OMB APPROVAL
--------------------------
OMB Number: 3235-0059
Expires: August 31, 2004
Estimated average burden
hours per response...12.75
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement
[ ] CONFIDENTIAL, FOR USE OF THE COMMISSION ONLY (AS PERMITTED BY
RULE 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-12
IBT BANCORP, INC
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
1) Title of each class of securities to which transaction applies:
- --------------------------------------------------------------------------------
2) Aggregate number of securities to which transaction applies:
- --------------------------------------------------------------------------------
3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
- --------------------------------------------------------------------------------
4) Proposed maximum aggregate value of transaction:
- --------------------------------------------------------------------------------
5) Total fee paid:
- --------------------------------------------------------------------------------
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
- --------------------------------------------------------------------------------
2) Form, Schedule or Registration Statement No.:
- --------------------------------------------------------------------------------
3) Filing Party:
- --------------------------------------------------------------------------------
4) Date Filed:
- --------------------------------------------------------------------------------
PERSONS WHO POTENTIALLY ARE TO RESPOND TO THE COLLECTION OF INFORMATION
CONTAINED IN THIS FORM ARE NOT REQUIRED TO RESPOND UNLESS THE FORM DISPLAYS A
CURRENTLY VALID OMB CONTROL NUMBER.
SEC 1913 (02-02)
IBT BANCORP, INC.
200 EAST BROADWAY
MOUNT PLEASANT, MICHIGAN 48858
---------------------
NOTICE OF THE ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD APRIL 27, 2004
---------------------
Notice is hereby given that the Annual Meeting of Shareholders of IBT
Bancorp, Inc. will be held on Tuesday, April 27, 2004 at 7:00 p.m. Eastern
Standard Time, at the Holiday Inn, 5665 E. Pickard Street, Mount Pleasant,
Michigan. The meeting is for the purpose of considering and acting upon the
following:
1. The election of three directors.
2. Such other business as may properly come before the meeting, or any
adjournment or adjournments thereof.
The Board of Directors has fixed March 1, 2004 as the record date for
determination of shareholders entitled to notice of, and to vote at, the meeting
or any adjournments thereof.
Your vote is important. Even if you plan to attend the meeting, please date
and sign the enclosed proxy form, indicate your choice with respect to the
matters to be voted upon, and return it promptly in the enclosed envelope. Note
that if stock is held in more than one name, all parties should sign the proxy
form.
By order of the Board of Directors
MARY ANN BREUER,
Secretary
Dated: March 29, 2004
IBT BANCORP, INC.
200 EAST BROADWAY
MOUNT PLEASANT, MICHIGAN 48858
---------------------
PROXY STATEMENT
---------------------
GENERAL INFORMATION
This Proxy Statement is furnished in connection with the solicitation of
proxies by the Board of Directors of IBT Bancorp, Inc. (the Corporation) a
Michigan financial holding company, to be voted at the Annual Meeting of
Shareholders of the Corporation to be held on Tuesday, April 27, 2004 at 7:00
p.m. at the Holiday Inn, 5665 E. Pickard Street, Mount Pleasant, Michigan, or at
any adjournment or adjournments thereof, for the purposes set forth in the
accompanying Notice of Annual Meeting of Shareholders and in this Proxy
Statement.
This Proxy Statement has been mailed on March 29, 2004 to all holders of
record of common stock as of the record date.
VOTING AT THE MEETING
The Board of Directors of the Corporation has fixed the close of business
on March 1, 2004 as the record date for the determination of shareholders
entitled to notice of, and to vote at, the Annual Meeting of Shareholders and
any adjournment thereof. The Corporation has only one class of common stock and
no preferred stock. As of March 1, 2004, there were 4,845,357 shares of common
stock of the Corporation outstanding. Each outstanding share entitles the holder
thereof to one vote on each separate matter presented for vote at the meeting.
If the enclosed proxy is executed and returned, it may be revoked at any time
before it is exercised at the meeting. All shareholders are encouraged to date
and sign the enclosed proxy form, indicate their choice with respect to the
matters to be voted upon, and return it to the Corporation.
ELECTION OF DIRECTORS
The Board of Directors is divided into three classes, with the directors in
each class being elected for a term of three years. At the Annual Meeting of
Shareholders, three directors will be elected for terms ending with the annual
meeting of shareholders in 2007. On December 31, 2003, L.A. Johns retired as a
director. Additionally, in accordance with the retirement guidelines set forth
in the Corporation's Bylaws, Dean E. Walldorff retired as a director on June 30,
2003. At its July 29, 2003 meeting, the Board of Directors elected W. Joseph
Manifold to fill the directorship left vacant by Mr. Walldorff's retirement.
Except as otherwise specified in the proxy, proxies will be voted for
election of the three nominees named below. If a nominee becomes unable or
unwilling to serve, proxies will be voted for such other person, if any, as
shall be designated by the Board of Directors. However, the Corporation's
management now knows of no reason to anticipate that this will occur. Directors
are elected by a plurality of the votes cast, whether in person or by proxy, by
holders of the Corporation's common stock at the Annual Meeting of Shareholders,
provided a quorum (a majority of the shares entitled to be voted at the Annual
Meeting of Shareholders) is present or represented. Thus, the three nominees for
election as directors who receive the greatest number of votes cast will be
elected directors. Consequently, shares not voted, including broker non-votes,
whether by withholding of authority or otherwise, have no effect on the election
of directors. If a proxy is returned for such shares or they are represented in
person at the Annual Meeting of Shareholders, they will be counted toward the
establishment of a quorum.
Nominees for reelection and other current directors are listed below. Also
shown for each nominee and each other current director is his principal
occupation for the last five or more years, age and length of service as a
director of the Corporation.
DIRECTOR NOMINEES FOR TERMS ENDING IN 2007
James C. Fabiano (age 60) has been a director of Isabella Bank and Trust
since 1979 and of the Corporation since 1988. Mr. Fabiano is President and CEO
of Fabiano Brothers, Inc.
David W. Hole (age 66) has been a director of Isabella Bank and Trust since
1982. He has served on the board of the Corporation since 1988. He currently is
a director of IBT Loan Production and Financial Group Information Services. He
retired as President and CEO of Isabella Bank and Trust and the Corporation on
December 30, 2001.
Dale Weburg (age 60) has been a director of Farmers State Bank since 1987.
He has served on the board of the Corporation since 2000. Mr. Weburg is
President of Weburg Farms.
CURRENT DIRECTORS WITH TERMS ENDING IN 2005
Richard J. Barz (age 55) was appointed director of the Corporation in 2002.
He has been a director of Isabella Bank and Trust since 2000. Mr. Barz also
serves on the Board of Farmers State Bank, IBT Loan Production, IBT Title, and
Financial Group Information Services. Mr. Barz has been President and CEO of
Isabella Bank and Trust since December 30, 2001. Prior to his appointment as
President and CEO he served as Executive Vice President of Isabella Bank and
Trust.
Gerald D. Cassel (age 69) has been a director of Isabella Bank and Trust
since 1980 and the Corporation since 1988. He also serves as a director of IBT
Loan Production. Mr. Cassel is presently the Board of Directors Chairman for
Isabella Bank and Trust. Mr. Cassel is a Certified Public Accountant.
Ronald E. Schumacher (age 67) has been a director of Isabella Bank and
Trust since 1984, and the Corporation since 1988. Mr. Schumacher is the
President of A. Schumacher Sons, a grain and beef farm operation.
Herbert C. Wybenga (age 68) has been a director of Farmers State Bank since
1990. Mr. Wybenga has been a director of the Corporation since 2000. He is
currently Board of Directors Chairman for Farmers State Bank. He retired as
President and CEO of Farmers State Bank on December 31, 2002.
CURRENT DIRECTORS WITH TERMS ENDING IN 2006
Frederick L. Bradford (age 69) has been a director of Isabella Bank and
Trust since 1974 and the Corporation since 1988. Dr. Bradford is a dentist.
William J. Strickler (age 63) was appointed director of the Corporation in
2002. He has been a director of Isabella Bank and Trust since 1995. Mr.
Strickler is President of Michiwest Energy, a oil and gas producer.
W. Joseph Manifold (age 52) was appointed to IBT Bancorp's Board of
Directors in July 2003. Mr. Manifold also serves as a director of IBT Title,
Inc. Mr. Manifold is a Certified Public Accountant and Controller of Federal
Broach & Machine Company, a manufacturing company.
Dennis P. Angner (age 48) has been a director of the Corporation since
2000. He also serves as an ex-officio member of all of the Corporation's
subsidiary Boards of Directors. Mr. Angner has been President and CEO of the
Corporation since December 30, 2001. Prior to his appointment as President and
CEO, he served as Executive Vice President of the Corporation.
Each of the directors has been engaged in their stated professions for more
than five years. The principal occupation of Dennis P. Angner is with the
Corporation, and has been employed by Isabella Bank and Trust and or the
Corporation since 1984. Other executive officers of the Corporation include:
Richard J. Barz, President of Isabella Bank and Trust, has been employed by the
Bank since 1972; Tim Miller (age 52), President of Farmers State Bank of
Breckenridge, has been employed by the bank since 1985; Mary Ann Breuer (age
64), Senior Vice President and Cashier of Isabella Bank and Trust, has been
employed by the Bank since 1959. All officers of the Corporation serve at the
pleasure of the Board of Directors.
2
COMMITTEES OF THE BOARD OF DIRECTORS AND MEETING ATTENDANCE
The Board of Directors of the Corporation met 13 times during 2003. All
incumbent directors attended 75% or more of the meetings held in 2003. The Board
of Directors has an Audit Committee and a Nominating Committee. The entire Board
of Directors serves as the compensation committee.
The Audit Committee is composed of independent directors who meet the
requirements for independence as defined in Rule 4200(a)(15) of the National
Association of Securities Dealers' listing standards. Information regarding the
functions performed by the Committee, its membership, and the number of meetings
held during the year, is set forth in the "Report of the Audit Committee"
included elsewhere in this annual proxy statement. The Audit Committee is
governed by a written charter approved by the Board of Directors and is included
as Appendix A. In accordance with the provisions of the Sarbanes -- Oxley Act of
2002, Directors Cassel and Manifold meet the requirements of Audit Committee
Financial Expert and have been so designated by the Board of Director.
The Corporation has a standing Nominating Committee consisting of
independent directors who meet the requirements for independence as defined in
Rule 4200(a)(15) of the National Association of Security Dealer's listing
standards. The Committee consists of directors Cassel, Schumacher, and
Strickler. The Nominating Committee held 6 meetings in 2003, and all directors
attended 75% or more of the meetings in 2003. The Nominating Committee is
presently developing a written charter but has not yet finalized the charter.
The Nominating Committee is responsible for evaluating and recommending
individuals for nomination to the Board of Directors for approval. In making its
selections and recommendations, the Nominating Committee considers a variety of
factors, which generally include the candidate's personal and professional
integrity, independence, business judgment, and communication skills.
The Nominating Committee will consider as potential nominees, persons
recommended by shareholders. Recommendations should be submitted in writing to
the Secretary of the Corporation, 200 East Broadway, Mount Pleasant, Michigan
48858 and include the shareholder's name, address and number of shares of the
Corporation owned by the shareholder. The recommendation should also include the
name, age, address and qualifications of the recommended candidate for
nomination. Recommendations for the 2005 Annual Meeting of Shareholders should
be delivered no later than November 30, 2004. The Nominating Committee does not
evaluate potential nominees for director differently based on whether they are
recommended to the Nominating Committee by a shareholder.
3
REPORT OF THE AUDIT COMMITTEE
The Audit Committee oversees the Corporation's financial reporting process
on behalf of the Board of Directors. The Committee consists of directors Cassel,
Schumacher, Manifold, and Weburg.
The Audit Committee is responsible for pre-approving all auditing services
and permitted non-audit services to be performed during 2004 or thereafter for
the Corporation by its independent auditors or any other auditing or accounting
firm, except as noted below. The Audit Committee has established general
guidelines for the permissible scope and nature of any permitted non-audit
services in connection with its annual review of the audit plan and reviews the
guidelines with the Board of Directors.
Management has the primary responsibility for the consolidated financial
statements and the reporting process including the systems of internal controls.
In fulfilling its oversight responsibilities, the Committee reviewed the audited
consolidated financial statements in the Annual Report with management including
a discussion of the quality, not just the acceptability, of the accounting
principles, the reasonableness of significant judgments, and the clarity of
disclosures in the consolidated financial statements.
The Committee reviewed with the independent auditors, who are responsible
for expressing an opinion on the conformity of those audited consolidated
financial statements with auditing standards generally accepted in the United
States of America, their judgments as to the quality, not just the
acceptability, of the Corporation's accounting principles and such other matters
as are required to be discussed with the Committee under SAS 61, as may be
modified or supplemented. In addition, the Committee has received the written
disclosures and the letter from the independent accountants required by
Independence Standards Board Standard No. 1 as may be modified or supplemented,
and has discussed with the independent accountant the independent accountant's
independence.
The Committee discussed with the Corporation's internal and independent
auditors the overall scope and plans for their respective audits. The Committee
meets with the internal and independent auditors, with and without management
present, to discuss the results of their examinations, their evaluations of the
Corporation's internal controls and the overall quality of the Corporation's
financial reporting process. The Committee held six meetings during 2003, and
all directors attended 75% or more of the meetings held in 2003.
In reliance on the reviews and discussions referred to above, the Committee
recommended to the Board of Directors (and the Board has approved) that the
audited consolidated financial statements be included in the Annual Report on
Form 10-K for the year ended December 31, 2003 for filing with the Securities
and Exchange Commission. The Committee and the Board have also approved the
reappointment of the Corporation's independent auditors.
Respectfully submitted,
Gerald D. Cassel, Chairman
Ronald E. Schumacher
W. Joseph Manifold
Dale D. Weburg
4
EXECUTIVE OFFICERS
Executive Officers of the Corporation are compensated in accordance with
their employment with the applicable entity. The executive officers of the
Corporation whose annual compensation exceeded $100,000 for the periods
indicated are as follows:
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
ANNUAL
COMPENSATION
---------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) COMPENSATION(2)
- --------------------------- ---- --------- ---------------
Dennis P. Angner, .................................. 2003 $218,090 $ 8,390
President and CEO of IBT Bancorp 2002 204,605 12,607
2001 117,600 5,843
Richard J. Barz, ................................... 2003 $216,340 $ 8,993
Senior Vice President of IBT Bancorp and 2002 200,980 13,735
President and CEO of Isabella Bank and Trust 2001 121,000 5,916
Tim Miller, ........................................ 2003 $128,396 $ 1,770
Vice President of IBT Bancorp and
President and CEO of Farmers State Bank(3)
</Table>
- ---------------
(1) Includes compensation voluntarily deferred under the Corporation's 401(k)
and Non-qualified Deferred Salary Agreement and Board of Directors fees,
paid in cash or deferred under the Non-qualified Deferred Directors
Compensation Plan.
