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, 2000
[ ] 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, 2001 was $23,845,703. 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, 2001 was 1,940,502 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 August
2000, SMB Mortgage Company was established as a subsidiary of the Bank and all
residential real estate loans of the Bank were transferred to this subsidiary.
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.
Residential mortgage loans are originated by SMB Mortgage Company. Some
residential mortgage loans are retained by SMB Mortgage Company while others are
sold to investors in the secondary market. When SMB Mortgage Company sells
originated mortgage loans to investors, it makes a determination to either
retain or sell the rights to service those loans.
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 Office of Financial and Insurance Services (the "OFIS"). The OFIS is
the Bank's chartering authority and primary regulator. Under OFIS 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 1999, as amended, 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.
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 from the Bank for the Company's cash needs, including funds for
acquisitions, payments of dividends and interest, and the payment of operating
expenses. Based on the Bank's balance sheet as of December 31, 2000, the Bank
could pay a dividend to the Company in the amount of $5,028,000 without prior
regulatory approval.
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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 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.
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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. As of December 31, 2000, the Bank's
capital ratios exceed the requirements to be considered a well-capitalized
institution under FDIC regulation.
FDICIA also contains a variety of other provisions that may affect the
operations of depository institutions including 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, principal
shareholders, and 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 (and the
interested party must abstain from participating directly or indirectly in the
vote). 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. Each financial
institution is assigned to one of three capital groups -- well capitalized,
adequately capitalized or undercapitalized -- and further assigned to one of
three subgroups within a capital group, on the basis of supervisory evaluations
by the institution's primary federal and, if applicable, state supervisors and
other information relevant to the institution's financial condition and the risk
posed to the applicable insurance fund. The assessment rate applicable to the
bank in the future will depend in part upon the risk assessment classification
assigned to the Bank by the FDIC and in part on the BIF assessment schedule
adopted by the FDIC. FDIC regulations currently provide that premiums related to
deposits assessed by the BIF are to be assessed at a rate of between 0 cents and
27 cents per $100 of deposits.
Under the Deposit Insurance Funds Act of 1996, effective January 1,
1997, the Bank is required to pay, in addition to the BIF deposit insurance
assessment, if any, the Financing Corporation ("FICO") assessment to service the
interest on FICO bond obligations. FICO assessment rates may be adjusted
quarterly to reflect a change in assessment base for the BIF. The current FICO
annual assessment rate is 1.9 cents per $100 of deposits.
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, 2000, the Company's Total Capital to
risk-weighted assets was 11.6 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. The Company's
Tier I Capital leverage ratio at December 31, 2000 was 8.1 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, 2000, the
Bank met all applicable capital requirements.
Community Reinvestment Act
Under the Community Reinvestment Act of 1977, as amended (the "CRA"), a
financial institution is required to help meet the credit needs of its entire
community, including low-income and moderate-income areas. The Bank's CRA rating
is determined by evaluation of the Bank's lending, service and investment
performance. The Federal banking agencies may take CRA compliance into account
in an agency's review of applications for mergers, acquisitions, and to
establish branches or facilities.
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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.
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, 2000, 143 persons were employed by the Bank; 124
were full time employees and 19 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)
2000 1999 1998
--------------------------------- ------------------------------- -------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ------ ------- -------- ------ ------- -------- ------
ASSETS
Interest earning assets:
Loans (A) (B) (C) $ 208,160 $ 20,131 9.7% $ 178,906 $ 16,606 9.3% $ 160,666 $ 15,816 9.8%
Taxable investment
securities (D) 33,966 2,212 6.5 35,784 2,235 6.2 32,449 2,305 7.1
Tax-exempt investment
securities (A) 18,210 1,376 7.6 22,716 1,715 7.6 22,342 1,657 7.4
Federal funds sold 548 23 4.2 2,154 107 5.0 4,782 266 5.6
--------- --------- --------- --------- --------- ---------
Total interest earning
assets 260,884 23,742 9.1 239,560 20,663 8.6 220,239 20,044 9.1
Non-interest earning assets:
Cash and due from banks 11,858 12,679 15,591
Other assets 19,370 18,028 16,415
Less allowance for loan
loss (2,066) (2,161) (1,955)
--------- --------- ---------
Total assets $ 290,046 $ 268,106 $ 250,290
========= ========= =========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest bearing
liabilities:
Demand deposits $ 83,326 3,274 3.9% $ 77,664 $ 2,482 3.2% $ 74,154 $ 2,440 3.3%
Savings deposits 43,793 1,467 3.3 45,722 1,496 3.3 44,356 1,509 3.4
Time deposits 73,450 4,171 5.7 73,553 3,760 5.1 68,177 3,673 5.4
Federal funds purchased 4,337 281 6.5 2,044 97 4.7 -- -- --
Other borrowings 20,915 1,504 7.2 9,716 600 6.2 6,146 410 6.7
--------- --------- --------- --------- --------- ---------
Total interest bearing
liabilities 225,821 10,697 4.7 208,699 8,435 4.0 192,833 8,032 4.2
Non-interest bearing
liabilities:
Demand deposits 36,334 32,982 30,570
Other 2,854 1,261 1,124
Common stock subject to
repurchase obligation 2,734 5,009 5,464
Shareholders' equity 22,303 20,155 20,299
--------- --------- ---------
Total liabilities and
shareholders' equity $ 290,046 $ 268,106 $ 250,290
========= ========= =========
Net interest earnings $ 13,045 $ 12,228 $ 12,012
========= ========= =========
Interest rate spread 4.4% 4.6% 4.9%
Net yield on interest
earning assets 5.0% 5.1% 5.5%
=== === ===
(A) Includes tax equivalent adjustment of interest (assuming a 34% tax rate)
for securities and loans of $468,000 and $29,000, respectively for 2000;
$583,000 and $29,000, respectively for 1999; and $563,000 and $35,000,
respectively for 1998.
(B) Average balance includes average nonaccrual loan balances of $745,000 in
2000; $593,000 in 1999; and $815,000 in 1998.
(C) Interest income includes loan fees of $650,000 in 2000; $663,000 in 1999;
and $563,000 in 1998.
(D) Average balance includes average unrealized gain (loss) of $(515,000) in
2000; $(104,000) in 1999; and $128,000 in 1998 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 2000, 1999 and 1998.
2000 Compared to 1999 1999 Compared to 1998
Increase (Decrease) Due To Increase (Decrease) Due To
------------------------------------ -----------------------------------
Interest income on: Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
Loans $ 2,806 $ 719 $ 3,525 $ 1,727 $ (937) $ 790
Taxable investment securities (116) 93 (23) 224 (294) (70)
Tax-exempt investment securities (340) 1 (339) 28 30 58
Federal funds sold (70) (14) (84) (133) (26) (159)
------- ------- ------- ------- ------- -------
Total interest earning assets $ 2,280 $ 799 $ 3,079 $ 1,846 $(1,227) $ 619
======= ======= ======= ======= ======= =======
Interest expense on:
Demand deposits $ 191 $ 601 $ 792 $ 113 $ (71) $ 42
Savings deposits (64) 35 (29) 46 (59) (13)
Time deposits (5) 416 411 281 (194) 87
Federal funds purchased 139 45 184 97 -- 97
Other borrowings 791 113 904 222 (32) 190
------- ------- ------- ------- ------- -------
Total interest bearing liabilities $ 1,052 $ 1,210 $ 2,262 $ 759 $ (356) $ 403
======= ======= ======= ======= ======= =======
Net interest income $ 1,228 $ (411) $ 817 $ 1,087 $ (871) $ 216
======= ======= ======= ======= ======= =======
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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:
2000 1999 1998
---- ---- ----
Fair Amortized Fair Amortized Fair Amortized
Value Cost Value Cost Value Cost
----- ---- ----- ---- ----- ----
U.S. Treasury and other
U.S. Government agencies
and corporations $ 19,163 $ 19,023 $ 15,541 $ 15,885 $ 9,087 $ 9,087
States and political subdivisions 22,737 22,575 28,411 28,529 37,903 37,006
Corporate securities 6,054 6,031 6,172 6,203 15,942 15,902
Other securities 3,521 3,566 4,105 4,201 5,899 5,899
--------- --------- --------- -------- -------- ---------
Total investment securities $ 51,475 $ 51,195 $ 54,229 $ 54,818 $ 68,831 $ 67,894
========= ========= ========= ======== ======== =========
The following table sets forth the amortized cost of debt securities by maturity
(or anticipated call date, if earlier) and weighted average yield for each range
of maturities at December 31, 2000:
-----------------------------------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 $ 6,477 5.83% $11,546 6.11% $ 1,000 -- % $ -- -- %
States and political subdivisions (1) 7,256 5.69 10,862 5.33 2,187 5.85 2,270 6.49
Corporate securities 725 6.32 5,306 7.22 -- -- -- --
Other securities -- -- 1,888 5.30 395 5.73 -- --
------- ------- ------- -------
Total (1) $14,458 5.41% $29,602 5.63% $ 3,582 5.83% $ 2,270 6.49%
======= ==== ======= ==== ======= ==== ======= ====
(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 2000 and 1999, the amortized
cost of securities issued by the state of Michigan and all its political
subdivisions totaled $11,079,000 and $13,114,000 with an estimated market value
of $11,511,000 and $13,132,000, 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:
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Commercial, financial, and
agricultural $ 112,748 $ 96,758 $ 82,533 $ 74,819 $ 72,108
Real estate mortgage (1) 70,246 63,423 51,567 50,057 47,561
Installment 31,411 33,190 29,203 33,865 33,009
----------- ----------- ----------- ----------- -----------
Total loans $ 214,405 $ 193,371 $ 163,303 $ 158,741 $ 152,678
=========== =========== =========== =========== ===========
(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, 2000. 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 $ 38,304 $ 52,612 $ 21,832 $ 112,748
Real estate mortgages 6,397 1,760 62,089 70,246
Installment 1,660 13,675 16,076 31,411
----------- ----------- ----------- -----------
Total $ 46,361 $ 68,047 $ 99,997 $ 214,405
=========== =========== =========== ===========
Loans maturing after one year with:
Fixed interest rates $ 45,539 $ 24,996
Variable interest rates 22,508 75,001
----------- -----------
Total $ 68,047 $ 99,997
=========== ===========
(A) Amounts include demand loans, loans having no stated schedule of
repayments, or no stated maturity and overdrafts.
