3,549 $ 3,032
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in (undistributed)/excess distributed net income of subsidiary 708 346 (1,697)
Depreciation 35 31 31
Net amortization of investment securities 25 16 13
Other 54 (253) (146)
------------------------------------------
Net cash from operating activities 4,122 3,689 1,233
FS-16
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION (CONTINUED)
Statements of Cash Flows Year ended December 31,
1999 1998 1997
------------------------------------------
INVESTING ACTIVITIES
Activity in available for sale investment securities:
Maturities and calls 776 1,977 734
Purchases (717) (2,059) (1,248)
Activity in held to maturity investment securities:
Maturities and calls (250)
Additions to premises and equipment (60) (62)
------------------------------------------
Net cash from investing activities 59 (392) (576)
FINANCING ACTIVITIES
Common stock issued 251 390
Cash dividends paid (1,428) (1,252) (1,049)
Repurchase of common stock (2,672) (2,299)
------------------------------------------
Net cash from financing activities (4,100) (3,300) (659)
------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 81 (3) (2)
Beginning cash and cash equivalents 16 19 21
------------------------------------------
ENDING CASH AND CASH EQUIVALENTS $ 97 $ 16 $ 19
==========================================
Transfers of securities held to maturity to securities available for $ 250
sale
NOTE N - FAIR VALUE INFORMATION
The following methods and assumptions were used by the Company in estimating
fair values for financial instruments:
CASH AND CASH EQUIVALENTS AND FEDERAL FUNDS SOLD: The carrying amounts
reported in the balance sheet for cash and due from banks approximate those
assets' fair values.
SECURITIES: Fair values for investment securities are based on quoted
market prices, where available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable instruments.
The fair value of restricted equity securities approximates amortized cost.
LOANS: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying
values. The fair values for other loans are estimated using discounted cash
flows analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality.
OFF-BALANCE-SHEET INSTRUMENTS: Fair values for the Bank's letters of credit
are based on fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the
counterparties' credit standing. It is not practicable to estimate the fair
value of lending commitments because of the wide variety of the
instruments.
FS-17
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - FAIR VALUE INFORMATION (CONTINUED)
DEPOSITS: The fair values disclosed for demand deposits (e.g., interest and
non-interest checking, passbook savings, and certain types of money market
accounts) are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on
certificates to a schedule of expected monthly maturities on time deposits.
OTHER BORROWINGS: The fair value of other borrowings is estimated using
discounted cash flows analysis based on the Bank's current incremental
borrowing rate for similar types of borrowing arrangements.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that if the Company had disposed
of such items at December 31, 1999 and 1998, the estimated fair values would
have been achieved. Market values may differ depending on various circumstances
not taken into consideration in this methodology. The estimated fair values at
December 31, 1999 and 1998 should not necessarily be considered to apply at
subsequent dates.
In addition, other assets and liabilities that are not defined as financial
instruments are not included in the following disclosures, such as property and
equipment. Also, non-financial instruments typically not recognized in financial
statements may have value but are not included in the following disclosures.
These include, among other items, the estimated earnings power of core deposit
accounts, the trained work force, customer goodwill and similar items.
The estimated fair values of the Company's financial instruments at year end are
as follows (in thousands):
1999 1998
--------------------------- ---------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
Financial assets:
Cash and cash equivalents $ 12,046 $ 12,046 $ 16,228 $ 16,228
Federal funds sold 4,000 4,000
Securities available for sale 54,229 54,229 36,138 36,138
Securities held to maturity 31,756 32,693
Loans 193,371 192,425 163,303 163,588
Financial liabilities:
Deposits $ (233,303) $ (233,285) $ (233,361) $ (234,938)
Other borrowings (15,000) (15,000) (5,000) (5,000)
Unrecognized financial instruments:
Commercial letters of credit $ (8) $ (8)
Standby letters of credit (13) (3)
NOTE O - REGULATORY MATTERS
The Company and Bank are subject to regulatory capital requirements administered
by federal banking agencies. Capital adequacy guidelines and prompt corrective
action regulations involve quantitative measures of assets, liabilities and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to qualitative
judgments by regulators about components, risk weightings and other factors, and
the regulators can lower classifications in certain cases. Failure to meet
various capital requirements can initiate regulatory action that could have a
direct material effect on the consolidated financial statements.