(2) The amounts shown represent contributions by the Corporation under its
Employee Stock Ownership Plan (ESOP), in which substantially all employees
participate and expenses related to a nonqualified supplemental Executive
Retirement Plan (ERP). The amounts contributed are as follows:
<Table>
<Caption>
YEAR ESOP ERP
---- ------ ------
Dennis P. Angner............................................ 2003 $3,006 $5,384
2002 4,262 8,345
2001 2,383 3,460
Richard J. Barz............................................. 2003 $2,982 $6,011
2002 4,353 9,382
2001 2,456 3,460
Tim Miller.................................................. 2003 $1,770 --
</Table>
(3) Mr. Miller was appointed President of Farmers State Bank of Breckenridge on
January 1, 2003.
The Corporation believes it generally maintains a conservative level of
perquisites and personal benefits. The dollar value of perquisites and personal
benefits provided to the named executive officer does not exceed 10% of his
annual compensation.
5
REPORT ON EXECUTIVE COMPENSATION
Dennis Angner serves as President and Chief Executive Officer of the
Corporation. With the exception of Dennis Angner, services performed by other
executive officers of the Corporation are incidental to their primary services
as officers and employees of a subsidiary Bank, and they receive no compensation
directly from the Corporation. The compensation for the President of each Bank
subsidiary is reviewed and approved by the Corporation's Board of Directors
based on recommendations from each Bank's Board of Directors.
The entire Board of Directors of the Corporation serves as a compensation
committee with Angner and Barz excused from the meetings where decisions with
respect to their own compensation are made. The Board of Directors has the
responsibility for establishing all formal employee benefit plans offered to
subsidiary employees.
The Board's approach to determining the annual salary of executive officers
is to offer competitive salaries in comparison with other comparable financial
institutions. The Board utilizes regional and national compensation surveys
which provide salary ranges for banks of similar size. Based on these surveys,
the Board establishes salary ranges for all job classifications. In setting
salaries, the Corporation and the Banks seek to assure relative fairness in the
compensation of officers and to recognize the value of their contribution to the
Corporation's overall success. Specific factors used to decide where an
executive officer salary should be within the established range include the
historical financial performance, financial performance outlook, years of
service, and job performance. The salary paid to Dennis P. Angner, President and
Chief Executive Officer of the Corporation, was in the 25th to 50th percentile
in 2003. The Board's primary consideration in where Angner's salary fits within
the defined range was based on a discretionary evaluation of his personal
performance and years of service as President and CEO, and the Corporation
exceeding its financial performance goals.
Respectfully submitted,
<Table>
Dennis P. Angner W. Joseph Manifold
Richard J. Barz Ronald E. Schumacher
Frederick L. Bradford William J. Strickler
Gerald D. Cassel Dale D. Weburg
James C. Fabiano Herbert C. Wybenga
David W. Hole
</Table>
6
THE DEFINED BENEFIT PENSION PLAN
The Corporation sponsors a defined benefit pension plan. This plan was
originally adopted in 1973 and was substantially revised in 1989. Only employees
who have attained the age of 21 and who have worked more than 1,000 hours in the
current plan year are eligible to participate.
Annual contributions are made to the plan as required by accepted actuarial
principles, applicable federal tax law, and expenses of operating and
maintaining the plan. The amount of contributions on behalf of any one
participant cannot be separately or individually computed.
Pension plan benefits are based on an average of a participant's five
highest years of compensation. A participant may earn a benefit for up to 35
years of accredited service. Earned benefits are 100 percent vested after five
years of service. Benefit payments normally start when a participant reaches age
65. A participant with more than five years of service may elect to take early
retirement benefits anytime after reaching age 55. Benefits payable under early
retirement are reduced actuarially for each month prior to age 65 in which
benefits begin.
The following table indicates estimated annual benefits payable upon normal
retirement for various compensation levels and years of service. Additional
benefits may be earned due to integration of social security benefits. The
amounts that may be earned are undeterminable until retirement.
<Table>
<Caption>
FIVE YEAR
AVERAGE YEARS OF ACCREDITED SERVICE
OF HIGHEST ------------------------------------
COMPENSATION 5 15 25 35
- ------------ ------ ------- ------- -------
$ 20,000 $ 900 $ 2,700 $ 4,500 $ 6,300
50,000 2,250 6,750 11,250 15,750
75,000 3,375 10,125 16,875 23,625
100,000 4,500 13,500 22,500 31,500
125,000 5,625 16,875 28,125 39,375
150,000 6,750 20,250 33,750 47,750
200,000 7,875 23,625 39,375 56,125
</Table>
The amounts calculated under the plan's benefit formula assume a monthly
payment for life. A married participant will generally receive an actuarially
reduced monthly payment because the participant's surviving spouse will also
receive monthly payments for life after the participant's death. As of December
31, 2003, Richard J. Barz had 31 years, Dennis P. Angner had 20 years, and Tim
Miller had three years of credited service under the plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The entire Board of Directors serves as a Compensation Committee. Director
Angner was President and CEO of the Corporation and Director Barz was President
and CEO of Isabella Bank and Trust. Director Barz did not participated in any of
the procedures which pertain to executive officers compensation and was excused
from the meetings at such times. Director Angner participated in deliberations
concerning compensation of other executive officers, however, was excused from
the meeting at which his compensation was set.
REMUNERATION OF DIRECTORS
The Corporation paid $750 per board meeting to its directors during 2003
and $200 per committee meeting attended. Directors of Isabella Bank and Trust
are paid $700 per board meeting and $200 per committee meeting they attend.
Farmers State Bank paid a retainer of $2,000, $425 per board meeting, and $125
per committee meeting they attended (provided the committee meeting was on a
non-board meeting day). Directors who are officers of a subsidiary are not paid
for attendance at committee meetings.
The Corporation sponsors a deferred compensation plan for directors (the
Directors' Plan). The Directors' Plan was adopted in 1984 and was substantially
revised in 1989 and 1996. Under the Directors'
7
Plan, deferred directors' fees are converted on a quarterly basis into stock
units of the Corporation's common stock. The fees are converted based on the
purchase price for a share of the Corporation's common stock under the
Corporation's Dividend Reinvestment Plan.
Pursuant to the terms of the Directors' Plan, directors of the Corporation
and its subsidiaries are required to defer at least 25% of their earned board
fees. The amount deferred under the terms of the Directors' Plan in 2003 was
$336,000, resulting in 14,127 stock units being credited to participants'
accounts. As of December 31, 2003, there were 123,688 stock units credited to
participants' accounts. Stock units credited to a participant's account are
eligible for cash and stock dividends as payable. All amounts deferred are
unsecured claims against the Corporation's general assets. The net cost of this
benefit to the Corporation was $82,000 in 2003.
Distribution from the Directors' Plan occurs when the participant
terminates service with the Bank and/or attains age 65. Distributions may take
the form of shares of Corporation common stock equal to the number of stock
units credited to the participant's account, cash equal to the value of the
stock units on the date of distribution, or a combination of stock and cash. Any
Corporation common stock issued under the Directors' Plan will be considered
restricted stock under the Securities Act of 1933, as amended.
INDEBTEDNESS OF AND TRANSACTIONS WITH MANAGEMENT
Certain directors and officers of the Corporation and members of their
families were loan customers of the subsidiary Banks, or have been directors or
officers of corporations, or partners of partnerships which have had
transactions with the subsidiary Banks. In management's opinion, all such
transactions are made in the ordinary course of business and are substantially
on the same terms, including collateral and interest rates, as those prevailing
at the same time for comparable transactions with other customers. These
transactions do not involve more then normal risk of collectibility or present
other unfavorable features. Total loans to these customers were $8,414,000 as of
December 31, 2003.
STOCK PERFORMANCE
The graph on the following page compares the cumulative total shareholder
return on Corporation common stock for the last five years with the cumulative
total return on (1) the NASDAQ Stock Market Index, which is comprised of all
United States common shares traded on the NASDAQ and (2) the NASDAQ Bank Stock
Index, which is comprised of bank and bank holding company common shares traded
on the NASDAQ over the same period. The graph assumes the value of an investment
in the Corporation and each index was $100 at January 1, 1999 and all dividends
are reinvested.
8
STOCK PERFORMANCE
FIVE-YEAR TOTAL RETURN
[LINE GRAPH]
The dollar values for total shareholder return plotted in the graph above
are shown in the table below:
COMPARISON OF FIVE YEAR CUMULATIVE
AMONG IBT BANCORP, NASDAQ STOCK MARKET,
AND NASDAQ BANK STOCKS
<Table>
<Caption>
NASDAQ
YEAR IBT BANCORP NASDAQ BANKS
- ---- ----------- ------ ------
01/01/99 100.0 100.0 100.0
12/31/99 119.1 186.1 94.1
12/31/00 133.4 110.9 115.2
12/31/01 149.4 94.7 129.6
12/31/02 177.4 65.1 127.5
12/31/03 204.2 98.2 167.2
</Table>
9
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of March 1, 2004 as
to the common stock of the Corporation owned of record or beneficially by any
person who is known to the Corporation to be the beneficial owner of more than
5% of the common stock of the Corporation.
<Table>
<Caption>
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP
--------------------------------------------------------
SOLE VOTING PERCENTAGE OF
AND INVESTMENT SHARED VOTING AND COMMON STOCK
NAME AND ADDRESS OF OWNER POWERS INVESTMENT POWERS OUTSTANDING
- ------------------------- -------------- ----------------------- -------------
James J. McGuirk.............................. 272,876 -- 5.63%
P.O. Box 222
Mt. Pleasant, MI
</Table>
The following table sets forth certain information as of March 1, 2004 as
to the common stock of the Corporation owned beneficially by each director, by
each named executive officer, and by all directors and executive officers of the
Corporation as a group.
<Table>
<Caption>
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP
--------------------------------------------------------
SOLE VOTING PERCENTAGE OF
AND INVESTMENT SHARED VOTING AND COMMON STOCK
NAME OF OWNER POWERS INVESTMENT POWERS OUTSTANDING
- ------------- -------------- ----------------------- -------------
Dennis P. Angner*............................. 9,146 79 0.19%
Richard J. Barz*.............................. 10,610 -- 0.22%
Frederick L. Bradford......................... 77,834 -- 1.61%
Gerald D. Cassel*............................. 8,213 -- 0.17%
James C. Fabiano.............................. 196,731 -- 4.06%
David W. Hole................................. 18,512 -- 0.38%
W. Joseph Manifold............................ -- -- --
Tim Miller.................................... 996 -- 0.02%
Ronald E. Schumacher.......................... -- 19,634 0.41%
William J. Strickler.......................... 61,785 -- 1.28%
Dale D. Weburg................................ 48,129 -- 0.99%
Herbert C. Wybenga............................ -- 5,241 0.11%
All Directors and Executive Officers as a
Group....................................... 418,572 47,737 9.41%
</Table>
- ---------------
* Trustees of the ESOP who vote ESOP stock.
AS TO OTHER BUSINESS WHICH MAY COME BEFORE THE MEETING
Management of the Corporation does not intend to bring any other business
before the meeting for action. However, if any other business should be
presented for action, it is the intention of the persons named in the enclosed
form of proxy to vote in accordance with their judgment on such business.
RELATIONSHIP WITH INDEPENDENT ACCOUNTANTS
The Audit Committee and Board of Directors have reappointed Rehmann Robson,
P.C. as independent auditors of the Corporation for the year ending December 31,
2004.
A representative of Rehmann Robson, P.C., is expected to be present at the
Annual Meeting of Shareholders to respond to appropriate questions from
shareholders and to make any comments they believe appropriate.
10
FEES FOR PROFESSIONAL SERVICES PROVIDED BY REHMANN ROBSON P.C.
The following table shows the aggregate fees billed by Rehmann Robson P.C.
for audit and other services provided to the Corporation for 2003 and 2002.
<Table>
<Caption>
2003 2002
-------- --------
Audit Fees.................................................. $ 65,100 $ 63,960
Audit Related Fees.......................................... 18,500 14,000
Tax Fees.................................................... 31,320 27,660
Other Professional Services Fees............................ 51,510 57,610
-------- --------
Total..................................................... $166,430 $163,230
======== ========
</Table>
The audit fees were for providing the audit of the Corporation's
consolidated annual financial statements, review of financial statements
included in the Corporation's Forms 10-Q, and services that are normally
provided by Rehmann Robson P.C. in connection with statutory and regulatory
filings or engagements.
The audit related fees were for professional services provided in
conjunction with expanded loan review and various SEC matters.
The tax fees were for the preparation of the Corporation and its
subsidiaries state and federal tax returns and for consultation with the
Corporation on various tax matters.
Other professional service fees were for, information security review,
Federal Home Loan Bank required procedures, strategic planning facilitation, and
out of pocket costs. The Audit Committee has considered whether the services
provided by Rehmann Robson P.C., other than the audit fees, is compatible with
maintaining Rehmann Robson P.C. independence and believes that the other
services provided are compatible.
PRE-APPROVAL POLICIES AND PROCEDURES
All audit and non-audit services to be performed by Rehmann Robson P.C.
must be approved in advance by the Audit Committee. As permitted by the SEC's
rules, the Audit Committee has authorized its Chairman to pre-approve audit,
audit-related, tax and non-audit services, provided that such approved service
is reported to the full Audit Committee at its next meeting.
As early as practicable in each calendar year, the independent auditor
provides to the Audit Committee a schedule of the audit and other services that
the independent auditor expects to provide or may provide during the next twelve
months. The schedule will be specific as to the nature of the proposed services,
the proposed fees, and other details that the Audit Committee may request. The
Audit Committee will by resolution authorize or decline the proposed services.
Upon approval, this schedule will serve as the budget for fees by specific
activity or service for the next twelve months.
A schedule of additional services proposed to be provided by the
independent auditor, or proposed revisions to services already approved, along
with associated proposed fees, may be presented to the Audit Committee for their
consideration and approval at any time. The schedule will be specific as to the
nature of the proposed service, the proposed fee, and other details that the
Audit Committee may request. The Audit Committee will by resolution authorize or
decline authorization for each proposed new service.
Applicable SEC rules and regulations permit waiver of the pre-approval
requirements for services other than audit, review or attest services if certain
conditions are met. Out of the services characterized above as Audit-Related,
Tax and Professional Services, none were billed pursuant to these provisions in
2003 without pre-approval. Pre-approval requirements under applicable rules and
regulations were not in place during 2002.
11
SHAREHOLDER PROPOSALS
Any proposals which shareholders of the Corporation intend to present at
the next annual meeting of the Corporation must be received before November 30,
2004 to be considered for inclusion in the Corporation's proxy statement and
proxy form for that meeting. Proposals should be made in accordance with
Securities and Exchange Commission Rule 14a-8.
COMMUNICATIONS WITH THE BOARD
Shareholders may communicate with the Corporation's Board of Directors by
sending written communications to the Corporation's Secretary, IBT Bancorp,
Inc., 200 East Broadway, Mount Pleasant, Michigan 48858. Communications will be
forwarded to the Board of Directors or the appropriate committee, as soon as
practicable.