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:
11
12
December 31
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Non accrual loans:
Commercial, financial and
agricultural $ 1,759 $ 306 $ 343 $ 1,026 $ 448
Real estate mortgage - 23 - - -
Installment - - - 61 2
----------- ----------- ----------- ----------- -----------
1,759 329 343 1,087 450
Loans contractually past due 90 days
or more:
Commercial, financial, and
agricultural 123 432 807 1,067 82
Real estate mortgage 277 134 161 630 129
Installment 55 34 120 966 165
----------- ----------- ----------- ----------- -----------
455 600 1,088 2,663 376
----------- ----------- ----------- ----------- -----------
Total $ 2,214 $ 929 $ 1,431 $ 3,750 $ 826
=========== =========== =========== =========== ===========
Percent of total loans outstanding 1.03% .48% .88% 2.36% .54%
=========== ========== =========== =========== ==========
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 $124,000 and $9,000 was realized on nonaccrual loans during 2000 and
1999, respectively. Under original terms for these loans, interest income which
would have been recorded approximates $207,000 and $50,000 in 2000 and 1999,
respectively. There are no loan commitments outstanding to extend credits to
these customers.
Potential Problem Loans
At December 31, 2000, the Company had approximately $2,554,000 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. At December 31, 2000, the Company had loans of
$815,000 which were considered impaired, but were performing.
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
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Balance at beginning of year $ 2,132 $ 2,026 $ 1,863 $ 1,814 $ 1,609
Charge offs:
Commercial, financial and agricultural (512) (505) (227) (122) (13)
Installment (406) (492) (352) (386) (157)
Real estate (24) (53) -- -- --
--------- --------- --------- --------- ---------
(942) (1,050) (579) (508) (170)
Recoveries:
Commercial, financial and agricultural 96 171 41 31 43
Installment 109 132 101 66 62
Real estate 1 1 -- -- 3
--------- --------- --------- --------- ---------
206 304 142 97 108
--------- --------- --------- --------- ---------
Net charge offs (736) (746) (437) (411) (62)
Provision for loan losses 700 852 600 460 267
--------- --------- --------- --------- ---------
Balance at end of year $ 2,096 $ 2,132 $ 2,026 $ 1,863 $ 1,814
========= ========= ========= ========= =========
Average loans outstanding $ 208,160 $ 178,906 $ 160,666 $ 158,193 $ 137,273
========= ========= ========= ========= =========
Ratio of net charge offs to average
loans outstanding .35% .42% .27% .26% .05%
========= ========= ========= ========= =========
Subsequent to December 31, 2000, approximately $760,000 was charged against the
allowance for loan loss related to two commercial borrowers. As of December 31,
2000, approximately $586,000 had been reserved for these borrowers.
13
14
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:
---------2000--------- -------1999-------- --------1998-------- --------1997-------- --------1996---------
---- ---- ---- ---- ----
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category Category Category Category Category
Of Total Of Total Of Total Of Total Of Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
--------- -------- --------- -------- --------- -------- --------- -------- --------- --------
Commercial, financial
and agricultural $1,236 52.6% $ 924 50.0% $ 777 50.5% $ 628 47.1% $ 351 47.2%
Real estate mortgage 35 32.8 127 32.8 103 31.6 98 31.0 95 31.2
Installment 325 14.6 601 17.2 521 17.9 321 21.9 177 21.6
Unallocated 500 -- 480 -- 625 -- 816 -- 1,191 --
------ ----- ------ ----- ------ ----- ------- ----- ------ -----
$2,096 100.0% $2,132 100.0% $2,026 100.0% $ 1,863 100.0% $1,814 100.0%
====== ===== ====== ===== ====== ===== ======= ===== ====== =====
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 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 2000, 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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15
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:
2000 1999 1998
---- ---- ----
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
Non interest bearing demand deposits $ 36,334 $ 32,982 $ 30,570
Interest bearing demand deposits 83,326 3.9% 77,664 3.2% 74,154 3.3%
Savings deposits 43,793 3.3 45,722 3.3 44,356 3.4
Time deposits 73,450 5.7 73,553 5.1 68,177 5.4
--------- --------- ---------
$ 236,903 $ 229,921 $ 217,257
========= ========= =========
The following table sets forth as of December 31, 2000, the aggregate amount of
outstanding deposits (certificates of deposit) of $100,000 or more by maturity
(in thousands of dollars):
Three months or less $ 8,708
Over three months through six months 7,678
Over six months through twelve months 8,287
Over twelve months 4,839
----------
$ 29,512
==========
VI. RETURN ON EQUITY AND ASSETS
The following table sets forth consolidated operating and capital ratios for the
years ended December 31:
2000 1999 1998
---- ---- ----
Return on average assets 1.16% 1.23% 1.42%
Return on average equity (1) 15.13 16.37 17.48
Dividend payout ratio (2) 40.30 41.61 35.56
Average equity to average assets (1) 7.69 7.52 8.11
(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.
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. 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.
15
16
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 450 shareholders of record
at February 28, 2001.
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:
2000 1999
------------------------------------------ -------------------------------------------
BID PRICE CASH BID PRICE CASH
------------------------- DIVIDENDS -------------------------- DIVIDENDS
HIGH BID LOW BID DECLARED HIGH BID LOW BID DECLARED
Quarter Ended
- ------------------------------------------------------------------------------------------------------------------------
March 31 $ 32.00 $ 18.25 $ .19 $ 33.08 $ 27.00 $ .16
June 30 20.50 17.75 .17 32.40 27.23 .17
September 30 17.75 15.38 .17 29.70 26.10 .17
December 31 16.13 13.50 .17 30.60 27.23 .18
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,
2000.
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
2000 1999 1998 1997 1996
----------------------------------------------------------------------------
Total interest income $ 23,245 $ 20,051 $ 19,446 $ 18,669 $ 16,787
Net interest income 12,548 11,616 11,414 11,226 10,183
Provision for loan losses 700 852 600 460 267
Net income 3,375 3,300 3,549 3,032 3,058
Per share data:
Basic and diluted earnings per share 1.75 1.64 1.70 1.44 1.46
Cash dividends .70 .68 .60 .52 .48
Balance sheet data:
Other borrowings 25,000 15,000 5,000 3,000 -
Capital note - - - - -
Common stock subject to repurchase 1,478 3,990 6,029 4,899 3,555
Equity 24,211 19,990 19,345 20,590 19,616
Total assets 303,639 275,825 266,851 238,531 235,562
Return on average assets 1.16% 1.23% 1.42% 1.30% 1.45%
Return on average equity 15.13% 16.37% 17.48% 14.96% 16.09%
All per share amounts have been adjusted for a 10% stock dividend declared in
1999 and a 1997 stock split effected in the form of a 100% stock dividend.
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 10.9% in 2000 and 18.4% in 1999. The loan growth in 2000 occurred
in the commercial and real estate mortgage loan categories and is the result of
continued good economic conditions within the Company's market area. Commercial
loans increased 16.5% as the Bank focused attention on this area of lending and
actively called on current and potential customers. At the same time, local
businesses were also expanding to meet the growth demands of the region.
Installment loans decreased 5.4% as the Bank chose to focus on its commercial
and residential real estate lending and place less emphasis on indirect lending.