FS-18
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O - REGULATORY MATTERS (CONTINUED)
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
At year end, actual capital levels (in thousands) and minimum required levels
were:
MINIMUM REQUIRED
TO BE
MINIMUM REQUIRED WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS
------------------- -------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------------- -------------------- -----------------------
1999
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $25,300 12.0% $16,869 8.0% $21,086 10.0%
BANK $20,425 9.8% $16,673 8.0% $20,842 10.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $23,168 11.0% $8,435 4.0% $12,652 6.0%
BANK $18,293 8.8% $8,337 4.0% $12,505 6.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
CONSOLIDATED $23,168 8.4% $11,037 4.0% $13,797 5.0%
BANK $18,293 6.7% $10,917 4.0% $13,646 5.0%
1998
Total capital (to risk weighted assets)
Consolidated $25,808 13.4% $15,439 8.0% $19,298 10.0%
Bank $20,541 10.8% $15,238 8.0% $19,048 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $23,782 12.3% $7,719 4.0% $11,579 6.0%
Bank $18,515 9.7% $7,619 4.0% $11,428 6.0%
Tier 1 capital (to average assets)
Consolidated $23,782 9.2% $10,363 4.0% $12,954 5.0%
Bank $18,515 7.5% $9,845 4.0% $12,306 5.0%
The Company and Bank, at year end 1999 and 1998, were categorized as well
capitalized.
NOTE P - MERGER AGREEMENT (EVENT SUBSEQUENT TO DATE OF AUDITOR'S REPORT)
On February 15, 2000, the Company announced that it had agreed to merge with
Sturgis Bank & Trust Company of Sturgis, Michigan ("Sturgis"). The transaction
is anticipated to be a tax-free exchange. It is subject to regulatory approvals
and approval by the shareholders of Sturgis, and is anticipated to be effective
the second half of 2000. The exchange ratio is .398 shares of the Company's
common stock for one share of Sturgis' common stock.
FS-19
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SOUTHERN MICHIGAN BANCORP, INC.
Dated: March 20, 2000
By: /s/ James T. Grohalski
------------------------------------------
James T. Grohalski
Its: President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
/s/ James P. Briskey /s/ Thomas E. Kolassa
- ------------------------------------------ ------------------------------------------
James P. Briskey, Director Thomas E. Kolassa, Director
/s/ H. Kenneth Cole /s/ James J. Morrison
- ------------------------------------------ ------------------------------------------
H. Kenneth Cole, Director James J. Morrison, Director
/s/ William E. Galliers /s/ Jane L. Randall
- ------------------------------------------ ------------------------------------------
William E. Galliers, Director Jane L. Randall, Director
/s/ James T. Grohalski /s/ Freeman E. Riddle
- ------------------------------------------ ------------------------------------------
James T. Grohalski, President, Chief Freeman E. Riddle, Director
Executive Officer and Director
(Principal Financial & Accounting Officer)
/s/ Nolan E. Hooker /s/Jerry L. Towns
- ------------------------------------------ ------------------------------------------
Nolan E. Hooker, Director Jerry L. Towns, Director
/s/ Gregory J. Hull Dated: March 20, 2000
- ------------------------------------------
Gregory J. Hull, Director
S-1
55
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Annual Report on Form 10-K
For the Year Ended December 31, 1999
Index to Exhibits
Exhibits
SOUTHERN MICHIGAN BANCORP, INC.
(A Michigan corporation)
51 West Pearl Street
Coldwater, Michigan 49036
56
INDEX TO EXHIBITS
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 2 Agreement and Plan of Consolidation dated February
15, 2000 by and between the Company and Sturgis Bank
& Trust Company, a Michigan savings bank.
Exhibit 3(i) Articles of Incorporation incorporated by reference
to Exhibit 3 to the Company's Annual Report on Form
10-K for the year ended December 31, 1991 and
Exhibit 3 to Form S-3D filed April 30, 1998.
Exhibit 3(ii) Amended and Restated By-Laws are incorporated by
reference to Exhibit 3 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997.
Exhibit 4 Instruments Defining the Rights of Security Holders
of the Company are the Articles of Incorporation and
By-Laws (see Exhibits 3(i) and (ii) above).
Exhibit 9 Not applicable.
Exhibit 10(a) Material Contracts - Executive Compensation Plans
and Arrangements: (1) Master Agreements for
Directors' Deferred Income Plan; (2) Composite form
of Executive Employee Salary Continuation Agreement,
as amended; and (3) Master Agreements for
Executives' Deferred Compensation Plan, as amended,
are incorporated by reference to Exhibit 10 to the
Company's Annual Report on Form 10-K for the year
ended December 31, 1994.
Exhibit 10(b) Southern Michigan Bancorp, Inc. 2000 Stock Option
Plan.
Exhibit 11 Not applicable.
Exhibit 12 Not applicable.
Exhibit 13 Not applicable.
Exhibit 16 Not applicable.
Exhibit 18 Not applicable.
Exhibit 19 Not applicable.
Exhibit 21 Subsidiaries of the Company.
Exhibit 22 Not applicable.
Exhibit 23 Consent of Independent Auditors.
Exhibit 27 Financial Data Schedule.