DIRECTORS' ATTENDANCE AT THE ANNUAL MEETING OF SHAREHOLDERS
The Corporation's directors are encouraged to attend the annual meeting of
shareholders. At the 2003 annual meeting, all directors were in attendance.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Corporation's directors and certain officers and persons who own more than ten
percent of the Corporation's common stock, to file with the SEC initial reports
of ownership and reports of changes in ownership of the Corporation's common
stock. These officers, directors, and greater than ten percent shareholders are
required by SEC regulation to furnish the Corporation with copies of these
reports.
To the Corporation's knowledge, based solely on review of the copies of
such reports furnished to the Corporation, during the year ended December 31,
2003 all Section 16(a) filing requirements were satisfied, with respect to the
applicable officers, directors, and greater than 10 percent beneficial owners.
OTHER MATTERS
The cost of soliciting proxies will be borne by the Corporation. In
addition to solicitation by mail, officers and other employees of the
Corporation may solicit proxies by telephone or in person, without compensation
other than their regular compensation.
By order of the Board of Directors
Mary Ann Breuer, Secretary
12
APPENDIX A
(IBT BANCORP, INC. LOGO)
CHARTER OF THE
AUDIT COMMITTEE OF THE
BOARD OF DIRECTORS OF
IBT BANCORP, INC.
I. ORGANIZATION
The members of the Audit Committee are appointed annually by the Board of
Directors (the "Board") of IBT Bancorp, Inc. (the "Corporation") from among the
Corporation's directors. The members shall serve until their successors are duly
elected and qualified by the Board. The Board determines the number of members
on the Audit Committee from time to time, but the number will not be less than
the minimum number prescribed by applicable law or the Corporation's Bylaws. In
no event will such number of members be less than five (5). Audit Committee
members must fully satisfy independence and experience requirements as
prescribed by Rule 4200(a) (15) of the National Association of Securities
Dealers' listing standards, Section 10A of the Securities Exchange Act of 1934
(the "Exchange Act") and the rules and regulations of the Securities and
Exchange Commission ("SEC"), and the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") and applicable rules and regulations there
under. At least one member of the Audit Committee shall be a "financial expert"
as defined by the rules of the SEC, and all members of the Audit Committee shall
have a strong level of accounting or financial acumen and shall be able to read
and understand fundamental financial statements at the time of their appointment
to the Audit Committee. No member of the Audit Committee may be an "affiliated
person" of the Corporation or any of its subsidiaries (as defined in the federal
securities laws).
Director's fees are the only compensation that an Audit Committee member
may receive directly or indirectly from or on behalf of the Corporation.
The Board will appoint one of the members of the Audit Committee to serve
as Audit Committee Chair. The Audit Committee may also appoint a Secretary, who
need not be a director.
The Audit Committee has the authority, to the extent it deems necessary or
appropriate, to retain independent legal, accounting or other advisors. The
Audit Committee shall also have the authority, to the extent it deems necessary
or appropriate, to ask the Corporation to provide the Audit Committee with the
support of one or more Corporation employees to assist it in carrying out its
duties. The Corporation shall provide for appropriate funding, as determined
solely by the Audit Committee, for payment of compensation to the independent
auditors for the purpose of rendering or issuing an audit report and to any
other advisors employed by the Audit Committee, and for the ordinary
administrative expenses of the Audit Committee that are necessary or appropriate
in carrying out its duties. The Audit Committee may request any officer or
employee of the Corporation or the Corporation's outside counsel, independent
auditors or other advisors to attend a meeting of the Audit Committee or to meet
with any members of, or consultant to, the Audit Committee.
The Audit Committee shall provide assistance to the corporate directors in
fulfilling their responsibility to the shareholders, potential shareholders,
outside auditors, government agencies, and investment community relating to
corporate accounting, reporting practices of the Corporation, and the quality
and integrity of the financial reports of the Corporation. In so doing, it is
the responsibility of the Audit Committee to maintain free and open means of
communication between the directors, the independent auditors, the internal
auditors, and the senior management of the Corporation.
13
II. STATEMENT OF POLICY AND PURPOSE OF THE AUDIT COMMITTEE
The Audit Committee shall provide assistance to the Board by monitoring:
1) the integrity of the financial statements of the Corporation;
2) the independent auditors' qualifications and independence;
3) the performance of the Corporation's and its subsidiaries' internal
audit function and independent auditors;
4) the Corporation's system of internal controls;
5) the Corporation's financial reporting and system of disclosure
controls; and
6) the compliance by the Corporation with legal and regulatory
requirements and with the Corporation's Code of Business Conduct and
Ethics.
The Audit Committee shall prepare the Audit Committee report required by
the rules of the SEC to be included in the Corporation's annual proxy statement.
The Audit Committee's job is one of oversight as set forth in this charter.
It is not the duty of the Audit Committee to prepare the Corporation's financial
statements, to plan or conduct audits, or to determine that the Corporation's
financial statements are complete and accurate and are in accordance with
generally accepted accounting principles ("GAAP"). The Corporation's management
is responsible for preparing the Corporation's financial statements and for
maintaining internal controls, and the independent auditors are responsible for
auditing the financial statements. Nor is it the duty of the Audit Committee to
conduct investigations or to assure compliance with laws and regulations and the
Corporation's Code of Business Conduct and Ethics.
III. RESPONSIBILITIES OF THE AUDIT COMMITTEE
A. CHARTER REVIEW
1. Review and reassess the adequacy of this charter at least annually and
recommend to the Board any proposed changes to this charter; and
2. Publicly disclose the charter and any such amendments at the times and
in the manner as required by the SEC and/or any other regulatory body having
authority over the Corporation.
B. FINANCIAL REPORTING/INTERNAL CONTROLS
1. Review and discuss with the internal auditors and the independent
auditors their respective annual audit plans, reports and the results of their
respective audits;
2. Review and discuss with management and the independent auditors the
Corporation's quarterly financial statements and its Form 10-Q (prior to filing
the same as required by the Exchange Act), including disclosures made in the
section regarding management's discussion and analysis, the results of the
independent auditors' reviews of the quarterly financial statements, and
determine whether the quarterly financial statements should be included in the
Corporation's Form 10-Q;
3. Review and discuss with management and the independent auditors the
Corporation's annual audited financial statements and its Form 10-K (prior to
filing the same as required by the Exchange Act), including disclosures made in
the section regarding management's discussion and analysis, and recommend to the
Board whether the audited financial statements should be included in the
Corporation's Form 10-K;
4. Review and discuss with management, and where appropriate, the
independent auditors, the Corporation's financial disclosures in its
registration statements, press releases, earnings releases, current reports,
real time disclosures, or other public disclosures before the same are filed,
posted, disseminated or released, including the use of "pro forma" or "adjusted"
non-GAAP information, all reconciliations of the same, and
14
any earnings guidance, as well as all financial information provided to rating
agencies and/or securities analysts including presentations at industry,
investor or other conferences;
5. Review and discuss with the Corporation's Chief Executive Officer and
Chief Financial Officer all matters such officers are required to certify in
connection with the Corporation's Form 10-Q and 10-K or other filings or
reports;
6. Discuss with management and the independent auditors, significant
financial reporting issues and judgments made in connection with the preparation
of the Corporation's financial statements, including any significant changes in
the Corporation's selection or application of accounting principles, the
development, selection and disclosure of critical accounting estimates and
principles and the use thereof, and analyses of the effect of alternative
assumptions, estimates, principles or generally accepted accounting principles
("GAAP") methods on the Corporation's financial statements;
7. Discuss with management and the independent auditors the effect of
regulatory and accounting initiatives and off-balance sheet transactions on the
corporation's financial statements, conditions or results and any necessary
disclosures related thereto;
8. Discuss with management the Corporation's major financial risk exposures
and the steps management has taken to monitor and control such exposures,
including the Corporation's risk assessment and risk management policies;
9. Discuss with the independent auditors the matters required to be
discussed by Statement on Auditing Standards No. 61;
10. Confirm that the Corporation's independent auditors report to the Audit
Committee all of the Corporation's critical accounting policies and procedures
and alternative accounting treatments of financial information within GAAP that
have been discussed with management, including the ramifications of the use of
such alternative treatments and disclosures and the treatment preferred by the
independent auditors;
11. Confirm that the Corporation's independent auditors share with the
Audit Committee all material written communication between the auditors and
management;
12. Discuss with the Corporation's independent auditors, internal auditors,
and management their assessments of the adequacy of the Corporation's internal
controls and disclosure controls and procedures;
13. Assess whether management is resolving any internal control weaknesses
diligently;
14. Discuss with the Corporation's independent auditors, internal auditors
and management as appropriate the Corporation's FDICIA internal controls report
and the attestation of the Corporation's independent auditors to the same;
15. Discuss with the Corporation's independent auditors, internal auditors
and management as appropriate any weaknesses or deficiencies that any of the
foregoing have identified relating to financial reporting, internal controls or
other related matters and their proposals for rectifying such weaknesses or
deficiencies;
16. Monitor the Corporation's progress in promptly addressing and
correcting any and all identified weaknesses or deficiencies in financial
reporting, internal controls or related matters;
17. Receive periodic reports from the independent auditors and appropriate
officers of the Corporation on significant accounting or reporting developments
proposed by the Financial Accounting Standards Board or the SEC that may impact
the Corporation; and
18. Receive periodic reports from independent auditors and appropriate
officers of the Corporation on significant financial reporting, internal
controls or other related matters of the Corporation's subsidiaries.
C. INDEPENDENT AUDITORS
1. Review and oversee the work of the independent auditors (including
resolution of disagreements between management and the auditors regarding
financial reporting);
15
2. Evaluate the selection and retention of the outside auditors and
recommend to the Board of Directors the outside auditors to be selected to audit
the financial statements of the Corporation and its subsidiaries. The outside
auditor is ultimately responsible to the Board of Directors and the Audit
Committee, as representatives of the shareholders. In connection with this duty,
the Committee shall receive on an annual basis a written statement from the
outside auditor detailing all relationships between the outside auditor and the
Corporation;
3. Review the experience, rotation and qualifications of the senior members
of the independent auditors' team;
4. Monitor the independence, qualifications and performance of the
independent auditors including, but not limited to, consideration of whether the
provision of any non-audit services is compatible with maintaining the auditors'
independence, and taking into account the opinions of management and the
internal auditors;
5. Meet with the independent auditors prior to each annual audit to discuss
the planning and staffing of the audit;
6. Pre-approve all auditing services and permitted non-audit services to be
performed for the Corporation by the independent auditors or any other auditing
or accounting firm, except as provided in this paragraph. In no event shall the
independent auditors perform any non-audit services for the Corporation which
are prohibited by Section 10A(g) of the Exchange Act or the rules of the SEC or
the Public Company Accounting Oversight Board (or other similar body as may be
established from time to time). The Audit Committee shall establish general
guidelines for the permissible scope and nature of any permitted non-audit
services in connection with its annual review of the audit plan and shall review
such guidelines with the Board. Pre-approval may be granted by action of the
full Audit Committee or, in the absence of such Audit Committee action, by the
Audit Committee Chair whose action shall be considered to be that of the entire
Audit Committee. Pre-approval shall not be required for the provision of
non-audit services if (i) the aggregate amount of all such non-audit services
constitutes no more than 5% of the total amount of revenues paid by the
Corporation to the auditors during the fiscal year in which the non-audit
services are provided, (ii) such services were not recognized by the Corporation
at the time of engagement to be non-audit services, and (iii) such services are
promptly brought to the attention of the Audit Committee and approved prior to
the completion of the audit. Approval of a non-audit service to be performed by
the auditors and, if applicable, the guidelines pursuant to which such services
were approved, shall be disclosed when required as promptly as practicable in
the Corporation's quarterly or annual reports required by Section 13(a) of the
Exchange Act;
7. Oversee the rotation of the lead (or coordinating) audit partner having
primary responsibility for the audit and the audit partner responsible for
reviewing the audit at least once every five years and considering whether, in
order to assure continuing auditor independence, it is appropriate to rotate the
auditing firm itself from time to time;
8. Recommend to the Board, policies for the Corporation's hiring of
employees or former employees of the independent auditors who participated in
any capacity in an audit of the Corporation, including in particular the
prohibition on employment under Section 10A (1) of the Exchange Act as chief
executive officer, controller, chief financial officer, chief accounting
officer, or any person serving in an equivalent position for the Corporation,
during the preceding one-year period; and
9. Ensure that the independent auditors have access to all necessary
Corporation personnel, records or other resources.
D. INTERNAL AUDIT FUNCTION
1. Review and oversee the appointment, performance and replacement of the
senior internal audit executive;
2. Review and approve any plan to outsource the internal audit function and
if so approved, review and oversee the appointment, performance and replacement
of the auditors.
3. Review the internal audit plan and assess whether it is consistent with
the Corporation's needs;
16
4. To the extent applicable, review the significant reports to management
prepared by the internal auditing department and management's responses;
5. Review and discuss with the internal auditors the results of their work
(including their audit report) as well as their control risk assessment;
6. Discuss with the independent auditors and approve the internal audit
department responsibilities, budget and staffing and any recommended changes in
the planned scope of the internal audit; and
7. Ensure that the internal auditors have access to all necessary
Corporation resources.
E. COMPLIANCE OVERSIGHT
1. Discuss with management and the internal auditors the Corporation's
processes regarding compliance with applicable laws and regulations and with the
Corporation's Code of Business Conduct and Ethics, obtain information from
management, the Corporation's senior internal auditing executive and the
independent auditors regarding compliance by the Corporation and its
subsidiary/affiliated entities with applicable legal requirements and the
Corporation's Code of Business Conduct and Ethics and from time to time advise
the Board with respect to the same. Obtain from the independent auditors any
reports required to be furnished to the Audit Committee under Section 10A of the
Exchange Act or an assurance that Section 10A of the Exchange Act has not been
implicated;
2. Review procedures designed to identify related party transactions that
are material to the financial statements or otherwise require disclosure;
3. Establish procedures and require the Corporation to obtain or provide
the necessary resources and mechanisms for (i) the receipt, retention and
treatment of complaints received by the Corporation regarding accounting,
internal accounting controls or auditing matters, and (ii) the confidential,
anonymous submission by employees of the Corporation of concerns regarding
questionable accounting or auditing matters;
4. Discuss with management and the independent auditors any correspondence
with regulators or governmental agencies and any employee complaints or
published reports which raise material issues regarding the Corporation's
financial statements or accounting policies or compliance with the Corporation's
Code of Business Conduct and Ethics; and
5. Discuss with the Corporation's general counsel legal matters that may
have a material impact on the financial statements and that may have an impact
on the Corporation's compliance policies.