Real estate mortgage loans increased 10.9% as the Bank funded larger real estate
loans, construction loans and other loans that did not conform to secondary
market guidelines.
Gains recognized on the sale of real estate mortgage loans to the secondary
market decreased in 2000 from $758,000 in 1999 to $533,000. The secondary market
loan activity declined in 2000 as mortgage rates increased. Fixed rate loans
which represent all of the loans sold on the secondary market were not as
attractive. During the fourth quarter of 2000 secondary market loan activity
began to pick up as interest rates began to decrease. Loans held for sale at
December 31, 2000 were $1,024,000. The real estate portfolio largely consists of
residential mortgages within the local area with a low risk of loss.
16
17
The loan growth in 1999 occurred in all loan categories. Commercial loans
increased by 17.2% as local businesses expanded. Installment 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.
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 $38,056,000 and $37,949,000 at December 31, 2000 and
1999, 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,
industry or location. Substantially all loans are granted to customers located
in the Bank's service area, which is primarily southern Michigan.
Another significant component of cash flow is the securities portfolio. Total
securities decreased by 5.1% in 2000 and 20.1% in 1999. The funds received from
maturing securities were used to partially fund the 2000 and 1999 loan growth.
The securities available for sale portfolio had net unrealized gains of $280,000
in 2000 and losses of $589,000 in 1999. During 1999, the Company adopted
Financial Accounting Standards Board (FASB) Statement 133, Accounting for
Derivative Instruments and Hedging Activities and reclassified the entire
portfolio of held to maturity securities to available for sale. The
reclassification was done so that the securities would be available to sell
should the Company's liquidity needs require it. There is no concentration of
securities in the portfolio which would constitute an unusual risk except at
year-end 2000 and 1999, the amortized cost of securities issued by the State of
Michigan and all its political subdivisions totaled $11,079,000 and $13,114,000
with an estimated market value of $11,511,000 and $13,132,000, respectively.
Deposits traditionally represent the Company's principal source of funds. Total
deposits increased 5.2% in 2000 and remained stable in 1999. In 2000 the Bank
chose to increase the rates offered on certificates of deposit (CDs) in order to
attract deposits. The largest increases in CDs were the over $100,000 category
and the 24 - 36 month term CDs. Growth also occurred in other categories of
deposits as lenders were encouraged to bring deposits in with their loan
relationships. Business checking and money market accounts increased by
$10,952,000 in 2000. The Bank was not able to increase its deposit base in 1999
because of increased competition within the Bank's market area. Local
competitors offered premium rates for deposits and the Bank chose not to match
such rates. Also contributing to the lack of deposit growth in 1999 was an
increase in customer cash withdrawals late in the year in preparation for the
Year 2000 rollover.
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). 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 mortgage loans, government
and agency securities and highly rated mortgage-backed securities. FHLB advances
may be a less expensive way to obtain longer term funds than paying a premium
for long term deposits. Accordingly, the Company borrowed $10 million in both
1999 and 2000.
Premises and equipment increased by 13.6% in 2000 and decreased by 4.7% in 1999.
In 2000, the Bank spent approximately $1,459,000 to renovate the Coldwater main
office and the Beckley Road office. The 1999 decrease was due to a lack of
significant additions in consideration of the renovations planned for 2000 and
increased depreciation because of the high level of additions in 1998.
17
18
Capital Resources
The Company maintains a strong capital base to take advantage of business
opportunities while ensuring that it has resources to absorb the risk 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 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). As seen in Note O, the
Company exceeds the well capitalized requirements at December 31, 2000.
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 2000 and 1999, total average assets grew 8.2% and 7.1%. At the same time,
average equity (including common stock held by the ESOP) decreased 0.5% in 2000
and 2.3% in 1999. Equity grew at lower levels than assets in both 2000 and 1999
because of the repurchase and retirement of common stock shares (28,757 shares
in 2000 and 82,442 in 1999). 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 $13,459,000 at
December 31, 2000 representing 26.1% of the market value of the investment
securities portfolio, a decrease from the 32.7% level of 1999. Loans maturing
within 1 year were $46,361,000 at December 31, 2000 representing 21.6% of the
gross loan portfolio, a slight decrease from the 22.1% level of 1999.
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 it 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.
18
19
During the year ended December 31, 2000, there was a net increase in cash and
cash equivalents of $6,443,000. The major sources of cash in 2000 were increases
in deposits, maturing securities, loan sales and additional borrowings from the
Federal Home Loan Bank. The major uses of cash in 2000 were loan growth and
loans originated for sale.
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.
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, 2000:
0-30 31-90 91-365 1-5 Over 5
Days Days Days Years Years
---- ----- ------ ----- ------
Interest-earning assets $ 65,125 $ 8,549 $ 51,243 $109,238 $ 32,280
Interest-bearing liabilities $ 54,285 $ 83,843 $ 41,275 $ 46,808 $ 7,130
Interest sensitivity gap $ 10,840 $(75,294) $ 9,968 $ 62,430 $ 25,150
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.
19
20
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 8.0% in 2000, 1.8% in 1999 and 1.7% in 1998. The
2000 increase is due to the increase in the commercial and real estate mortgage
loan portfolio and the increases to prime rate throughout the year. These
increases were partially offset by the increased interest paid for money market
and CD deposits and increased interest paid for Federal Home Loan Bank
borrowings. The 1999 increase is due to the reinvestment of funds held in the
investment securities portfolio 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 uncertain economic environment and potential fluctuations in interest rates
are expected to continue to impact the Company and the industry in 2001. 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 competitors' 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 probable 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 $700,000 in 2000, $852,000 in 1999 and
$600,000 in 1998. The 2000 provision was set at a level considered necessary to
expected loan losses. 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 $417,000 in 2000. This was
primarily attributable to three commercial customers. Two of these customers had
been provided for in 1999. 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. It is anticipated that the Company
will continue to experience higher than normal losses in 2001. 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 remained constant in
2000, decreased by 5.4% in 1999 and increased by 30.2% in 1998. In 2000 trust
fees, service charges on loans and earnings on life insurance assets increased
but were offset by a decrease in the gains recognized on the sale of real estate
mortgage loans to the secondary market. The Bank increased its deposit base by
5.2% and generated additional service charges as a result of the growth. Trust
fees increased due to a new fee schedule put in place January 1, 2000. 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 during the first half
of 2000, the number of new loans and refinancing activities declined.
The 1999 decrease is due primarily to the decline in gains recognized on the
sale of real estate mortgage loans to the secondary market.
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
20
21
fee to noncustomers who use the Bank's ATMs and thus generated increased fees.
Security losses of $3,000 were recognized on sales of securities in 2000. No
gains or losses occurred in 1999 or 1998.
Non-interest expense increased by 8.8% in 2000, 2.2% in 1999 and 1.8% in 1998.
In 2000 the largest increase came in the professional and outside services
category. The Company spent $456,000 in legal and accounting fees in an attempt
to merge with Sturgis Bank & Trust. The merger was called off in October of 2000
after Sturgis Bank and Trust did not obtain a fairness opinion from their
investment advisors. In 2000 salaries and benefit expenditures increased as a
cost of living increase of 2.6% was given to all employees at the beginning of
the year. In addition, the loan department employees hired during 1999 were
employees for the entire year of 2000 adding to the increase.
In 1999, salaries and benefit expenditures increased as additional loan
department employees were added to assist with the increased loan volume.
Occupancy costs were higher in 1999 as a result of the addition of the new
Hillsdale branch and increasing maintenance on the Bank's older properties.
Equipment costs increased as a result of equipment additions for the new
Hillsdale branch and technological upgrades to the Bank's mainframe and personal
computers.
The primary expense categories that increased in 1998 were occupancy, equipment
and marketing. Occupancy and equipment costs increased as a result of the
opening or the new Hillsdale branch and continued upgrades to the Bank's
technology base. Marketing expenditures increased as the Bank revamped its
checking account products.
Income tax expense was $1,179,000 in 2000, $1,005,000 in 1999 and $1,185,000 in
1998. Tax-exempt income continues to have a major impact on the Company's tax
expense. The benefit offsetting lower coupon rates on municipal instruments is
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 $290,000 in 2000, $360,000 in 1999 and $350,000 in 1998.
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 equity was 15.13% in 2000, 16.37% in 1999 and
17.48% in 1998. The return on average assets was 1.16% in 2000, 1.23% in 1999
and 1.42% in 1998. The Company's 2000 return on equity and return on average
assets was 17.18% and 1.32%, respectively, if the costs relating to the
attempted merger are excluded.
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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Nonperforming Assets
Nonperforming assets include nonaccrual loans, accruing loans past due 90 days
or more, and other real estate which includes foreclosures, deeds in lieu of
foreclosure and real estate in redemption.