F. GENERAL
1. Meet as often as the Audit Committee or the Audit Committee Chair
determines, but not less frequently than quarterly;
2. On a regular basis, as appropriate, meet separately with management
(especially the Chief Financial Officer), the internal auditors, and with the
independent auditors;
3. Report to the Board on the Audit Committee's activities at each Board
meeting;
4. Maintain minutes or other records of the Audit Committee's meetings and
activities;
5. Review and assess the quality and clarity of the information provided to
the Audit Committee and make recommendations to management, and the independent
auditors as the Audit Committee deems appropriate from time to time for
improving such materials;
6. Form and delegate authority to subcommittees or members when
appropriate;
7. Prepare the Audit Committee report to be included in the Corporation's
proxy statement when and as required by the rules of the SEC; and
8. Annually review the performance of the Audit Committee.
17
In performing their duties and responsibilities, Audit Committee members
are entitled to rely in good faith on information, opinions, reports or
statements prepared or presented by:
- One or more officers or employees of the Corporation whom the Audit
Committee member reasonably believes to be reliable and competent in the
matters presented;
- Counsel, independent auditors, or other persons as to matters which the
Audit Committee member reasonably believes to be within the professional
or expert competence of such person; or
- Another committee of the Board as to matters within its designated
authority which committee the Audit Committee member reasonably believes
to merit confidence.
Approved by Audit Committee: October 27, 2003
Approved by Board of Directors: November 25, 2003
Last reviewed: November 25, 2003
18
IBT BANCORP, INC.
FINANCIAL INFORMATION INDEX
<Table>
<Caption>
PAGE DESCRIPTION
- ---- ------------------------------------------------------------
20 Summary of Selected Financial Data
21 Report of Independent Auditors
22 - 26 Consolidated Financial Statements
27 - 48 Notes to Consolidated Financial Statements
49 - 62 IBT Bancorp Financial Review
63 Common Stock and Dividend Information
</Table>
19
SUMMARY OF SELECTED FINANCIAL DATA(1)
<Table>
<Caption>
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA
Total interest income................. $ 35,978 $ 38,161 $ 40,798 $ 38,754 $ 35,445
Net interest income................... 23,528 22,905 21,538 20,352 19,224
Provision for loan losses............. 1,455 1,025 770 565 509
Net income............................ 7,205 6,925 6,066 5,431 5,244
BALANCE SHEET DATA
End of year assets.................... $664,079 $652,717 $592,143 $540,897 $503,596
Daily average assets.................. 659,323 623,507 566,547 516,145 493,606
Daily average deposits................ 563,600 549,970 494,847 452,664 441,566
Daily average loans/net............... 399,008 390,613 399,239 380,392 332,083
Daily average equity.................. 65,770 59,540 54,787 50,506 45,482
PER SHARE DATA(2)
Net income............................ $ 1.50 $ 1.46 $ 1.29 $ 1.16 $ 1.14
Cash dividends........................ 0.60 0.55 0.50 0.45 0.41
Book value (at year end).............. 14.23 13.30 12.09 11.08 10.12
FINANCIAL RATIOS
Shareholders' equity to assets........ 10.38% 9.71% 9.60% 9.60% 9.35%
Net income to average equity.......... 10.95 11.63 11.07 10.75 11.53
Cash dividend payout to net income.... 39.99 37.33 38.36 38.30 36.80
Net income to average assets.......... 1.09 1.11 1.07 1.05 1.06
</Table>
<Table>
<Caption>
2003 2002
--------------------------------- ---------------------------------
4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
------ ------ ------ ------ ------ ------ ------ ------
Quarterly Operating
Results:
Total interest
income.............. $8,560 $9,035 $9,119 $9,264 $9,530 $9,731 $9,433 $9,467
Interest expense....... 2,819 3,070 3,238 3,323 3,581 3,754 3,850 4,071
Net interest income.... 5,741 5,965 5,881 5,941 5,949 5,977 5,583 5,396
Provision for loan
losses.............. 688 222 333 212 487 188 162 188
Noninterest income..... 1,927 2,891 2,973 2,954 2,750 2,213 1,572 1,568
Noninterest expenses... 5,819 5,809 5,879 6,071 6,279 5,227 4,648 4,618
Net income............. 1,222 2,085 1,956 1,942 1,499 2,063 1,749 1,614
Per Share of Common
Stock:(2)
Net income............. $ 0.25 $ 0.43 $ 0.41 $ 0.41 $ 0.32 $ 0.43 $ 0.37 $ 0.34
Cash dividends......... 0.30 0.10 0.10 0.10 0.28 0.09 0.09 0.09
Book value............. 14.23 14.21 14.15 13.69 13.30 13.51 12.75 12.28
</Table>
- ---------------
(1) 2000 and 1999 were restated for the merger in August 2000 with FSB Bancorp,
which was accounted for as a pooling of interests.
(2) Retroactively restated for the 10% stock dividend paid on February 19, 2004.
20
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
IBT Bancorp, Inc.
Mt. Pleasant, Michigan
We have audited the accompanying consolidated balance sheets of IBT
Bancorp, Inc. as of December 31, 2003 and 2002, and the related consolidated
statements of changes in shareholders' equity, income, comprehensive income, and
cash flows for each of the years in the three year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
IBT Bancorp, Inc. as of December 31, 2003 and 2002, and the consolidated results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
Rehmann Robson P.C.
Saginaw, Michigan
January 30, 2004
21
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31
-----------------------
2003 2002
---------- ----------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and cash equivalents................................... $ 25,918 $ 28,587
Federal funds sold.......................................... 5,300 25,850
-------- --------
CASH AND CASH EQUIVALENTS............................ 31,218 54,437
Investment securities
Securities available for sale (amortized cost of $166,730
in 2003 and $153,499 in 2002).......................... 169,832 157,909
Securities held to maturity (fair value of $1,349 in 2003
and $1,803 in 2002).................................... 1,312 1,736
-------- --------
TOTAL INVESTMENT SECURITIES.......................... 171,144 159,645
Mortgage Loans available for sale........................... 4,315 13,392
Loans
Agricultural.............................................. 50,548 53,223
Commercial................................................ 149,931 143,957
Residential real estate mortgage.......................... 157,598 139,386
Installment............................................... 63,782 54,522
-------- --------
TOTAL LOANS.......................................... 421,859 391,088
Less allowance for loan losses............................ 6,204 5,593
-------- --------
NET LOANS............................................ 415,655 385,495
Premises and equipment...................................... 15,785 14,470
Bank-owned life insurance................................... 10,029 9,810
Accrued interest receivable................................. 4,534 4,897
Acquisition intangibles and goodwill, net................... 3,440 3,498
Other assets................................................ 7,959 7,073
-------- --------
TOTAL ASSETS......................................... $664,079 $652,717
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest bearing....................................... $ 67,760 $ 63,106
NOW accounts.............................................. 117,560 111,195
Certificates of deposit and other savings................. 312,914 316,845
Certificates of deposit over $100......................... 69,473 70,310
-------- --------
TOTAL DEPOSITS....................................... 567,707 561,456
Other borrowed funds........................................ 18,053 17,793
Accrued interest and other liabilities...................... 9,383 10,011
-------- --------
TOTAL LIABILITIES.................................... 595,143 589,260
Shareholders' equity
Common stock -- no par value; 10,000,000 shares
authorized; 4,403,404 shares issued and outstanding
(4,336,283 shares at December 31, 2002)................ 47,491 45,610
Retained earnings........................................... 20,623 16,299
Accumulated other comprehensive income...................... 822 1,548
-------- --------
TOTAL SHAREHOLDERS' EQUITY........................... 68,936 63,457
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........... $664,079 $652,717
======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
22
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<Table>
<Caption>
YEAR ENDED DECEMBER 31
------------------------------------
2003 2002 2001
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING
Balance at beginning of year........................... 4,336,283 3,884,985 3,871,552
10% stock dividend..................................... -- 388,758 --
Issuance of common stock............................... 70,340 81,326 37,434
Common stock repurchased............................... (3,219) (18,786) (24,001)
---------- ---------- ----------
BALANCE END OF YEAR................................. 4,403,404 4,336,283 3,884,985
========== ========== ==========
COMMON STOCK
Balance at beginning of year........................... $ 45,610 $ 31,017 $ 30,814
10% stock dividend..................................... -- 12,829 --
Issuance of common stock............................... 2,008 2,383 971
Common stock repurchased............................... (127) (619) (768)
---------- ---------- ----------
BALANCE END OF YEAR................................. 47,491 45,610 31,017
RETAINED EARNINGS
Balance at beginning of year........................... 16,299 24,788 21,049
Net income............................................. 7,205 6,925 6,066
10% stock dividend..................................... -- (12,829) --
Cash dividends ($0.60 per share in 2003, $0.55 in 2002,
and $0.50 in 2001).................................. (2,881) (2,585) (2,327)
---------- ---------- ----------
BALANCE END OF YEAR................................. 20,623 16,299 24,788
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year........................... 1,548 1,023 67
Other comprehensive (loss) income...................... (726) 525 956
---------- ---------- ----------
BALANCE END OF YEAR................................. 822 1,548 1,023
---------- ---------- ----------
TOTAL SHAREHOLDERS' EQUITY END OF YEAR.............. $ 68,936 $ 63,457 $ 56,828
========== ========== ==========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
23
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------
2003 2002 2001
------- ------- -------
(DOLLARS IN THOUSANDS
EXCEPT PER SHARE DATA)
INTEREST INCOME
Loans, including fees..................................... $29,193 $31,527 $35,091
Investment securities
Taxable................................................ 4,588 4,362 3,173
Tax exempt............................................. 2,004 1,849 1,637
Federal funds sold and other.............................. 193 423 897
------- ------- -------
TOTAL INTEREST INCOME................................ 35,978 38,161 40,798
------- ------- -------
INTEREST EXPENSE
Deposits.................................................. 11,610 14,578 18,678
Borrowings................................................ 840 678 582
------- ------- -------
TOTAL INTEREST EXPENSE............................... 12,450 15,256 19,260
------- ------- -------
NET INTEREST INCOME.................................. 23,528 22,905 21,538
Provision for loan losses................................... 1,455 1,025 770
------- ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES............................................ 22,073 21,880 20,768
NONINTEREST INCOME
Service charges and fees.................................. 5,141 2,681 2,522
Title insurance revenue................................... 2,340 2,221 1,578
Gain on sale of mortgage loans............................ 2,091 1,762 1,051
Other..................................................... 1,173 1,439 1,047
------- ------- -------
TOTAL NONINTEREST INCOME............................. 10,745 8,103 6,198
NONINTEREST EXPENSES
Compensation.............................................. 13,345 11,307 9,790
Occupancy................................................. 1,471 1,422 1,201
Furniture and equipment................................... 2,560 2,277 2,037
Charitable donations...................................... 1,158 815 490
Other..................................................... 5,044 4,951 5,177
------- ------- -------
TOTAL NONINTEREST EXPENSES........................... 23,578 20,772 18,695
------- ------- -------
INCOME BEFORE FEDERAL INCOME TAXES................... 9,240 9,211 8,271
Federal income taxes........................................ 2,035 2,286 2,205
------- ------- -------
NET INCOME........................................... $ 7,205 $ 6,925 $ 6,066
======= ======= =======
Net income per basic share of common stock.................. $ 1.50 $ 1.46 $ 1.29
======= ======= =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
24
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<Table>
<Caption>
YEAR ENDING DECEMBER 31
--------------------------
2003 2002 2001
------- ------- ------
(DOLLARS IN THOUSANDS)
NET INCOME.................................................. $ 7,205 $ 6,925 $6,066
------- ------- ------
Other comprehensive income (loss) before income taxes
Unrealized (losses) gains on securities available for sale
Unrealized holding (loss) gain arising during year..... (1,223) 2,861 1,440
Reclassification adjustment for realized (gain) loss
included in net income............................... (85) (2) 8
Minimum pension liability adjustment...................... 208 (2,063) --
------- ------- ------
Other comprehensive (loss) income before income tax benefit
(expense)................................................. (1,100) 796 1,448
Income tax benefit (expense) related to other comprehensive
(loss) income............................................. 374 (271) (492)
------- ------- ------
OTHER COMPREHENSIVE (LOSS) INCOME........................... (726) 525 956
------- ------- ------
COMPREHENSIVE INCOME................................. $ 6,479 $ 7,450 $7,022
======= ======= ======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
------------------------------
2003 2002 2001
-------- -------- --------
(DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES
Net income................................................ $ 7,205 $ 6,925 $ 6,066
Reconciliation of net income to net cash provided by
operations
Provision for loan losses.............................. 1,455 1,025 770
Depreciation........................................... 1,703 1,647 1,197
Net amortization on investment securities.............. 1,592 1,006 295
Realized (gain) loss on sales of investment
securities........................................... (85) (2) 8
Amortization and impairment of mortgage servicing
rights............................................... 643 994 390
Decrease (increase) in cash surrender value of life
insurance............................................ 66 (472) (205)
Amortization of acquisition intangibles................ 94 94 655
Deferred income tax (benefit).......................... (41) (276) (277)
Gain on sale of mortgage loans......................... (2,091) (1,762) (1,051)
Net change in loans held for sale...................... 11,168 (3,369) (6,061)
Decrease in accrued interest receivable................ 363 64 92
Increase in other assets............................... (1,008) (1,959) (1,461)
(Decrease) increase in accrued interest and other
liabilities.......................................... (526) 2,207 1,735
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES............ 20,538 6,122 2,153
INVESTING ACTIVITIES
Activity in available-for-sale securities
Maturities, calls, and sales........................... 49,776 40,021 24,927
Purchases.............................................. (64,710) (93,225) (48,479)
Activity in held-to-maturity securities
Maturities and calls................................... 620 1,386 4,537
Net (increase) decrease in loans....................... (31,615) (2,388) 12,466
Purchases of premises and equipment....................... (3,018) (2,107) (3,921)
Acquisition of title office............................... (36) (25) --
Purchase of cash value life insurance..................... (285) (300) (7,135)
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES................ (49,268) (56,638) (17,605)
FINANCING ACTIVITIES
Net increase in noninterest bearing deposits.............. 4,654 1,086 1,222
Net increase in interest bearing deposits................. 1,597 44,129 38,203
Net increase in borrowings................................ 260 5,897 5,188
Cash dividends............................................ (2,881) (2,585) (2,327)
Proceeds from issuance of common stock.................... 2,008 1,583 971
Common stock repurchase................................... (127) (619) (768)
-------- -------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES............ 5,511 49,491 42,489
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............ (23,219) (1,025) 27,037
Cash and cash equivalents beginning of year................. 54,437 55,462 28,425
-------- -------- --------
CASH AND CASH EQUIVALENTS END OF YEAR................ $ 31,218 $ 54,437 $ 55,462
======== ======== ========
Supplemental cash flows information:
Federal income taxes paid................................. $ 2,034 $ 2,774 $ 2,670
Interest paid............................................. 12,450 15,312 19,357
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
NOTE A -- BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION:
The consolidated financial statements include the accounts of IBT Bancorp,
Inc. (the "Corporation"), a Financial Services Holding company, and its wholly
owned subsidiaries, Isabella Bank and Trust, Farmers State Bank of Breckenridge,
IBT Title, IBT Loan Production, Financial Group Information Services, and its
majority owned subsidiaries, IBT Personnel, LLC (79%), and IB&T Employee
Leasing, LLC (79%). All intercompany transactions and accounts have been
eliminated.
NATURE OF OPERATIONS:
IBT Bancorp is a Financial Service Holding Company offering a wide array of
financial products and services in mid-Michigan. Its banking subsidiaries,
Isabella Bank and Trust and Farmers State Bank of Breckenridge, offer banking
services through 19 locations, 24-hour banking services locally and nationally
through shared automatic teller machines, and direct deposits to businesses,
institutions, and individuals. Lending services offered include commercial real
estate loans and lines of credit, agricultural loans, residential real estate
loans, consumer loans, student loans, and credit cards. Deposit services include
interest and noninterest bearing checking accounts, savings accounts, money
market accounts, and certificates of deposit. Other related financial products
include trust services, safe deposit box rentals, and credit life insurance.
Active competition, principally from other commercial banks, savings banks and
credit unions, exists in all of the Banks' principal markets. The Corporation's
results of operations can be significantly affected by changes in interest rates
or changes in the local economic environment.
IBT Title does business under the names Isabella County Abstract and Title,
Mecosta County Abstract and Title, IBT Title Clare, and Benchmark Title of
Greenville. IBT Title provides title insurance and abstract searches, and closes
real estate loans.
Financial Group Information Services provides network processing for all of
IBT Bancorp's subsidiaries.
IBT Loan Production is a mortgage loan origination company. Principal loan
products include 15 and 30 year fixed rate mortgage loans. All loans originated
are sold to Isabella Bank and Trust.
IBT Personnel and IB&T Employee Leasing provide payroll services, benefit
administration, and other human resource services to IBT Bancorp's subsidiaries.
USE OF ESTIMATES:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowance for loan losses,
the valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans, and the valuation of mortgage servicing rights.
Management obtains independent appraisals and valuations in connection with the
determination of the allowance for loan losses, foreclosed real estate and
originated mortgage servicing rights.
SIGNIFICANT GROUP CONCENTRATION OF CREDIT RISK:
Most of the Corporation's activities conducted are with customers located
within the central Michigan area. A significant amount of its outstanding loans
are secured by real estate or are made to finance agricultural production. Other
than these types of loans, there is no significant concentration to any other
industry or customer.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CASH AND CASH EQUIVALENTS:
For purposes of the consolidated statements of cash flows, the Corporation
considers cash on hand, demand deposits due from banks, and federal funds sold
as cash and cash equivalents. Generally, federal funds are sold for a one day
period. The Corporation maintains deposit accounts in various financial
institutions which at times may exceed FDIC insured limits or are not insured.
Management believes the Corporation is not exposed to any significant interest
rate or other financial risk as a result of these deposits.
SECURITIES:
Management determines the appropriate classification of debt securities at
the time of purchase. Debt securities are classified as held to maturity when
the Corporation has the positive intent and ability to hold the securities to
maturity. Securities held to maturity are stated at amortized cost. Debt
securities not classified as held to maturity are classified as available for
sale and are stated at fair value with the unrealized gains and losses net of
taxes excluded from earnings and reported in other comprehensive income.
The amortized cost of debt securities classified as either held to maturity
or available for sale is adjusted for amortization of premiums and accretion of
discounts to maturity and is computed using a method that approximates the level
yield method. Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are determined to be other
than temporary are reflected in earnings as realized losses. Gains or losses on
the sale of securities available for sale are calculated using the adjusted cost
for the specific securities sold.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of the loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component is maintained to cover uncertainties that
management believes affects its estimate of probable losses inherent in the
portfolio. The unallocated component of the allowance reflects the margin of
imprecision inherent in the underlying assumptions used in the methodologies for
estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstance surrounding the loan and the borrower,
including the length of the delay, the reason for the delay, the borrower's
prior payment record, and
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the amount of the shortfall in relation to the principal and interest owned.
Impairment is measured on a loan by loan basis for commercial, agricultural and
construction loans by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Corporation does not separately
identify individual consumer and residential loans for impairment disclosures.
LOANS AND RELATED INCOME:
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
principal balance adjusted for any charge offs, the allowance for loans losses,
and any deferred fees or costs on originated loans. Interest income on loans is
accrued over the term of the loan based on the principal amount outstanding. The
accrual of interest on mortgage and commercial loans is discontinued at the time
the loan is 90 days or more past due unless the credit is well-secured and in
the process of collection. Credit card loans and other personal loans are
typically charged off no later than 180 days past due. Past due status is based
on contractual terms of the loan. In all cases, loans are placed on nonaccrual
or charged off at an earlier date if collection of principal or interest is
considered doubtful.
When the accrual of interest is discontinued, all uncollected accrued
interest is reversed against interest income. The interest income on such loans
is subsequently recognized only to the extent cash payment is received. Loans
are returned to accrual status when all principal and interest amounts
contractually due are brought current and future payments are reasonably
assured. For impaired loans not classified as nonaccrual, interest income
continues to be accrued over the term of the loan based on the principal amount
outstanding.
Loan origination fees and certain direct loan origination costs are
capitalized and recognized as a component of interest income over the term of
the loan using the constant yield method.
MORTGAGE BANKING ACTIVITIES:
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Gains
or losses on sales of such loans are recognized at the time of sale and are
determined by the difference between the net sales proceeds and the unpaid
principal balance of the loans sold, adjusted for any yield differential,
servicing fees, and servicing costs applicable to future years. Net unrealized
losses, if any, are recognized in a valuation allowance by charges to income.
The Corporation currently retains servicing on all loans originated and
sold into the secondary market. Originated mortgage servicing rights retained
are recognized for loans sold by allocating total costs incurred between the
loan and the servicing rights based on their relative fair values. Mortgage
servicing rights ("MSR") are reported in other assets and amortized into
noninterest income in proportion to, and over the period of, estimated net
servicing income. Servicing assets are evaluated for impairment based upon the
fair value of the rights as compared to amortized cost. Impairment is determined
by stratifying rights by predominant characteristics, such as interest rates and
terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation allowance
for an individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
OTHER REAL ESTATE OWNED:
Real estate properties acquired through or in lieu of loan foreclosure are
initially recorded at the lower of the Bank's carrying amount or fair value less
estimated selling costs at the date of transfer. Any write-downs based on the
asset's fair value at the date of acquisition are charged to the allowance for
loan losses. After
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
foreclosure, property held for sale is carried at the lower of the new cost
basis or fair value less costs to sell. Costs of significant property
improvements are capitalized, whereas costs relating to holding property are
expensed. Valuations are periodically performed by management, and any
subsequent write-downs are recorded as a charge to operations, if necessary, to
reduce the carrying value of a property to the lower of its cost or fair value
less costs to sell.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost less accumulated depreciation.
Premises include land and buildings. For financial reporting purposes, the
provision for depreciation is computed principally by the straight line method
based upon the useful lives of the assets which generally range from 5 to 30
years. Maintenance, repairs and minor alterations are charged to current
operations as expenditures occur and major improvements are capitalized.
Management annually reviews these assets to determine whether carrying values
have been impaired.
A summary of premises and equipment at December 31 follows:
<Table>
<Caption>
2003 2002
------- -------
Premises.................................................... $13,302 $12,194
Equipment................................................... 17,146 15,479
------- -------
30,448 27,673
Less accumulated depreciation............................... 14,663 13,203
------- -------
NET PREMISES AND EQUIPMENT................................ $15,785 $14,470
======= =======
</Table>
RESTRICTED INVESTMENTS:
Included in other assets are restricted securities of $2,720 in 2003 and
$2,648 in 2002. Restricted securities include the stock of the Federal Reserve
Bank and the Federal Home Loan Bank and have no contractual maturity.
BANK OWNED LIFE INSURANCE:
The Corporation maintains life insurance policies on key members of
management. In the event of death of one of these individuals, the Corporation
would receive a specified cash payment equal to the face value of the policy.
Such policies are recorded at their cash surrender value. Increases in cash
surrender value in excess of premiums paid are reported as other noninterest
income.
CREDIT RELATED FINANCIAL INSTRUMENTS:
In the ordinary course of business, the Corporation has entered into
commitments to extend credit, including commitments under credit card
arrangements, home equity lines of credit, commercial letters of credit, and
standby letters of credit. Such financial instruments are recorded only when
funded.
FEDERAL INCOME TAXES:
Federal income taxes are provided for the tax effects of transactions
reported in the consolidated financial statements and consist of taxes currently
due plus deferred income taxes. Deferred income taxes are recognized for
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Deferred income tax assets and liabilities represent the future tax return
consequences of those differences, which will either be taxable or deductible
when the assets or liabilities are recorded or settled. Valuation allowances are
established when necessary to
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reduce deferred tax assets to the amount expected to be realized. As changes in
income tax laws or rates are enacted, deferred tax assets and liabilities are
adjusted through the provision for income taxes.
PER SHARE AMOUNTS:
Net income per share amounts were computed by dividing net income by the
weighted average number of shares outstanding. All per share amounts have been
adjusted for the stock dividend declared on December 17, 2003 and paid February
19, 2004. The weighted average numbers of common shares outstanding were
4,790,986 in 2003; 4,721,714 in 2002; and 4,692,791 in 2001, as adjusted for the
stock dividend.
ACQUISITION INTANGIBLES:
Isabella Bank and Trust previously acquired branch facilities and related
deposits in a business combination accounted for as a purchase. The acquisition
of the branches included amounts related to the valuation of customer deposit
relationships (core deposit intangibles). The deposit intangible is being
amortized on the straight line basis over nine years, the expected life of the
acquired relationship.
RECLASSIFICATIONS:
Certain amounts reported in the 2002 and 2001 consolidated financial
statements have been reclassified to conform with the 2003 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS:
In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretation (FIN) No. 46, "Consolidation of Variable Interest
Entities." This standard clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," and addressed
consolidation by business enterprises of variable interest entities (more
commonly known as Special Purpose Entities or SPE's). FIN No. 46 requires
existing unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risk among the
parties involved. FIN No. 46 also enhances the disclosure requirements related
to variable interest entities. The Interpretation, which was revised in December
2003, is effective for interests in variable interest entities created after
January 31, 2003. For interests in variable interest entities created before
February 1, 2003, the Interpretation applies to the first interim or annual
reporting period beginning after March 15, 2004. The adoption of FIN No. 46 on
consolidated results of operations, financial position and cash flows is not
expected to be material.
In April 2003 the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149 which amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of SFAS No. 133,
clarifies when a derivative contains a financing component, amends the
definition of an underlying option to conform to language used in FASB
Interpretation No. 45, and amends certain other existing pronouncements. This
statement was effective for contracts entered into or modified after June 30,
2003. The adoption of Statement No. 149 did not have a material impact on the
financial position, results of operations or cash flows of the Corporation.
In May 2003 the FASB issued SFAS No. 150, which establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). This statement was effective for financial
instruments entered into or modified after May 31, 2003, and otherwise was
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of Statement No. 150 did not have a material impact on the financial position,
results of operations or cash flows of the Corporation.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other postretirement Benefits -- an amendment of
FASB Statements No. 87, 88 and 106" (SFAS 132 revised 2003). SFAS 132 (revised
2003) is effective for fiscal years ending after December 15, 2003. The
statement addresses disclosures only and does not address measurement and
recognition accounting for pension and postretirement benefits. Interim
disclosure requirements under SFAS 132 (revised 2003) are effective for interim
periods beginning after December 15, 2003, and required disclosures related to
estimated benefit payments are effective for fiscal years ending after June 15,
2004.
SFAS 132 (revised 2003) retains the disclosure requirements in the original
SFAS 132, but requires additional disclosures related to the description of plan
assets including investment strategies, plan obligations, cash flows and net
periodic benefit cost of defined benefit pension and other defined benefit
postretirement plans.
NOTE B -- BUSINESS COMBINATION
On July 1, 2002, the Corporation's subsidiary IBT Title completed the
purchase of Benchmark Abstract and Title of Greenville, Michigan. The
acquisition was accounted for as a purchase according to the SFAS No. 141. The
purchase price of Benchmark was approximately $1.1 million, which was funded
through the issuance of $800 (24,243 shares) of IBT Bancorp stock, $25 cash, and
a note payable in the amount of $264. The purchase price was allocated $25 to
premises and equipment and $1,064 to goodwill. Results of operations of the
acquired business have not been significant.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE C -- INVESTMENT SECURITIES
The following is a summary of securities available for sale and held to
maturity:
<Table>
<Caption>
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
DECEMBER 31, 2003
Securities available for sale
U.S. Treasury and U.S. government
agencies............................... $ 88,802 $1,256 $(124) $ 89,934
States and political subdivisions........ 74,717 2,183 (244) 76,656
Commercial paper......................... 3,211 31 -- 3,242
-------- ------ ----- --------
TOTAL.................................. $166,730 $3,470 $(368) $169,832
======== ====== ===== ========
Securities held to maturity
U.S. Treasury and U.S. government
agencies............................... $ 9 $ -- $ -- $ 9
States and political subdivisions........ 1,303 37 -- 1,340
-------- ------ ----- --------
TOTAL.................................. $ 1,312 $ 37 $ -- $ 1,349
======== ====== ===== ========
DECEMBER 31, 2002
Securities available for sale
U.S. Treasury and U.S. government
agencies............................... $ 88,546 $2,428 $ -- $ 90,974
Corporate................................ 2,284 44 -- 2,328
States and political subdivisions........ 62,669 1,960 (22) 64,607
-------- ------ ----- --------
TOTAL.................................. $153,499 $4,432 $ (22) $157,909
======== ====== ===== ========
Securities held to maturity
U.S. Treasury and U.S. government
agencies............................... $ 74 $ 1 $ -- $ 75
States and political subdivisions........ 1,662 66 -- 1,728
-------- ------ ----- --------
TOTAL.................................. $ 1,736 $ 67 $ -- $ 1,803
======== ====== ===== ========
</Table>
The following table summarizes the fair value, realized gains, and realized
losses on sales of securities available for sale.
<Table>
<Caption>
2003 2002 2001
------- ------ ------
Fair value of securities sold on the date of sale......... $16,874 $2,066 $3,165
Gross realized gains
U.S. Treasury and U.S. government agencies.............. 85 2 4
Gross realized losses
Municipals.............................................. -- -- 12
</Table>
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table shows the amortized cost and estimated fair value of
securities owned at December 31, 2003 by contractual maturity. Expected
maturities will differ from contractual maturities because the issuers of
securities may have the right to prepay obligations without prepayment penalty.
<Table>
<Caption>
AVAILABLE FOR SALE HELD TO MATURITY
---------------------- ------------------
AMORTIZED AMORTIZED FAIR
COST FAIR VALUE COST VALUE
--------- ---------- --------- ------
Due within one year or less.................. $ 47,189 $ 47,842 $1,108 $1,135
Due after 1 year thru 5 years................ 76,696 78,073 195 205
Due after 5 years thru 10 years.............. 23,943 24,805 -- --
Due after 10 years........................... 4,915 4,981 -- --
-------- -------- ------ ------
Subtotal.............................. 152,743 155,701 1,303 1,340
Mortgage backed securities................... 13,987 14,131 9 9
-------- -------- ------ ------
TOTAL................................. $166,730 $169,832 $1,312 $1,349
======== ======== ====== ======
</Table>
Investment securities with carrying values of approximately $7,087 and
$10,359 were pledged to secure public deposits and for other purposes as
necessary or required by law at December 31, 2003 and 2002, respectively.