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
2000 1999 1998
---- ---- ----
(Dollars in thousands)
Nonaccrual loans:
Commercial, financial and agricultural $ 1,759 $ 306 $ 343
Real estate mortgage - 23 -
Installment - - -
--------- --------- ----------
1,759 329 343
Loans contractually past due 90 days or more:
Commercial, financial and agricultural 123 432 807
Real estate mortgage 277 134 161
Installment 55 34 120
--------- --------- ----------
455 600 1,088
--------- --------- ----------
Total nonperforming loans 2,214 929 1,431
Other real estate owned 1,415 161 207
--------- --------- ----------
Total nonperforming assets $ 3,629 $ 1,090 $ 1,638
========= ========= ==========
Nonperforming loans to year-end loans 1.03% .48% .88%
======== ======== =========
Nonperforming assets to year-end loans
and other real estate owned 1.69% .56% 1.00%
======== ======== =========
Nonperforming loans increased in 2000 with the largest increase coming in
nonaccrual loans. In 2000, nonaccrual loans were made up of several commercial
and agricultural loans where the borrower experienced severe financial
difficulties and therefore became delinquent. Nonperforming loans are subject to
continuous monitoring by management and are specifically reserved for in the
allowance for loan losses where appropriate. At December 31, 2000 and 1999, the
Company had loans of $815,000 and $1,338,000, which were considered impaired,
but performing.
At December 31, 2000, the Company had approximately $2,554,000 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
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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 FDIC completed an examination at the Company's subsidiary
bank using financial information as of December 31, 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 liquidity
risk. See Liquidity and Interest Rate Sensitivity, above. Business is transacted
in U.S. dollars with no foreign exchange rate risk or any 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,
2000 and 1999. 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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Principal Amount Maturing in:
Fair Value
2001 2002 2003 2004 2005 Thereafter Total 12/31/00
---- ---- ---- ---- ---- ---------- ---- ---------
Rate sensitive assets:
Fixed interest rate loan $ 10,968 $ 5,206 $ 9,849 $ 16,833 $ 13,651 $ 24,996 $ 81,503 $ 77,385
Average interest rate 9.53% 9.75% 9.73% 9.51% 9.51% 9.20% 9.20%
Variable interest rate loans 35,393 3,136 2,892 6,349 10,132 75,001 132,902 132,902
Average interest rate 10.25 10.29 10.32 10.35 10.28 9.77 9.77
Fixed interest rate securities 8,400 12,050 12,937 8,255 1,185 8,648 51,475 51,475
Average interest rate 5.50 5.83 6.06 6.50 5.42 6.07 5.97
Other interest bearing assets 555 555 555
Average interest rate 6.27 6.27
Rate sensitive liabilities:
Interest bearing checking 85,475 85,475 85,475
Average interest rate 3.74 3.74
Savings 29,799 29,799 29,799
Average interest rate 2.46 2.46
Time deposits 62,214 9,952 6,881 2,739 90,289 90,506
Average interest rate 6.16 6.15 6.10 6.22 6.16
Fixed interest rate
borrowings 15,000 10,000 25,000 25,067
Average interest rate 6.64 6.28 6.49
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 checking 82,498 82,498 82,498
Average interest rate 3.19 3.19
Passbook saving 30,793 30,793 30,793
Average interest rate 2.40 2.40
Time deposits 65,261 8,988 7,898 2,598 29 84,774 84,868
Average interest rate 5.11 5.65 5.55 5.15 5.14 5.23
Fixed interest rate
borrowings 13,000 2,000 15,000 15,000
Average interest rate 5.32 5.77 5.38
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 28, 2001, 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 67 Owner - Pittsford Grain Incorporated 1982
(grain elevator operator)
H. Kenneth Cole 52 Treasurer - Hillsdale College 1998
William E. Galliers 58 Co-Owner and Chief Executive Officer - 1993
G & W Display Fixtures, Inc.
(manufacturer of display fixtures)
James T. Grohalski 60 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 49 Owner - Hooker Oil Co. (distributor of 1991
heating oil); Co-Owner - Best American
Car Washes
Gregory J. Hull 52 Farmer 1995
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YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR PAST 5 DIRECTOR OF THE COMPANY
NAME OF DIRECTOR AGE YEARS(1)
- -------------------------- ----- ---------------------------------------- -------------------------
Thomas E. Kolassa 53 Partner - Burnham Insurance Group 1995
since 2000; Owner - The Planning Group
(insurance) prior to joining Burnham
Insurance Group
James J. Morrison 52 Chairman of the Board of Directors of 1991
the Company; Owner - Morrison &
Associates (insurance)
Jane L. Randall 79 Owner - Dally Tire Co. (tire 1982
distributor)
Freeman E. Riddle 68 Owner - Spoor & Parlin, Inc. (farm 1982
equipment)
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, 2000 to the Company's
Chief Executive Officer. Mr. Grohalski is the only executive officer of the
Company.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
-------------------------------
ALL OTHER COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY ($)(1) ($)(2)
- ----------------------------------------------- ------------ ------------------ ---------------------------
James T. Grohalski
President and Chief Executive Officer of the 2000 $161,665 $7,844
Company and the Bank 1999 $140,570 $7,344
1998 $133,813 $7,400
(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 2000: (i) employer
contributions to accounts in the ESOP and the Deferred
Compensation Plan of $4,004 and $3,000 respectively for Mr.
Grohalski; and (ii) $840 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
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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 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
------------------ ------------- -------------- ------------
$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
$160,000 $46,700 $56,000 $56,000
James T. Grohalski has 33 years of credited service and $141,300 current covered
remuneration.
The Bank also has in effect a supplemental retirement arrangement in
the form of an Executive Employee Salary Continuation Agreement with Mr.
Grohalski 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.
The Company and the Bank have executed an Employment Agreement with Mr.
Grohalski whereby Mr. Grohalski will serve as the President and Chief Executive
Officer of the Company and the Bank. The term of the Employment Agreement is for
one year and it may be renewed by mutual agreement of the Company, the Bank and
Mr. Grohalski. Pursuant to the Employment Agreement, commencing January 23,
2001, Mr.
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Grohalski's annual salary will be $163,000 plus such additional or special
compensation based upon his performance as the Company's Board of Directors, in
its discretion, may from time to time determine. Under the Employment Agreement,
in the event that Mr. Grohalski is terminated for any reason other than for
cause, or in the event of Mr. Grohalski's "voluntary termination for good
reason," then, in addition to receiving the compensation and benefits under the
Employment Agreement, upon the expiration of the term of the Employment
Agreement, Mr. Grohalski will be entitled to monthly installments equal to
1/12th of his annual salary, commencing thirty days after expiration of the term
of the Employment Agreement, until the earlier of his death, the age of 65, or
the date he receives twelve monthly installments.
Under the Employment Agreement, the term "voluntary termination for
good reason" means voluntary termination of employment by Mr. Grohalski after
any of the following actions without Mr. Grohalski's express written consent:
(1) the assignment of duties of a nonexecutive nature or for which Mr. Grohalski
is not reasonably equipped by his skills and experience; (2) without reasonable
justification, a reduction in the salary, or a material reduction in the amount
of paid vacations or in the fringe benefits and perquisites, of Mr. Grohalski;
(3) the relocation of Mr. Grohalski's principal business office or principal
place of residence to a place that is more than sixty miles from Coldwater,
Michigan or the assignment of duties to Mr. Grohalski that would reasonably
require such relocation; (4) the assignment of duties to Mr. Grohalski which
would reasonably require him to spend more than ninety working days away from
Coldwater, Michigan during any consecutive twelve month period; (5) the failure
to provide office facilities, secretarial services, and other administrative
services to Mr. Grohalski which are substantially equivalent to the facilities
and services provided to him on the date the Employment Agreement was executed;
or (6) the termination of incentive and benefit plans or arrangements provided
to Mr. Grohalski under the Employment Agreement, or a material reduction in the
aggregate value of Mr. Grohalski's incentive compensation and benefits below
their aggregate value as of the date of the Employment Agreement.
The Employment Agreement also provides that in the event of a
"termination for cause," Mr. Grohalski will not be entitled to receive
compensation or other benefits for any period after such termination. The term
"termination for cause" means the termination of employment based on: (1)
conviction of any criminal violation involving dishonesty, fraud or breach of
trust; (2) the willful engagement in any misconduct in the performance of Mr.