NOTE D -- LOANS
An analysis of changes in the allowance for loan losses follows:
<Table>
<Caption>
2003 2002 2001
------- ------- ------
Balance at beginning of year............................. $ 5,593 $ 5,471 $5,162
Loans charged off...................................... (1,140) (1,202) (692)
Recoveries............................................. 296 299 231
Provision charged to income............................ 1,455 1,025 770
------- ------- ------
BALANCE AT END OF YEAR............................ $ 6,204 $ 5,593 $5,471
======= ======= ======
</Table>
<Table>
<Caption>
The following is a summary of information pertaining to impaired
loans at December 31:
2003 2002 2001
------ ------ ----
Impaired loans without a valuation allowance.................. $1,836 $1,085 $ --
Impaired loans with a valuation allowance..................... 2,787 1,639 544
------ ------ ----
Total impaired loans.......................................... $4,623 $2,724 $544
====== ====== ====
Valuation allowance related to impaired loans................. $ 622 $ 103 $ 56
====== ====== ====
Average investment in impaired loans.......................... $5,155 $2,968 $544
====== ====== ====
</Table>
Interest income recognized on impaired loans was not significant during any
of the three years ended December 31, 2003. No additional funds are committed to
be advanced in connection with impaired loans.
Certain directors and executive officers (including their families and
companies in which they have 10% or more ownership) of the Corporation and the
Banks were loan customers of the Banks. Total loans to these customers
aggregated $8,414 and $7,721 at December 31, 2003 and 2002, respectively. During
2003, $5,488 of new loans were made and repayments totaled $4,795.
Residential mortgage loans serviced for others are not included in the
accompanying consolidated balance sheets. The unpaid principal balances of
mortgages serviced for others was $245,709, $208,432 and $153,136
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
at December 31, 2003, 2002, and 2001 respectively. Servicing loans for others
generally consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors and taxing authorities, and foreclosure
processing.
The following table summarizes the fair value of mortgage servicing rights
included in other assets as of December 31:
<Table>
<Caption>
2003 2002 2001
------- ------ -----
Balance at beginning of year............................... $ 511 $ 402 $ 271
Mortgage servicing rights capitalized...................... 3,369 1,632 660
Accumulated amortization................................... (1,955) (885) (358)
Impairment valuation allowance............................. (211) (638) (171)
------- ------ -----
BALANCE AT END OF YEAR................................ $ 1,714 $ 511 $ 402
======= ====== =====
</Table>
NOTE E -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The Corporation utilizes quoted market prices, where available, to compute
the fair value of its financial instruments. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Certain financial instruments and all
nonfinancial instruments are excluded from the disclosure requirements.
Accordingly, the aggregate of the fair value amounts presented are not
necessarily indicative of the underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in
estimating fair value disclosures for financial instruments.
CASH AND CASH EQUIVALENTS:
The carrying amounts reported in the balance sheets for cash and demand
deposits due from banks and federal funds sold approximate those assets' fair
value.
INVESTMENT SECURITIES:
Fair values for investment securities are based on quoted market prices,
where available. If quoted market prices are unavailable, fair values are based
on quoted market prices of comparable instruments.
LOANS:
Fair values for variable rate loans that reprice at least quarterly and
have no significant change in credit risk are assumed to equal recorded book
value. Fixed rate loans are valued using present value discounted cash flow
techniques. The discount rate used in these calculations was the U.S. government
bond rate for securities with similar maturities adjusted for servicing costs,
credit loss, and prepayment risk.
DEPOSIT LIABILITIES:
Demand, savings, and money market deposits have no stated maturities and
are payable on demand; thus their estimated fair value is equal to their
recorded book balance. Fair values for variable rate certificates of deposit
approximate their recorded book balance. Fair values for fixed rate certificates
of deposit are determined using discounted cash flow techniques that apply
interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities on time deposits.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OFF-BALANCE-SHEET INSTRUMENTS:
Fair values for off-balance-sheet lending commitments are based on fees
currently charged to enter into similar agreements, taking into consideration
the remaining terms of the agreements and the counterparties' credit standings.
The Corporation does not charge fees for lending commitments; thus it is not
practicable to estimate the fair value of these instruments.
The following sets forth the estimated fair value and recorded book balance
of the Corporation's financial instruments as of December 31:
<Table>
<Caption>
2003 2002
------------------------------ ------------------------------
ESTIMATED FAIR RECORDED BOOK ESTIMATED FAIR RECORDED BOOK
VALUE BALANCE VALUE BALANCE
-------------- ------------- -------------- -------------
ASSETS
Cash and demand deposits due from
banks................................ $ 25,918 $ 25,918 $ 28,587 $ 28,587
Federal funds sold..................... 5,300 5,300 25,850 25,850
Investment securities.................. 171,181 171,144 159,712 159,645
Mortgage loans available for sale...... 4,343 4,315 13,599 13,392
Net loans.............................. 417,984 415,655 386,817 385,495
Accrued interest receivable............ 4,534 4,534 4,897 4,897
Mortgage servicing rights.............. 2,656 1,714 1,011 511
LIABILITIES
Deposits with no stated maturities..... 329,029 329,029 310,194 310,194
Deposits with stated maturities........ 245,239 238,678 256,755 251,262
Borrowed funds......................... 19,118 18,053 18,507 17,793
Accrued interest payable............... 830 830 1,037 1,037
</Table>
NOTE F -- FEDERAL INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Corporation's deferred tax assets and liabilities,
included in other assets, as of December 31 are as follows:
<Table>
<Caption>
2003 2002
------ ------
Deferred tax assets
Allowance for loan losses................................. $1,379 $1,175
Deferred directors' fees.................................. 735 664
Employee benefit plans.................................... 755 608
Core deposit premium and acquisition expenses............. 192 245
Net unrealized loss on minimum pension liability.......... 631 701
Other..................................................... 186 225
------ ------
TOTAL DEFERRED TAX ASSETS.............................. 3,878 3,618
------ ------
Deferred tax liabilities
Premises and equipment.................................... 494 222
Accretion on securities................................... 32 73
Net unrealized gain on available-for-sale securities...... 1,055 1,498
Other..................................................... 138 80
------ ------
TOTAL DEFERRED TAX LIABILITIES......................... 1,719 1,873
------ ------
NET DEFERRED TAX ASSETS.............................. $2,159 $1,745
====== ======
</Table>
Components of the consolidated provision for income taxes are as follows
for the year ended December 31:
<Table>
<Caption>
2003 2002 2001
------ ------ ------
Current.................................................... $2,076 $2,562 $2,482
Deferred benefit........................................... (41) (276) (277)
------ ------ ------
PROVISION FOR FEDERAL INCOME TAXES....................... $2,035 $2,286 $2,205
====== ====== ======
</Table>
The reconciliation of the provision for federal income taxes and the amount
computed at the federal statutory tax rate of 34% of income before federal
income taxes is as follows for the year ended December 31:
<Table>
<Caption>
2003 2002 2001
------ ------ ------
Income tax on pretax income................................ $3,142 $3,132 $2,812
Effect of nontaxable income and nondeductible expenses..... (1,107) (846) (607)
------ ------ ------
PROVISION FOR FEDERAL INCOME TAX......................... $2,035 $2,286 $2,205
====== ====== ======
</Table>
NOTE G -- BENEFIT PLANS
DEFINED BENEFIT PENSION PLAN
The Corporation has a defined benefit pension plan covering substantially
all of its employees. The benefits are based on years of service and the
employees' average compensation over their best five years of service. The
funding policy is to contribute annually the maximum amount that can be deducted
for federal income tax purposes. Contributions are intended to provide not only
for benefits attributed to services to date but also for those expected to be
earned in the future. The defined pension plan's assets are invested primarily
in common stocks.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in the projected benefit obligation and plan assets during each
year, the funded status of the plan and reconciliation to the amount recognized
in the Corporation's consolidated balance sheets are summarized as follows at
December 31:
<Table>
<Caption>
2003 2002 2001
------- ------- ------
Change in projected benefit obligation
Benefit obligation January 1........................... $ 6,949 $ 5,870 $5,130
Service cost........................................ 391 297 271
Interest cost....................................... 463 425 384
Actuarial loss...................................... 687 634 305
Benefits paid....................................... (407) (277) (220)
------- ------- ------
BENEFIT OBLIGATION, DECEMBER 31................... $ 8,083 $ 6,949 $5,870
======= ======= ======
Change in plan assets
Fair value of plan assets, January 1................... $ 4,830 $ 5,259 $5,446
Investment return (loss)............................... 479 (509) (439)
Corporation contribution............................... 525 357 472
Benefits paid.......................................... (407) (277) (220)
------- ------- ------
FAIR VALUE OF PLAN ASSETS, DECEMBER 31............ $ 5,427 $ 4,830 $5,259
======= ======= ======
Reconciliation of funded status
Funded status.......................................... $(2,656) $(2,119) $ (611)
Unrecognized net transition asset...................... -- (22) (44)
Unrecognized prior service cost........................ 94 113 125
Unrecognized net loss from experience different than
that assumed and effects of changes in
assumptions......................................... 4,254 3,843 2,409
Additional minimum pension liability................... (1,951) (2,176) --
------- ------- ------
(ACCRUED LIABILITY) PREPAID PENSION COST.......... $ (259) $ (361) $1,879
======= ======= ======
</Table>
An adjustment to record the additional minimum pension liability as of
December 31, 2003 and 2002 was established by the recording of an intangible
pension asset of $94 and $113 and a credit (charge) to other comprehensive
income of $208 and ($2,063) in 2003 and 2002, respectively.
The amounts recognized in the consolidated statement of financial position
consists of:
<Table>
<Caption>
PENSION BENEFITS
-----------------
2003 2002
------- -------
Accrued benefit cost........................................ $ (259) $ (361)
Intangible assets........................................... 94 113
Accumulated other comprehensive income...................... 1,855 2,063
------ ------
Net amount recognized....................................... $1,690 $1,815
====== ======
</Table>
The accumulated benefit obligation was $5,686 and $5,191 at December 31,
2003 and 2002 respectively.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for pension plans with an accumulated benefit obligation in
excess of plan assets for year ended December 31:
<Table>
<Caption>
2003 2002
------ ------
Projected benefit obligation................................ $8,083 $6,949
Accumulated benefit obligation.............................. 5,686 5,191
Fair value of plan assets................................... 5,427 4,830
</Table>
<Table>
<Caption>
PENSION BENEFITS
----------------
2003 2002
----- --------
Increase in minimum liability included in other
comprehensive income (loss)............................... $208 $(2,063)
</Table>
Net pension expense consists of the following components for the year ended
December 31:
<Table>
<Caption>
2003 2002 2001
----- ----- -----
Service cost on benefits earned for
services rendered during the year........................... $ 391 $ 297 $ 271
Interest cost on projected benefit obligation............... 463 425 384
Expected return on plan assets.............................. (390) (409) (445)
Amortization of unrecognized transition asset............... (22) (22) (22)
Amortization of unrecognized prior service cost............. 18 18 18
Amortization of unrecognized actuarial net loss............. 188 113 48
----- ----- -----
NET PENSION EXPENSE.................................... $ 648 $ 422 $ 254
===== ===== =====
</Table>
Actuarial assumptions used in determining the projected benefit obligation
are as follows for the year ended December 31:
<Table>
<Caption>
2003 2002 2001
---- ---- ----
Weighted average discount rate.............................. 6.25% 6.75% 7.25%
Rate of increase in future compensation..................... 4.50 4.50 4.50
Expected long-term rate of return........................... 8.00 8.00 8.00
</Table>
The actual weighted average assumptions used in determining the net
periodic pension costs are as follows for the year ended December 31:
<Table>
<Caption>
2003 2002 2001
---- ---- ----
Discount rate............................................... 6.75% 7.25% 7.50%
Expected long-term return on plan assets.................... 8.00 8.00 8.00
Rate of compensation increase............................... 4.50 4.50 4.50
</Table>
The discount rate was decreased from 6.75% to 6.25% to reflect lower rates
of return on high quality fixed income investments. The expected long term rate
of return is based on the Corporation's actual recommended rate. The factors
used to establish the rate include historical plan performance, comparison of
rates used by similar plans with similar asset allocations, and historical
performance of long-term investments.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
IBT Bancorp's pension plan weighted-average asset allocations at December
31, 2003, and 2002, by asset category as are follows:
<Table>
<Caption>
ASSET CATEGORY 2003 2002
- -------------- ------ ------
Equity securities........................................... 55.23% 50.58%
Debt securities............................................. 21.41 24.42
Other....................................................... 23.36 25.00
------ ------
Total.................................................. 100.00% 100.00%
====== ======
</Table>
The Corporation's investment policy for the benefit plan includes asset
holdings in publicly traded equities, U.S. Government agency obligations and
investment grade corporate and municipal bonds. The policy restricts equity
investment to less than 20% of equity investments in any sector and to less than
4% of plans assets in any one company. The Corporation's weighted asset
allocations in 2003 and 2002 were as follows:
<Table>
Equity Securities........................................... 55.0% to 65%
Debt Securities............................................. 25.0% to 35%
Real Estate................................................. 0.00%
Other....................................................... 15.0%
</Table>
The asset mix, the sector weighting of equity investments, and debt issues
to hold are based on a third party investment advisor retained by the
Corporation to manage the plan. The Corporation reviews the performance of the
advisor no less than annually.
OTHER EMPLOYEE BENEFIT PLANS
The Corporation maintains a nonqualified supplementary retirement plan for
officers to provide supplemental retirement benefits and death benefits to each
participant. Insurance policies, designed primarily to fund death benefits, have
been purchased on the life of each participant with the Corporation as the sole
owner and beneficiary of the policies. Expenses related to this program for
2003, 2002, and 2001 were $388, $41, and $84, respectively, and are being
recognized over the participants' expected years of service.
The Corporation maintains an employee stock ownership plan (ESOP) and a
profit sharing plan which cover substantially all of its employees.
Contributions to the Plans are discretionary and are approved by the Board of
Directors and recorded as compensation expense. Compensation expense related to
the Plans for 2003, 2002, and 2001 was $122, $196, and $146, respectively. Total
shares outstanding related to the ESOP at December 31, 2003 and 2002 were
150,583 and 166,139, respectively, and were included in the computation of
dividends and earnings per share in each of the respective years.
NOTE H -- DEPOSITS
At December 31, 2003, the scheduled maturities of time deposits were as
follows:
<Table>
<Caption>
YEAR AMOUNT
- ---- --------
2004........................................................ $111,236
2005........................................................ 53,131
2006........................................................ 33,216
2007........................................................ 27,984
2008........................................................ 12,270
Thereafter.................................................. 841
</Table>
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE I -- BORROWED FUNDS
Borrowed funds at December 31 consist of the following obligations:
<Table>
<Caption>
2003 2002
------- -------
Federal Home Loan Bank advances............................. $16,337 $14,360
Securities sold under agreements to repurchase.............. 1,500 3,169
Unsecured note payable...................................... 216 264
------- -------
$18,053 $17,793
======= =======
</Table>
The Federal Home Loan Bank borrowings are collateralized by a blanket lien
on all qualified 1 to 4 family residential mortgage loans and U.S. Treasury and
government agency securities. Advances are also secured by FHLB stock owned by
the Banks.
The maturity and weighted average interest rates of FHLB advances at
December 31 follow:
<Table>
<Caption>
2003
--------------
AMOUNT RATE
------- ----
Fixed rate advance due 2004................................. $ 1,000 5.05%
Two year putable advance due 2006........................... 5,000 5.08
Fixed rate advance due 2009................................. 1,000 4.19
Fixed rate advance due 2010................................. 2,337 6.62
One year putable advance due 2010........................... 3,000 4.98
Fixed rate advance due 2010................................. 2,000 3.97
Fixed rate advance due 2012................................. 2,000 4.90
------- ----
TOTAL ADVANCES............................................ $16,337 5.07%
======= ====
</Table>
<Table>
<Caption>
2002
--------------
AMOUNT RATE
------- ----
Fixed rate advance due 2004................................. $ 1,000 5.05%
Two year putable advance due 2006........................... 5,000 5.08
Fixed rate advance due 2009................................. 1,000 4.19
Fixed rate advance due 2010................................. 2,360 6.62
One year putable advance due 2010........................... 3,000 4.98
Fixed rate advance due 2012................................. 2,000 4.90
------- ----
TOTAL ADVANCES............................................ $14,360 5.22%
======= ====
</Table>
Securities sold under agreements to repurchase, which are classified as
secured borrowings, generally mature within one to four days from the
transaction date. Securities sold under agreements to repurchase are reflected
at the amount of cash received in connection with the transaction. The U.S.
government agency securities underlying the agreements have a carrying value and
a fair value of approximately $502 and $3,625 at December 31, 2003 and 2002,
respectively. Such securities remain under the control of the Corporation. The
Corporation may be required to pledge additional collateral based on the fair
value of the underlying securities.
The unsecured note payable has an imputed interest rate of 4.16% and is
payable in annual installments of $60,000, including interest, through July
2007.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE J -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation is party to financial instruments with off-balance-sheet
risk. These instruments are entered into in the normal course of business to
meet the financing needs of its customers. These financial instruments, which
include commitments to extend credit and standby letters of credit, involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amounts recognized in the consolidated balance sheets. The contract or notional
amounts of these instruments reflect the extent of involvement the Corporation
has in a particular class of financial instrument.
The Corporation's exposure to credit loss in the event of nonperformance by
the other party to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contractual notional amount
of those instruments. The Corporation uses the same credit policies in deciding
to make these commitments as it does for extending loans to customers.
Commitments to extend credit, which totaled $58,448 at December 31, 2003,
are agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments generally have variable
interest rates, fixed expiration dates, or other termination clauses and may
require the payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued by the
Corporation to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support private borrowing arrangements,
including commercial paper, bond financing, and similar transactions. At
December 31, 2003, the Corporation had a total of $715 in outstanding standby
letters of credit.
Generally, these commitments to extend credit and letters of credit mature
within one year. The credit risk involved in these transactions is essentially
the same as that involved in extending loans to customers. The Corporation
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary by the Corporation upon the
extension of credit, is based on management's credit evaluation of the borrower.
Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment, and other income producing commercial properties.
The Corporation sponsors the IBT Foundation (the "Foundation"), which is a
nonprofit entity formed for the purpose of distributing charitable donations to
recipient organizations generally located in the communities serviced by
Isabella Bank and Trust. The Corporation periodically makes charitable
contributions in the form of cash transfers to the Foundation. The Foundation is
administered by members of the Corporation's Board of Directors. The assets and
transactions of the Foundation are not included in the consolidated financial
statements of IBT Bancorp, Inc. The assets of the Foundation as of December 31,
2003 approximated $1 million.
NOTE K -- COMMITMENTS AND OTHER MATTERS
Banking regulations require banks to maintain cash reserve balances in
currency or as deposits with the Federal Reserve Bank. The Corporation's
requirement was approximately $12,687 at December 31, 2003, and $11,031 at
December 31, 2002.
Banking regulations also limit the transfer of assets in the form of
dividends, loans, or advances from the subsidiary Banks to the Corporation. At
December 31, 2003, substantially all of the subsidiary Banks' assets were
restricted from transfer to the Corporation in the form of loans or advances.
Consequently, bank dividends are the principal source of funds for the
Corporation. Payment of dividends without regulatory approval is limited to the
current years retained net income plus retained net income for the preceding two
years, less any required transfers to capital surplus. At January 1, 2004, the
amount available for dividends without regulatory approval was approximately
$7,321.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Corporation maintains a self-funded medical plan under which the
Corporation is responsible for the first $50 per year of claims made by a
covered individual. Medical claims are subject to a lifetime maximum of $2,000
per covered individual. Expenses are accrued based on estimates of the aggregate
liability for claims incurred and the Corporation's experience. Expenses were
$1,532 in 2003, $1,370 in 2002 and $1,063 in 2001.
The Corporation offers a dividend reinvestment and employee stock purchase
plan. The dividend reinvestment plan allows shareholders to purchase previously
unissued IBT Bancorp common shares. The employee stock purchase plan allows
employees to purchase IBT Bancorp common stock through payroll deduction. The
number of shares authorized for issuance under these plans are 280,000 with
74,198 shares unissued at December 31, 2003. During 2003, 2002 and 2001, 70,340
shares were issued for $2,008, 52,473 shares were issued for $1,524, and 37,434
shares were issued for $971, respectively, in cash pursuant to these plans.
The subsidiary Banks of the Corporation have obtained approval to borrow up
to $30,000 from the Federal Home Loan Bank (FHLB) of Indianapolis. Under the
terms of the agreement, the Banks may obtain advances at the stated rate at the
time of the borrowings. The Banks have agreed to pledge eligible mortgage loans
and U.S. Treasury and governmental agencies as collateral for any such
borrowings.
Certain directors and executive officers and their related interests of the
Corporation and the Banks were deposit customers of the Banks. Total deposits of
these customers aggregate approximately $6,380 and $6,956 at December 31, 2003
and December 31, 2002, respectively. In addition, the IBT Bancorp's defined
benefit plan and the Employee Stock Ownership Plan (Note G) held certificates of
deposit with the Banks aggregating $100 and $831 and $350 and $100 respectively
at December 31, 2003 and 2002.
NOTE L -- OPERATING SEGMENTS
The Corporation's reportable segments are based on legal entities that
account for at least 10% of operating results. The accounting policies are the
same as those discussed in Note A to the Consolidated Financial Statements. The
Corporation evaluates performance based principally on net income and asset
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
quality of the respective segments. A summary of selected financial information
for the Corporation's reportable segments follows:
<Table>
<Caption>
ALL OTHERS
ISABELLA BANK FARMERS (INCLUDING
AND TRUST STATE BANK PARENT) TOTAL
------------- ---------- ---------- --------
2003
Total assets................................... $527,805 $127,124 $ 9,150 $664,079
Interest income................................ 28,013 7,797 168 35,978
Net interest income............................ 18,295 5,005 228 23,528
Provision for loan losses...................... 570 885 -- 1,455
Net income (loss).............................. 6,415 1,008 (218) 7,205
2002
Total assets................................... $515,831 $126,850 $10,036 $652,717
Interest income................................ 29,689 8,353 119 38,161
Net interest income............................ 17,559 5,135 211 22,905
Provision for loan losses...................... 650 375 -- 1,025
Net income..................................... 5,516 1,206 203 6,925
2001
Total assets................................... $469,408 $116,903 $ 5,832 $592,143
Interest income................................ 31,718 8,987 93 40,798
Net interest income............................ 16,292 5,003 243 21,538
Provision for loan losses...................... 500 270 -- 770
Net income (loss).............................. 4,824 1,269 (27) 6,066
</Table>
NOTE M -- REGULATORY CAPITAL MATTERS
The Corporation (on a consolidated basis) and its subsidiary banks,
Isabella Bank and Trust and Farmers State Bank of Breckenridge ("Banks") are
subject to various regulatory capital requirements administered by their primary
regulator, the Federal Reserve Bank. Failure to meet minimum capital
requirements can initiate mandatory and/or discretionary actions by the Federal
Reserve. These actions could have a material effect on the Corporation's and
Banks' financial statements. Under the Federal Reserve's capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Corporation and the Banks must meet specific capital guidelines that include
quantitative measures of their assets, certain off-balance-sheet items, and
capital, as calculated under regulatory accounting standards. The Banks'
required capital is also subject to regulatory qualitative judgment regarding
the Banks' interest rate risk exposure and credit risk. Prompt corrective action
provisions are not applicable to bank holding companies.
Measurements established by regulation to ensure capital adequacy require
the Corporation and the Banks to maintain minimum total capital to risk weighted
assets (as defined in the regulations), Tier 1 capital to risk weighted assets
(as defined), and Tier 1 capital to average assets (as defined). Management
believes, as of December 31, 2003 and 2002, that the Corporation and the Banks
met all capital adequacy requirements to which they are subject.
As of December 31, 2003, the most recent notifications from the Federal
Reserve Bank categorized the Banks as well capitalized. To be categorized as
well capitalized, a bank must maintain total risk based capital,
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following
tables. There have been no conditions or events since the notifications that
management believes has changed the Banks' category.
The Corporation's and each Bank's actual capital amounts (in thousands) and
ratios are also presented in the table.
<Table>
<Caption>
MINIMUM TO BE
WELL CAPITALIZED
UNDER PROMPT
MINIMUM CAPITAL CORRECTIVE ACTION
ACTUAL REQUIREMENTS PROVISIONS
--------------- --------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- -------- ------
AS OF DECEMBER 31, 2003
Total capital to risk weighted assets
Isabella Bank and Trust............... $43,727 13.1% $26,749 8.0% $33,436 10.0%
Farmers State Bank of Breckenridge.... 13,320 14.6 7,289 8.0 9,111 10.0
Consolidated.......................... 68,638 15.9 34,456 8.0 N/A N/A
Tier 1 capital to risk weighted assets
Isabella Bank and Trust............... 39,734 11.9 13,375 4.0 20,062 6.0
Farmers State Bank of Breckenridge.... 12,168 13.4 3,645 4.0 5,467 6.0
Consolidated.......................... 63,244 14.7 17,228 4.0 N/A N/A
Tier 1 capital to average assets
Isabella Bank and Trust............... 39,734 7.6 21,043 4.0 26,304 5.0
Farmers State Bank of Breckenridge.... 12,168 9.6 5,062 4.0 6,328 5.0
Consolidated.......................... 63,244 9.7 26,227 4.0 N/A N/A
AS OF DECEMBER 31, 2002
Total capital to risk weighted assets
Isabella Bank and Trust............... $40,385 12.9% $24,998 8.0% $31,247 10.0%
Farmers State Bank of Breckenridge.... 12,957 14.2 7,284 8.0 9,106 10.0
Consolidated.......................... 62,030 15.2 32,670 8.0 N/A N/A
Tier 1 capital to risk weighted assets
Isabella Bank and Trust............... 36,525 11.7 12,499 4.0 18,748 6.0
Farmers State Bank of Breckenridge.... 11,811 13.0 3,642 4.0 5,463 6.0
Consolidated.......................... 56,919 13.9 16,335 4.0 N/A N/A
Tier 1 capital to average assets
Isabella Bank and Trust............... 36,525 7.4 19,856 4.0 24,820 5.0
Farmers State Bank of Breckenridge.... 11,811 9.6 4,912 4.0 6,140 5.0
Consolidated.......................... 56,919 9.2 24,795 4.0 N/A N/A
</Table>
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE N -- PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED BALANCE SHEET
<Table>
<Caption>
DECEMBER 31
-----------------
2003 2002
------- -------
ASSETS
Cash on deposit at subsidiary Banks....................... $ 7,592 $ 4,690
Securities available for sale............................. 2,133 1,497
Investments in subsidiaries............................... 61,775 58,949
Premises and equipment.................................... 117 98
Other assets.............................................. 1,444 1,722
------- -------
TOTAL ASSETS........................................... $73,061 $66,956
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities......................................... $ 4,126 $ 3,553
Shareholders' equity........................................ 68,935 63,403
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............. $73,061 $66,956
======= =======
</Table>
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31
------------------------
2003 2002 2001
------ ------ ------
Income
Dividends from subsidiaries.............................. $3,825 $3,325 $3,115
Interest income.......................................... 128 122 154
Management fee and other................................. 423 292 245
------ ------ ------
TOTAL INCOME.......................................... 4,376 3,739 3,514
Expenses................................................... 1,114 824 680
------ ------ ------
Income before income tax benefit and equity in
undistributed earnings of subsidiaries................ 3,262 2,915 2,834
Federal income tax benefit............................... 218 152 103
------ ------ ------
3,480 3,067 2,937
Undistributed earnings of subsidiaries..................... 3,725 3,858 3,129
------ ------ ------
NET INCOME............................................ $7,205 $6,925 $6,066
====== ====== ======
</Table>
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------
2003 2002 2001
------- ------- -------
OPERATING ACTIVITIES
Net income............................................ $ 7,205 $ 6,925 $ 6,066
Adjustments to reconcile net income to cash
provided by operations
Undistributed earnings of subsidiaries............. (3,725) (3,858) (3,129)
Net amortization of securities..................... -- -- 1
Decrease (increase) in interest receivable......... (2) (2) 1
(Increase) decrease in other assets................ 717 (1,947) (240)
Increase in accrued expenses....................... 675 389 1,353
Provision for depreciation......................... 19 20 19
Deferred income taxes (benefit).................... (348) 328 (401)
------- ------- -------
NET CASH PROVIDED BY OPERATIONS.................. 4,541 1,855 3,670
INVESTING ACTIVITIES
Proceeds from the maturities of investments securities
available for sale................................. 185 175 75
Purchases of investment securities available for
sale............................................... (820) (1,080) --
Investment in subsidiaries............................ 34 (495) --
Purchases of equipment and premises................... (38) (5) (39)
------- ------- -------
NET CASH (USED IN) PROVIDED BY INVESTING
ACTIVITIES.................................... (639) (1,405) 36
FINANCING ACTIVITIES
Cash dividends........................................ (2,881) (2,585) (2,327)
Issuance of common stock.............................. 2,008 1,583 971
Repurchase of common stock............................ (127) (619) (768)
------- ------- -------
NET CASH USED IN FINANCING ACTIVITIES............ (1,000) (1,621) (2,124)
------- ------- -------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS................................... 2,902 (1,171) 1,582
Cash and cash equivalents at beginning of year.......... 4,690 5,861 4,279
------- ------- -------
CASH AND CASH EQUIVALENTS AT YEAR END............ $ 7,592 $ 4,690 $ 5,861
======= ======= =======
</Table>
NOTE O -- GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Corporation adopted FASB Statement of Financial
Accounting Standard No. 142, "Goodwill and Other Intangible Assets." Statement
No. 142 addresses the reporting of other intangible assets subsequent to their
acquisition. This Statement requires that goodwill be separately disclosed if
material from other intangible assets on the consolidated balance sheet and that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead, tested for impairment at least annually. The adoption of
Statement No. 142 resulted in the reduction of goodwill amortization of $392 in
2003 and 2002 or $0.08 and $0.09 per share in 2003 and 2002, respectively.