Grohalski's duties that materially injures the Company or its subsidiaries; (3)
the performance of any act which, if known to the customers, clients or
shareholders of the Company or any of its subsidiaries, would materially and
adversely impact the business of the Company or any of its subsidiaries; (4) the
willful and substantial nonperformance of Mr. Grohalski's duties if such
nonperformance continues for more than ten days after written notice of such
nonperformance and of the Company's intention to terminate his employment; (5)
the willful violation of the noncompetition and nondisclosure obligations
contained in the Employment Agreement; (6) the suspension and/or temporary
prohibition, or the removal and/or permanent prohibition, from participating in
the conduct of the affairs of the Company or any of its affiliates by a notice,
order, ruling or other finding of any state or federal agency (including, but
not limited to, any Federal Reserve Bank, the FDIC, or Michigan's Office of
Financial and Insurance Services); or (7) any determination or action by any
federal or state regulatory agency that the Company's Board of Directors
determines to reflect adversely on the Company and to be related to Mr.
Grohalski's duties under the Employment Agreement.
The Employment Agreement also provides for a severance payment equal to
two year's salary in accordance with Section 280G of the Internal Revenue Code
in the event of a termination of employment without cause or a voluntary
termination with good reason within three years after a change in control that
occurs during the term of the Employment Agreement. In the event that it is in
the best interests of the Company and Mr. Grohalski, then Mr. Grohalski shall
have the right to elect to have the severance payment paid in installments, with
the first installment being equal to one year's salary and the balance being
paid in installments in accordance with Section 280G of the Internal Revenue
Code.
For purposes of the Employment Agreement, the term "change in control"
means: (1) the acquisition by any entity, person, or group of beneficial
ownership of more than 50% of the outstanding capital stock of the
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Company entitled to vote in an election of directors; (2) the commencement by
any entity, person, or group (other than the Company or a subsidiary of the
Company) of a tender offer or an exchange offer for more than 25% of the
outstanding voting stock of the Company entitled to vote in an election of
directors; (3) the merger of the Company with another entity that results in the
holders of the outstanding voting stock entitled to vote of the election of
directors of the Company immediately prior to such merger holding less than 50%
of the voting stock entitled to vote for the election of directors of the
surviving or resulting corporation; (4) the transfer of substantially all of the
assets of the Company other than to an entity of which the Company owns at least
80% of the voting stock entitled to vote for the election of directors; or (5)
the election to the Board of Directors of the Company, without the
recommendation or approval of the incumbent Board of Directors, of the lesser of
three directors or directors constituting a majority of the number of directors
then in office.
The Employment Agreement also provides that during the term thereof,
and for a period of one year following the termination of employment, Mr.
Grohalski will not: (1) within a geographic radius of 75 miles from Coldwater,
Michigan, engage in, or work for, manage, operate, control or participate in the
ownership, management, operation or control of, or be connected with, or have
any financial interest in, any individual, partnership, firm, corporation or
institution engaged in the same or similar activities to those now or hereafter
carried on by the Company or the Bank; (2) interfere with the relationship of
the Company or the Bank and any of their employees, agents or representatives;
or (3) directly or indirectly divert or attempt to divert from the Company or
the Bank any business in which the Company or the Bank has been actively engaged
during the term of the Employment Agreement, nor interfere with the
relationships of the Company or the Bank with their dealers, distributors,
sources of supply or customers. Finally, the Employment Agreement prohibits Mr.
Grohalski, during the term of the Employment Agreement and at any time
thereafter, from disclosing any confidential information of the Company or the
Bank.
Compensation Committee Report on Executive Compensation
Executive Compensation Policies.
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.
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.
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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. 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 $6,361 which will be
indexed for inflation in 2001. In addition, outside directors are compensated
$150 for each committee meeting attended and participate in a bonus program
based upon the achievement of growth and profitability goals. $1,000 per outside
director was paid as a bonus for 2000. The directors are 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 15, 2001, 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 AND ADDRESS OF BENEFICIAL AMOUNT AND NATURE OF BENEFICIAL PERCENT OF
TITLE OF CLASS OWNER OWNERSHIP(1) CLASS
------------------------ ------------------------------------ --------------------------------- ---------------
Common Stock Southern Michigan Bank 196,352(a) 10.12%
& Trust
51 West Pearl Street
Coldwater, MI 49036
Common Stock Harvey B. Randall 146,022(b) 7.52%
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.
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(a) Shares are held by the Trust Department of Southern
Michigan Bank & Trust (the "Bank") in various fiduciary
capacities. 1,089 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 15, 2001, 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 NUMBER OF AMOUNT AND NATURE OF BENEFICIAL TOTAL PERCENT OF
PERSONS IN GROUP OWNERSHIP(1) CLASS
------------------------------------- ------------------------------- ------- ----------
James P. Briskey 11,148 22,296 1.15
11,148 (a)
H. Kenneth Cole 366 366 (2)
William E. Galliers 3,711 (a) 3,711 (2)
James T. Grohalski(3) 23,700 (b) 23,700 1.22
Nolan E. Hooker 878 (a) 878 (2)
Gregory J. Hull 1,262 (a) 1,262 (2)
Thomas E. Kolassa 2,142 (a) 2,142 (2)
James J. Morrison 2,042 4,703 (2)
2,661 (a)
Jane L. Randall 5,945 (c) 5,945 (2)
Freeman E. Riddle 4,554 7,000 (2)
2,446 (a)
All directors and executive officers as a 72,003 72,003 3.71%
group (10 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 21,217 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.
(2) Less than one percent (1%).
(3) Mr. Grohalski is the only executive officer of the Company.
31
32
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 2000. 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, 2000 and 1999
- Consolidated Statements of Changes in Shareholders' Equity
- Years ended December 31, 2000, 1999 and 1998
- Consolidated Statements of Income - Years ended December
31, 2000, 1999 and 1998
- Consolidated Statements of Cash Flows - Years ended
December 31, 2000, 1999 and 1998
- Notes to Consolidated Financial Statements - December 31,
2000
(a)(2) Not applicable.
(a)(3) Exhibits (Numbered in accordance with Item 601 of Regulation
S-K).
Exhibit No. Description of Exhibit
----------- ----------------------
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.
32
33
Exhibit No. Description of Exhibit
----------- ----------------------
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 is
incorporated by reference to
Exhibit 10(b) to the Company's
Annual Report on Form 10-K for
the year ended December 31,
1999.
Exhibit 10(c) Employment Agreement dated
January 23, 2001 by and
between the Bank and the
Company and James T.
Grohalski.
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.
(b) In the last Quarter of the period covered by this report, on
October 6, 2000, the Company filed a Form 8-K regarding notification from
Sturgis Bank & Trust Company ("Sturgis") that Sturgis had terminated the
Agreement and Plan of Consolidation dated February 15, 2000 which was intended
to combine the two companies.
(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 16, 2001, the Company furnished to the Commission on
Form 8-K its proxy statement dated March 16, 2001 which was
prepared for its 2001 Annual Meeting of Shareholders, which
proxy statement included in Appendix A the information
required in its 2000 annual report to security holders. On the
date of filing this Form 10-K, the Company mailed to the
Commission four copies of the aforementioned proxy materials
and annual report.
(The remainder of this page is intentionally blank. The next
page is FS-1).
33
34
SOUTHERN MICHIGAN BANCORP, INC.
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, 2000 and 1999 and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2000. 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, 2000 and 1999 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2000 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 8, 2001
FS-1
35
SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except number of shares)
December 31,
2000 1999
--------- ---------
ASSETS
Cash $ 3,769 $ 4,217
Due from banks 14,720 7,829
--------- ---------
Cash and cash equivalents 18,489 12,046
Securities available for sale 51,475 54,229
Loans, net of allowance for loan losses $2,096 - 2000 ($2,132 - 1999) 212,309 191,239
Premises and equipment 7,619 6,705
Accrued interest receivable 3,062 2,442
Net cash surrender value of life insurance 5,507 5,251
Other assets 5,178 3,913
--------- ---------
TOTAL ASSETS $ 303,639 $ 275,825
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 37,677 $ 33,124
Interest bearing 207,753 200,179
--------- ---------
Total deposits 245,430 233,303
Accrued expenses and other liabilities 3,520 3,542
Federal funds purchased 4,000
Other borrowings 25,000 15,000
--------- ---------
TOTAL LIABILITIES 277,950 251,845
Common stock subject to repurchase obligation in
Employee Stock Ownership Plan, shares outstanding - 109,438 in 2000
(130,502 in 1999) 1,478 3,990
Shareholders' equity
Preferred stock, 100,000 shares authorized; none issued or outstanding
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 1,940,502 shares in 2000 (1,969,259 in 1999)
Outstanding - 1,831,064 shares in 2000 (1,838,757 in 1999) 4,578 4,597
Additional paid-in capital 10,072 8,421
Retained earnings 9,964 7,949
Accumulated other comprehensive income (loss) 185 (389)
Unearned Employee Stock Ownership Plan shares (588) (588)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 24,211 19,990
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 303,639 $ 275,825
========= =========
See accompanying notes to consolidated financial statements.
FS-2
36
SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except number of shares and per share data)
Accumulated
Other
Additional Compre- Unearned
Common Paid-In Retained hensive ESOP
Stock Capital Earnings Income Shares TOTAL
-------- -------- -------- -------- --------- --------
BALANCE AT JANUARY 1, 1998 $ 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
Net income for 2000 3,375 3,375
Cash dividends declared - $.70 per share (1,360) (1,360)
Common stock repurchased and
retired (28,757 shares) (72) (808) (880)
Change in common stock subject
to repurchase 53 2,459 2,512
Net change in unrealized gain (loss) on
available for sale securities, net of tax 574 574
-------- -------- -------- -------- ---------- --------
BALANCE AT DECEMBER 31, 2000 $ 4,578 $ 10,072 $ 9,964 $ 185 $ (588) $ 24,211
======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
FS-3
37
SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Year ended December 31,
2000 1999 1998
-------- -------- --------
Interest income:
Loans, including fees $ 20,102 $ 16,577 $ 15,781
Securities:
Taxable 2,212 2,235 2,305
Tax-exempt 908 1,132 1,094
-------- -------- --------
3,120 3,367 3,399
Other 23 107 266
-------- -------- --------
Total interest income 23,245 20,051 19,446
Interest expense:
Deposits 8,912 7,738 7,622
Other 1,785 697 410
-------- -------- --------
Total interest expense 10,697 8,435 8,032
-------- -------- --------
NET INTEREST INCOME 12,548 11,616 11,414
Provision for loan losses 700 852 600
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 11,848 10,764 10,814
Non-interest income:
Service charges on deposit accounts 1,102 1,064 978
Trust fees 535 486 500
Securities gains (losses) (3)
Net gains on loan sales 533 758 1,085
Earnings on life insurance assets 247 208 220
Other 614 509 413
-------- -------- --------
3,028 3,025 3,196
Non-interest expense:
Salaries and employee benefits 4,803 4,569 4,528
Occupancy 820 854 781
Equipment 1,040 979 872
Printing, postage and supplies 409 385 466
Advertising and marketing 271 287 417
Professional and outside services 1,032 428 326
Other 1,947 1,982 1,886
-------- -------- --------
10,322 9,484 9,276
-------- -------- --------
Income before income taxes 4,554 4,305 4,734
Federal income taxes 1,179 1,005 1,185
-------- -------- --------
NET INCOME 3,375 3,300 3,549
Other comprehensive income:
Unrealized gains (losses) on securities arising during the year 866 (1,599) 355
Net cumulative effect of adopting new accounting principle 616
Reclassification adjustment for accumulated losses
included in net income 3
Tax effect (295) 334 (121)
-------- -------- --------
Other comprehensive income (loss) 574 (649) 234
-------- -------- --------
COMPREHENSIVE INCOME $ 3,949 $ 2,651 $ 3,783
======== ======== ========
BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 1.75 $ 1.64 $ 1.70
======== ======== ========
See accompanying notes to consolidated financial statements.
FS-4
38
SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended December 31,
2000 1999 1998
-------- -------- --------
OPERATING ACTIVITIES
Net income $ 3,375 $ 3,300 $ 3,549
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 700 852 600
Depreciation 741 711 599
Net amortization of investment securities 45 206 182
Net realized losses on sales of securities 3
Loans originated for sale (18,805) (27,348) (34,550)
Proceeds on loans sold 19,305 27,773 35,167
Net gains on loan sales (533) (758) (1,085)
Net realized gain on disposal of fixed assets (25)
Net change in:
Accrued interest receivable (620) (24) (342)
Other assets (1,560) (607) 60
Accrued expenses and other liabilities (13) 481 (459)
-------- -------- --------
Net cash from operating activities 2,613 4,586 3,721
INVESTING ACTIVITIES
Net decrease in federal funds sold 4,000 500
Activity in available-for-sale securities:
Sales 997
Maturities and calls 12,731 19,238 9,522
Purchases (10,153) (19,387) (32,808)
Activity in held-to-maturity securities:
Maturities and calls 12,625 6,852
Purchases (6,213)
Increase in net cash surrender value of life insurance (256) (225) (612)
Loan originations and payments, net (21,737) (30,481) (4,531)
Proceeds from sale of premises and equipment 206
Additions to premises and equipment (1,836) (380) (2,047)
-------- -------- --------
Net cash from investing activities (20,048) (14,610) (29,337)
FINANCING ACTIVITIES
Net change in deposits 12,127 (58) 26,296
Net increase in federal funds purchased 4,000
Proceeds from other borrowings 10,000 10,000 2,000
Common stock issued 251
Cash dividends paid (1,369) (1,428) (1,252)
Repurchase of common stock (880) (2,672) (2,299)
-------- -------- --------
Net cash from financing activities 23,878 5,842 24,996
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 6,443 (4,182) (620)
Beginning cash and cash equivalents 12,046 16,228 16,848
-------- -------- --------
ENDING CASH AND CASH EQUIVALENTS $ 18,489 $ 12,046 $ 16,228
======== ======== ========
Transfers of securities from held to maturity
to available for sale $ -- $ 19,747 $ --
Cash paid for interest $ 10,687 $ 8,397 $ 8,054
See accompanying notes to consolidated financial statements
FS-5
39
SOUTHERN MICHIGAN BANCORP, INC.
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 and consumer loans to customers.
The majority of loans are secured by business assets, commercial real estate,
and consumer assets. There are no foreign loans. SMB Mortgage Company was
established in August 2000 as a wholly-owned subsidiary of the Bank. All
residential real estate loans are transacted through this subsidiary. The
majority of loans are secured by residential real estate.
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 accrued 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 HELD FOR SALE: Loans held for sale are reported at the lower of cost or
market value in the aggregate. Net unrealized losses are recorded in a valuation
allowance by charges to income.
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.
FS-6
40
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 based on past loan loss experience,
nature and volume of 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. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed.
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 $682,000 and $745,000 and core deposit intangibles were
$320,000 and $376,000 at December 31, 2000 and 1999, respectively. These
balances are included in other assets.
OTHER REAL ESTATE: Other real estate was $1,415,000 and $161,000 at December 31,
2000 and 1999 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. Expenses, gains and losses on
disposition, and changes in the valuation allowance are reported in other
expense.
FS-7
41
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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. The fair value
estimates of existing on-and off- balance sheet financial instruments does not
include the value of anticipated future business or values of assets and
liabilities not considered financial instruments.
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 53% 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 32% of the loan
portfolio and are collateralized by mortgages on residential real estate.
Consumer loans make up approximately 15% of the loan portfolio and are primarily
collateralized by consumer assets.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: Financial instruments include
off-balance sheet credit instruments, such as commitments to make loans and
standby letters of credit issued to meet customer needs. The face amount for
these items represents the exposure to loss before considering customer
collateral or ability to repay. Such financial instruments are recorded when
they are funded.
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, 2000
and 1999.
RECLASSIFICATIONS: Some items in the prior year consolidated financial
statements have been reclassified to conform with the current year presentation.
FS-8
42
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - BASIC AND DILUTED EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators of basic and diluted
earnings per common share for the years ended is presented below:
2000 1999 1998
----------- ----------- -----------
BASIC EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,375 $ 3,300 $ 3,549
=========== =========== ===========
Weighted average common shares outstanding 1,947,384 2,027,015 2,084,821
Less: Unallocated ESOP shares (15,400) (15,400) (2,566)
----------- ----------- -----------
Weighted average common shares outstanding for basic
earnings per common share 1,931,984 2,011,615 2,082,255
=========== =========== ===========
Basic earnings per common share $ 1.75 $ 1.64 $ 1.70
=========== =========== ===========
DILUTED EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,375 $ 3,300 $ 3,549
=========== =========== ===========
Weighted average common and dilutive
potential common shares outstanding 1,931,984 2,011,615 2,082,255
=========== =========== ===========
Diluted earnings per common share $ 1.75 $ 1.64 $ 1.70
=========== =========== ===========
NOTE C - SECURITIES
Year end investment securities were as follows (in thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE, 2000 COST GAINS LOSSES VALUE
------- ------- ------- -------
U.S. Treasury and Government agencies $19,023 $ 160 $ (20) $19,163
States and political subdivisions 22,575 176 (14) 22,737
Corporate securities 6,031 102 (79) 6,054
Mortgage-backed securities 2,283 (45) 2,238
------- ------- ------- -------
Total debt securities 49,912 438 (158) 50,192
Equity securities 1,283 1,283
------- ------- ------- -------
TOTAL $51,195 $ 438 $ (158) $51,475
======= ======= ======= =======
There were no securities held to maturity as of December 31, 2000.
FS-9
43
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - SECURITIES (CONTINUED)
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.
Sales of available for sale securities were (in thousands):
2000 1999 1998
----- ----- -----
Proceeds $ 997 $ 0 $ 0
Gross gains 1 0 0
Gross losses (4) 0 0
Contractual maturities of debt securities at year-end 2000 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 $ 8,398 $ 8,400
Due from one to five years 32,342 32,582
Due from five to ten years 4,335 4,399
Due after ten years 2,554 2,573
Mortgage-backed securities 2,283 2,238
------- -------
$49,912 $50,192
======= =======
Securities with a carrying value of $20,407,000 and $17,750,000 as of
December 31, 2000 and 1999, respectively, were pledged to secure FHLB
borrowings. Securities with an amortized cost of $2,340,000 and $2,911,000 were
pledged as collateral for public deposits and for other purposes in 2000 and
1999.
Except as indicated, total securities of any state (including all its
political subdivisions) were less than 10% of shareholders' equity. At year-end
2000 and 1999, the amortized cost of securities issued by the state of Michigan
and all its political subdivisions totaled $11,079,000 and $13,114,000 with an
estimated market value of $11,511,000 and $13,132,000, 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.
FS-10
44
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D - LOANS
Loans at year-end were as follows (in thousands):
2000 1999
--------- ---------
Commercial $ 112,748 $ 96,758
Consumer 31,411 33,190
Real estate mortgage 69,222 62,432
Loans held for sale, net of valuation allowance of $-0- in 2000 and 1999 1,024 991
--------- ---------
214,405 193,371
Less allowance for loan losses (2,096) (2,132)
--------- ---------
LOANS, NET $ 212,309 $ 191,239
========= =========
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.
2000 1999
------- -------
Balance at January 1 $ 4,502 $ 3,923
New loans 5,807 6,222
Repayments (5,766) (5,487)
Other changes, net (430) (156)
------- -------
BALANCE AT DECEMBER 31 $ 4,113 $ 4,502
======= =======
The unpaid principal balance of mortgage loans serviced for others, which are
not included on the consolidated balance sheet, was $72,920,000 and $69,880,000
at December 31, 2000 and 1999, respectively.
Activity for capitalized mortgage servicing rights was as follows (in
thousands):
2000 1999 1998
----- ----- -----
Balance at January 1 $ 796 $ 595 $ 327
Additions 184 377 468
Amortized to expense (200) (176) (200)
----- ----- -----
BALANCE AT DECEMBER 31 $ 780 $ 796 $ 595
===== ===== =====
No valuation allowance for capitalized mortgage servicing rights was
necessary at December 31, 2000 or 1999.
NOTE E - ALLOWANCES FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December
31 were as follows (in thousands):
2000 1999 1998
------- ------- -------
Balance at January 1 $ 2,132 $ 2,026 $ 1,863
Provision for loan losses 700 852 600
Loans charged off (942) (1,050) (579)
Recoveries 206 304 142
------- ------- -------
Net charge-offs (736) (746) (437)
------- ------- -------
BALANCE AT DECEMBER 31 $ 2,096 $ 2,132 $ 2,026
======= ======= =======
FS-11
45
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E - ALLOWANCES FOR LOAN LOSSES (CONTINUED)
2000 1999
------ ------
Information regarding impaired loans follows:
Year end loans with allowance for loan losses allocated $2,312 $1,543
Year end loans with no allowance for loan losses allocated 421 700
------ ------
Total impaired loans $2,733 $2,243
====== ======
Amount of allowance allocated to these loans $ 850 $ 275
2000 1999 1998
------ ------ ------
Average balance of impaired loans during the year $3,121 $2,415 $1,566
Cash basis interest income recognized during the year $ 275 $ 191 $ 73
Interest income recognized during the year $ 257 $ 200 $ 102
NOTE F - PREMISES AND EQUIPMENT
Premises and equipment consist of (in thousands):
2000 1999
-------- --------
Land $ 786 $ 786
Buildings and improvements 8,782 7,685
Equipment 3,959 3,442
-------- --------
13,527 11,913
Less accumulated depreciation 5,908 (5,208)
-------- --------
TOTALS $ 7,619 $ 6,705
======== ========
Depreciation and amortization expense charged to operations was
approximately $741,000, $711,000 and $599,000 in 2000, 1999 and 1998,
respectively.
NOTE G - DEPOSITS
The carrying amount of domestic deposits at year-end follows (in
thousands):
2000 1999
-------- --------
Non-interest bearing checking $ 37,677 $ 33,124
Interest bearing checking 39,222 38,927
Passbook savings 29,799 30,793
Money market accounts 46,253 43,571
Time deposits 90,289 84,774
Other deposits 2,190 2,114
-------- --------
TOTALS $245,430 $233,303
======== ========
FS-12
46
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - DEPOSITS (CONTINUED)
The carrying amount of time deposits over $100,000 was $29,512,000 and
$24,340,000 at December 31, 2000 and 1999, respectively. Interest expense on
time deposits over $100,000 was $1,482,000, $1,263,000 and $1,145,000 for the
years ended December 31, 2000, 1999 and 1998, respectively.
At year-end, scheduled maturities of time deposits were as follows for the years
ending December 31 (in thousands):
2001 $ 66,928
2002 13,741
2003 6,881
2004 2,739
2005 --
-----------
TOTALS $ 90,289
===========
Related party deposits were $1,934,000 and $2,061,000 at December 31,
2000 and 1999, 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 5.71% to 6.89% until the stated call dates ranging from
February 20, 2001 to July 5, 2005. On the stated call dates, 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. Eligible FHLB
collateral at December 31, 2000 and 1999 was approximately $73,000,000 and
$67,000,000.
At year-end 2000, scheduled principal reductions on these advances were as
follows for the years ending December 31 (in thousands):
2001 $ --
2002 3,000
2003 2,000
2004 10,000
2005 10,000
Thereafter --
-------
TOTAL FHLB ADVANCES $25,000
=======
NOTE I - INCOME TAXES
Income tax expense consists of:
2000 1999 1998
------- ------- -------
Current $ 1,100 $ 1,021 $ 1,226
Deferred 79 (16) (41)
------- ------- -------
TOTALS $ 1,179 $ 1,005 $ 1,185
======= ======= =======
FS-13
47
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - INCOME TAXES (CONTINUED)
Income tax expense calculated at the statutory federal income tax rate
of 34% differs from actual income tax expense as follows (in thousands):
2000 1999 1998
------- ------- -------
Statutory rates $ 1,548 $ 1,464 $ 1,610
Tax-exempt interest income (288) (358) (350)
Increase in net cash surrender value of life insurance policies (87) (77) (82)
Other items, net 6 (24) 7
------- ------- -------
TOTALS $ 1,179 $ 1,005 $ 1,185
======= ======= =======
Year-end deferred tax assets and liabilities consist of (in thousands):
2000 1999
------ ------
Deferred tax assets:
Net unrealized depreciation on available for sale securities $ -- $ 200
Allowance for loan losses 484 497
Deferred compensation liability 499 502
Pension liability 90 99
Other 144 185
------ ------
Totals 1,217 1,483
Deferred tax liabilities:
Net unrealized appreciation on available for sale securities 95
Mortgage servicing rights 265 271
Other 60 41
------ ------
Totals 420 312
------ ------
NET DEFERRED TAX ASSET $ 797 $1,171
====== ======
The Company made income tax payments of $965,000 in 2000, $1,160,000 in
1999 and $1,165,000 in 1998. An allowance against the net deferred tax asset was
not considered necessary at December 31, 2000 or 1999.
NOTE J - BENEFIT 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. Assets held by the plan
primarily include corporate and foreign bonds and common equity securities.
FS-14
48
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - BENEFIT PLANS (CONTINUED)
Information about the pension plan was as follows (in thousands):
2000 1999
------- -------
Change in benefit obligation:
Beginning benefit obligation $(1,415) $(2,326)
Service cost (113) (133)
Interest cost (99) (134)
Actuarial (gain) loss (122) 511
Benefits paid 239 667
------- -------
Ending benefit obligation $(1,510) $(1,415)
======= =======
Change in plan assets, at fair value:
Beginning plan assets $ 1,772 $ 2,266
Actual return (86) 144
Employer contribution 80 29
Benefits paid (239) (667)
------- -------
Ending plan assets $ 1,527 $ 1,772
======= =======
Net amount recognized:
Funded status $ 17 $ 357
Unrecognized net actuarial gain (273) (650)
Unrecognized transition obligation 9 13
Unrecognized prior service cost 25 37
------- -------
Accrued pension cost $ (222) $ (243)
======= =======
The components of pension expense and related actuarial assumptions
were as follows:
2000 1999 1998
----- ----- -----
Components of net periodic benefit cost:
Service cost $ 113 $ 133 $ 140
Interest cost 99 134 115
Expected return on plan assets (137) (153) (345)
Net amortization and deferral (6) 16 188
----- ----- -----
Net periodic benefit cost $ 69 $ 130 $ 98
===== ===== =====
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% 3.0%
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 $73,000, $78,000 and
$90,000 in 2000, 1999 and 1998. 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.
FS-15
49
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - BENEFIT PLANS (CONTINUED)
Shares held by the ESOP at year-end are as follows:
2000 1999
------- -------
Allocated shares 109,438 130,502
Unallocated shares 15,400 15,400
------- -------
TOTAL ESOP SHARES 124,838 145,902
======= =======
The fair value of the allocated shares held by the ESOP is approximately
$1,478,000 and $3,990,000 at December 31, 2000 and 1999, 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 $216,000, $218,000 and
$229,000 in 2000, 1999 and 1998. The liability for vested benefits was
$1,467,000 and $1,476,000 at December 31, 2000 and 1999, respectively.
On April 17, 2000, the Company approved a Stock Option Plan to advance the
interests of the Company and its shareholders by affording to directors,
officers and other employees of the Company an opportunity to acquire or
increase their proprietary interest in the Company using stock options. Option
shares authorized under the plan total 110,000. Options are to be granted with
an exercise period of 10 years or less, an exercise price of not less than the
fair market value of the stock on the date the options are granted and a vesting
period as determined by the Board of Directors. The plan will terminate on the
earliest of: (i) March 20, 2010; (ii) when all shares have been issued through
exercise of options granted under this Plan; or (iii) at any earlier time that
the Board of Directors may determine. No options were granted in 2000.
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, 2000 and 1999, respectively, the Bank had commitments under
commercial letters of credit, used to facilitate customers' trade transactions,
of $147,000 and $414,000.
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,
2000 and 1999, respectively, commitments under outstanding standby letters of
credit were $480,000 and $626,000.
FS-16
50
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - COMMITMENTS (CONTINUED)
Loan commitments outstanding to extend credit are detailed below (in thousands):
2000 1999
------- -------
Fixed rate $ 2,963 $ 4,570
Variable rate 35,093 33,379
------- -------
TOTALS $38,056 $37,949
======= =======
The fixed rate commitments have stated interest rates ranging from 8.0% 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, 2000, the Company had line of credit agreements with LaSalle
Bank and Fifth Third Bank for $8,000,000 and $750,000, respectively. The
balances on these lines were $0 at December 31, 2000. The line of credit at
LaSalle Bank is secured by Bank stock.
At December 31, 2000, the Bank had line of credit agreements with Fifth Third
Bank, Bank One and Federal Home Loan Bank for $5,500,000, $7,000,000 and
$4,000,000, respectively. The balances on these lines were $0 at December 31,
2000.
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. At December
31, 2000, approximately $5,028,000 of the subsidiaries' retained earnings is
available for transfer in the form of dividends without prior regulatory
approval.
FS-17
51
SOUTHERN MICHIGAN BANCORP, INC.
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,
2000 1999
------- -------
ASSETS
Cash $ 1 $ 97
Securities available for sale 2,944 3,273
Investment in subsidiary 22,243 19,695
Premises and equipment 1,109 1,196
Other 295 704
------- -------
TOTAL ASSETS $26,592 $24,965
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 331 $ 340
Other liabilities 572 645
Common stock subject to repurchase obligation in ESOP 1,478 3,990
Shareholders' equity 24,211 19,990
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $26,592 $24,965
======= =======
Statements of Income Year ended December 31,
2000 1999 1998
------- ------- -------
Dividends from Bank $ 1,415 $ 3,718 $ 3,620
Interest income 151 154 167
Other income 249 269 226
Other expenses (500) (98) (33)
------- ------- -------
1,315 4,043 3,980
Federal income tax (expense) benefit 71 (35) (85)
------- ------- -------
1,386 4,008 3,895
Equity in undistributed (excess) distributed net income of
subsidiary 1,989 (708) (346)
------- ------- -------
NET INCOME 3,375 3,300 3,549
Net change in unrealized gains (losses) on securities
available for sale 574 (649) 234
------- ------- -------
Other comprehensive income 574 (649) 234
------- ------- -------
COMPREHENSIVE INCOME $ 3,949 $ 2,651 $ 3,783
======= ======= =======
Statements of Cash Flows Year ended December 31,
2000 1999 1998
------- ------- -------
OPERATING ACTIVITIES
Net income $ 3,375 $ 3,300 $ 3,549
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in (undistributed)/excess distributed net income of
subsidiary (1,989) 708 346
Depreciation 34 35 31
Net amortization of investment securities 22 25 16
Net realized gain on disposal of fixed assets (150)
Other 329 54 (253)
------- ------- -------
Net cash from operating activities 1,621 4,122 3,689
FS-18
52
SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION (CONTINUED)
Statements of Cash Flows (continued) Year ended December 31,
2000 1999 1998
------- ------- -------
INVESTING ACTIVITIES
Activity in available for sale investment securities:
Proceeds from sales of investment securities 799
Maturities and calls 516 776 1,977
Purchases (986) (717) (2,059)
Activity in held to maturity investment securities:
Maturities and calls (250)
Proceeds from sale of premises and equipment 204
Additions to premises and equipment (1) (60)
------- ------- -------
Net cash from investing activities 532 59 (392)
FINANCING ACTIVITIES
Common stock
issued 251
Cash dividends paid (1,369) (1,428) (1,252)
Repurchase of common stock (880) (2,672) (2,299)
------- ------- -------
Net cash from financing activities (2,249) (4,100) (3,300)
------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS (96) 81 (3)
Beginning cash and cash equivalents 97 16 19
------- ------- -------
ENDING CASH AND CASH EQUIVALENTS $ 1 $ 97 $ 16
======= ======= =======
Transfers of securities held to maturity to securities
available for sale $ -- $ 250 $ --
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-19
53
SOUTHERN MICHIGAN BANCORP, INC.
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, 2000 and 1999, 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, 2000 and 1999 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):
2000 1999
--------------------------- ---------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
----------- ----------- ----------- -----------
Financial assets:
Cash and cash equivalents $ 18,489 $ 18,489 $ 12,046 $ 12,046
Securities available for sale 51,475 51,475 54,229 54,229
Loans 212,309 208,191 191,239 190,293
Financial liabilities:
Deposits $ (245,430) $ (245,268) $ (233,303) $ (233,285)
Federal funds purchased (4,000) (4,000)
Other borrowings (25,000) (25,067) (15,000) (15,000)
Unrecognized financial instruments:
Commercial letters of credit $ (3) $ (8)
Standby letters of credit (10) (13)
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-20
54
SOUTHERN MICHIGAN BANCORP, INC.
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
------- ----- ------- ----- ------- -----
2000
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated $26,520 11.6% $18,369 8.0% $22,962 10.0%
Bank 23,087 10.2 18,059 8.0 22,574 10.0
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
Consolidated 24,424 10.6 9,185 4.0 13,777 6.0
Bank 20,991 9.3 9,030 4.0 13,544 6.0
TIER 1 CAPITAL (TO AVERAGE ASSETS)
Consolidated 24,424 8.1 12,052 4.0 15,065 5.0
Bank 20,991 7.1 11,898 4.0 14,873 5.0
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
The Company, at year-end 2000 and 1999, was categorized as well capitalized. The
Bank at year-end 2000 was categorized as well capitalized. The Bank for 1999 was
categorized as adequately capitalized.
NOTE P - QUARTERLY FINANCIAL DATA (UNAUDITED)
INTEREST NET INTEREST NET EARNINGS PER SHARE
INCOME INCOME INCOME BASIC FULLY DILUTED
-------- ------------ ------- -------- -------------
2000
FIRST QUARTER $ 5,434 $ 3,088 $ 757 $ .39 $ .39
SECOND QUARTER 5,697 3,175 901 .47 .47
THIRD QUARTER 6,086 3,140 781 .40 .40
FOURTH QUARTER 6,028 3,145 936 .49 .49
1999
First Quarter $ 4,759 $ 2,722 $ 781 $ .38 $ .38
Second Quarter 4,821 2,806 969 .48 .48
Third Quarter 5,129 3,007 738 .37 .37
Fourth Quarter 5,342 3,081 812 .41 .41
FS-21
55
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 27, 2001
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/ Gregory J. Hull
- -------------------------------------------- -----------------------------------------------------
Nolan E. Hooker, Director Gregory J. Hull, Director
Dated: March 27, 2001
S-1
56
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Annual Report on Form 10-K
For the Year Ended December 31, 2000
Index to Exhibits
Exhibits
SOUTHERN MICHIGAN BANCORP, INC.
(A Michigan corporation)
51 West Pearl Street
Coldwater, Michigan 49036
57
INDEX TO EXHIBITS
Exhibit No. Description of Exhibit
----------- ----------------------
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
is incorporated by reference to Exhibit 10(b) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
Exhibit 10(c) Employment Agreement dated January 23, 2001 by and
between the Bank and the Company and James T.
Grohalski.
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.