As required by the Statement, intangible assets that do not meet the
criteria for recognition apart from goodwill must be reclassified. As a result
of the Corporation's analysis, no reclassifications were required as of
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 2003. Included in other assets on the accompanying consolidated
balance sheets are the following amounts as of December 31:
<Table>
<Caption>
2003 2002
------ ------
Branch acquisition goodwill................................. $2,036 $2,036
Title company goodwill...................................... 1,100 1,064
------ ------
Total goodwill.............................................. 3,136 3,100
Core deposit intangibles.................................... 304 398
------ ------
$3,440 $3,498
====== ======
</Table>
The core deposit intangibles are being amortized on a straight-line basis
over nine years.
48
IBT BANCORP FINANCIAL REVIEW
(ALL DOLLARS IN THOUSANDS)
The following is management's discussion and analysis of the financial
condition and results of operations for IBT Bancorp (the Corporation). This
discussion and analysis is intended to provide a better understanding of the
financial statements and statistical data included elsewhere in the Annual
Report.
CRITICAL ACCOUNTING POLICIES:
The Corporation's significant accounting policies are set forth in Note A
of the Consolidated Financial Statements. Of these significant accounting
policies, the Corporation considers its policies regarding the allowance for
loan losses and servicing assets to be its most critical accounting policies.
The allowance for loan losses requires management's most subjective and
complex judgment. Changes in economic conditions can have a significant impact
on the allowance for loan losses and therefore the provision for loan losses and
results of operations. The Corporation has developed appropriate policies and
procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Corporation's assessments may be
impacted in future periods by changes in economic conditions, the impact of
regulatory examinations, and the discovery of information with respect to
borrowers that is not known to management at the time of the issuance of the
consolidated financial statements. For additional discussion concerning the
Corporation's allowance for loan losses and related matters, see Provision for
Loan Losses and Allowance for Loan Losses.
Servicing assets are evaluated for impairment based upon the fair value of
the rights as compared to amortized cost. Impairment is determined by
stratifying rights by predominant characteristics, such as interest rates and
terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation allowance
for an individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
49
TABLE 1. DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY;
INTEREST RATE AND INTEREST DIFFERENTIAL
The following schedules present the daily average amount outstanding for
each major category of interest earning assets, nonearning assets, interest
bearing liabilities, and noninterest bearing liabilities. This schedule also
presents an analysis of interest income and interest expense for the periods
indicated. All interest income is reported on a fully taxable equivalent (FTE)
basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following
computations, are included in the average loan amounts outstanding. Federal
Reserve and Federal Home Loan Bank Equity holdings are included in Other
Investments.
<Table>
<Caption>
2003 2002 2001
------------------------------- ------------------------------- -------------------------------
TAX AVERAGE TAX AVERAGE TAX AVERAGE
AVERAGE EQUIVALENT YIELD/ AVERAGE EQUIVALENT YIELD/ AVERAGE EQUIVALENT YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- ---------- ------- -------- ---------- ------- -------- ---------- -------
INTEREST EARNING ASSETS
Loans..................... $404,953 $29,196 7.21% $396,234 $31,554 7.96% $404,586 $35,118 8.68%
Taxable investment
securities.............. 123,927 4,437 3.58 94,383 4,197 4.45 54,171 2,993 5.53
Nontaxable investment
securities.............. 49,531 3,099 6.26 45,663 2,864 6.27 34,748 2,481 7.14
Federal funds sold........ 16,311 193 1.18 26,364 423 1.60 23,827 897 3.76
Other investments......... 2,857 151 5.29 2,735 165 6.03 2,626 180 6.85
-------- ------- ---- -------- ------- ---- -------- ------- ----
TOTAL EARNING ASSETS.... 597,579 37,076 6.20 565,379 39,203 6.93 519,958 41,669 8.01
NONEARNING ASSETS
Allowance for loan
losses.................. (5,946) (5,621) (5,347)
Cash and due from banks... 26,840 24,236 21,052
Premises and equipment.... 15,646 14,983 12,461
Accrued income and other
assets.................. 25,204 24,530 18,423
-------- -------- --------
TOTAL ASSETS............ $659,323 $623,507 $566,547
======== ======== ========
INTEREST BEARING LIABILITIES
Interest bearing demand
deposits................ $113,206 1,057 .93 $ 98,478 1,406 1.43 $ 81,260 1,955 2.41
Savings deposits.......... 141,227 1,325 .94 135,792 2,201 1.62 121,202 3,258 2.69
Time deposits............. 247,516 9,228 3.73 247,182 10,971 4.44 235,481 13,465 5.72
Borrowed funds............ 18,812 840 4.47 13,960 678 4.86 10,712 582 5.43
-------- ------- ---- -------- ------- ---- -------- ------- ----
TOTAL INTEREST BEARING
LIABILITIES........... 520,761 12,450 2.39 495,412 15,256 3.08 448,655 19,260 4.29
NONINTEREST BEARING
LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand deposits........... 61,651 59,518 56,904
Other..................... 11,141 9,037 6,201
Shareholders' equity...... 65,770 59,540 54,787
-------- -------- --------
TOTAL LIABILITIES AND
EQUITY................ $659,323 $623,507 $566,547
======== ======== ========
NET INTEREST INCOME (FTE)... $24,626 $23,947 $22,409
======= ======= =======
NET YIELD ON INTEREST
EARNING ASSETS (FTE)...... 4.12% 4.24% 4.31%
==== ==== ====
</Table>
50
RESULTS OF OPERATIONS
The Corporation achieved record net income for the seventeenth consecutive
year in 2003.
Two key measures of earnings performance commonly used in the banking
industry are return on average assets and return on average shareholders'
equity. Return on average assets measures the ability of a corporation to
profitably and efficiently employ its resources. The Corporation's return on
average assets was 1.09% in 2003, 1.11% in 2002, and 1.07% in 2001. Return on
average equity indicates how effectively a corporation is able to generate
earnings on capital invested by its shareholders. The Corporation's return on
average shareholders' equity was 10.95% in 2003, 11.63% in 2002, and 11.07% in
2001.
NET INTEREST INCOME
The Corporation derives the majority of its gross income from interest
earned on loans and investments, while its most significant expense is the
interest cost incurred for funds used. Net interest income is the amount by
which interest income on earning assets exceeds the interest cost of deposits
and borrowings. Net interest income is influenced by changes in the balance and
mix of assets and liabilities and market interest rates. Management exerts some
control over these factors, however, Federal Reserve monetary policy and
competition have a significant impact. Interest income includes loan fees of
$1,752 in 2003, $1,524 in 2002, and $1,425 in 2001. For analytical purposes, net
interest income is adjusted to a "taxable equivalent" basis by adding the income
tax savings from interest on tax-exempt loans and securities, thus making
year-to-year comparisons more meaningful.
TABLE 2. VOLUME AND RATE VARIANCE ANALYSIS
The following table details the dollar amount of changes in FTE net
interest income for each major category of interest earning assets and interest
bearing liabilities and the amount of change attributable to changes in average
balances (volume) or average rates. The change in interest due to both volume
and rate has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each.
<Table>
<Caption>
2003 COMPARED TO 2002 2002 COMPARED TO 2001
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
-------------------------- --------------------------
VOLUME RATE NET VOLUME RATE NET
------ ------- ------- ------ ------- -------
CHANGES IN INTEREST INCOME
Loans............................... $ 682 $(3,040) $(2,358) $ (713) $(2,851) $(3,564)
Taxable investment securities....... 1,156 (916) 240 1,878 (674) 1,204
Nontaxable investment securities.... 242 (7) 235 711 (328) 383
Federal funds sold.................. (136) (94) (230) 87 (561) (474)
Other investments................... 7 (21) (14) 7 (22) (15)
------ ------- ------- ------ ------- -------
TOTAL CHANGES IN INTEREST
INCOME......................... 1,951 (4,078) (2,127) 1,970 (4,436) (2,466)
CHANGES IN INTEREST EXPENSE
Interest bearing demand deposits.... 188 (537) (349) 357 (906) (549)
Savings deposits.................... 85 (961) (876) 356 (1,413) (1,057)
Time deposits....................... 15 (1,758) (1,743) 642 (3,136) (2,494)
Other borrowings.................... 220 (58) 162 163 (67) 96
------ ------- ------- ------ ------- -------
TOTAL CHANGES IN INTEREST
EXPENSE........................ 508 (3,314) (2,806) 1,518 (5,522) (4,004)
NET CHANGE IN FTE NET INTEREST
INCOME.............................. $1,443 $ (764) $ 679 $ 452 $ 1,086 $ 1,538
====== ======= ======= ====== ======= =======
</Table>
As shown in Tables 1 and 2, when comparing year ending December 31, 2003 to
2002, fully taxable equivalent (FTE) net interest income increased $679 or 2.8%.
An increase of 5.7% in average interest earning assets provided $1,951 of FTE
interest income. The majority of this growth was funded by a 5.1% increase in
51
interest bearing liabilities, resulting in $508 of additional interest expense.
Overall, changes in volume resulted in $1,443 in additional FTE interest income.
The average FTE interest rate earned on assets decreased by .73%, decreasing FTE
interest income by $4,078, and the average rate paid on deposits decreased by
..69%, decreasing interest expense by $3,314. The net change related to interest
rates earned and paid was a $764 decrease in FTE net interest income.
The Corporation's FTE net yield as a percentage of average earning assets
decreased .12%. The decrease was primarily the result of a significant change in
the mix of assets and funding sources. Average investment securities as a
percentage of total earning assets increased 4.3% to 29.0% in 2003, while loans,
the Corporation's highest yielding assets, decreased 2.3% to 67.8%. The change
in mix resulted in a .08% decrease in the FTE net yield on interest earning
assets. The funding of interest earning assets was done primarily through a 5.1%
increase in interest bearing liabilities. The remaining decrease in net interest
margin is related to the average rate earned on earning assets declining
slightly faster than the average rate paid on interest bearing liabilities.
Net interest income increased $1,538 to $23,947 in 2002 from $22,409 in
2001. As shown in Tables 1 and 2, in 2002 (FTE) interest income increased
$1,970, from an 8.7% increase in the volume of average earning assets. The
growth of interest earning assets was funded primarily by a 10.4% increase in
interest bearing liabilities that resulted in additional interest expense of
$1,518. Overall, the Corporation earned an additional $452 in FTE interest
income as a result of increased volume. The average rate earned in 2002
decreased by 1.08%, decreasing FTE interest income by $4,436, and the average
rate paid on deposits decreased by 1.21%, decreasing interest expense by $5,522.
The net change related to interest rates earned and paid was a $1,086 increase
in FTE net interest income.
PROVISION FOR LOAN LOSSES
The viability of any financial institution is ultimately determined by its
management of credit risk. Total loans outstanding represent 75% of the
Corporation's total year end deposits and is the Corporation's single largest
concentration of risk. Inevitably, poor operating performance may result from
the failure to control credit risk. Given the importance of maintaining sound
underwriting practices, the Banks' Boards of Directors and senior management
teams spend a large portion of their time and effort in loan review. The
provision for loan losses is the amount added to the allowance for loan losses
on a monthly basis. The allowance for loan losses is management's estimation of
potential losses inherent in the loan portfolio, and is maintained at a level
considered by management to be adequate to absorb potential losses. Evaluation
of the allowance for loan losses and the provision for loan losses is based on a
continuous review of the changes in the type and volume of the loan portfolio,
reviews of specific loans to evaluate their collectibility, past and recent loan
loss history, financial condition of borrowers, the amount of impaired loans,
overall economic conditions, and other factors. This evaluation is inherently
subjective as it requires material estimates, including the amounts and timing
of future cash flows expected to be received on impaired loans that may be
subject to significant change.
As shown in Table 3, total loans outstanding increased 5.3% in 2003 and
increased 1.7% in 2002. The provision for loan losses in 2003 was $1,455, a $430
increase from 2002 and a $685 increase from 2001. The 2003 provision for loan
losses was increased as a result of a combination of factors. During the last
quarter of 2003 the Corporation experienced a decline in the overall credit
quality of its outstanding agricultural loans. The Corporation has under taken a
detailed review of the credit quality of all its significant agricultural
lending relationships, and believes that it has identified the most significant
troubled loans. The primary factor for the decline in the credit quality is the
third consecutive year of weak cash flows due to both low farm commodity prices
and unfavorable growing conditions in mid Michigan. The Corporation has
tightened its credit standards for new borrowings and will continue to monitor
existing relationships for further deterioration. Unfavorable prices or poor
growing conditions in 2004 could result in significant increases in the
provision for loan losses and net charge offs. Net charge offs to average loans
was 0.21% in 2003 and 0.23% in 2002, and have averaged 0.13% during the past 5
years versus the average for all commercial banks in the State of Michigan of
0.17%. The Corporations substandard loans were 1.29% as of December 31, 2003, a
0.10% increase from 2002, and slightly above the ratio for all commercial banks
in the State of Michigan of 1.05%.
52
The allowance to loan losses as a percentage of loans was increased from
1.38% to 1.46%, primarily due to the increase in loans classified as substandard
and the decline in the overall credit quality of agricultural loans. Management
believes that the allowance for loans is adequate as of December 31, 2003.
TABLE 3. SUMMARY OF LOAN LOSS EXPERIENCE
The following is a summary of loan balances at the end of each year and
their daily average balances, changes in the allowance for loan losses arising
from loans charged off and recoveries on loans previously charged off, and
additions to the allowance that have been expensed.
<Table>
<Caption>
DECEMBER 31
----------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Amount of loans outstanding at the end of
year.......................................... $426,174 $404,480 $397,864 $403,679 $355,846
======== ======== ======== ======== ========
Average gross loans outstanding for the year.... $404,953 $396,234 $404,586 $380,392 $332,083
======== ======== ======== ======== ========
Summary of changes in allowance
Allowance for loan losses -- January 1........ $ 5,593 $ 5,471 $ 5,162 $ 4,622 $ 4,412
Loans charged off
Commercial and agricultural.............. 578 506 271 65 221
Real estate mortgage..................... 117 236 70 58 78
Personal................................. 445 460 351 295 347
-------- -------- -------- -------- --------
TOTAL LOANS CHARGED OFF............... 1,140 1,202 692 418 646
Recoveries
Commercial and agricultural.............. 93 140 35 172 86
Real estate mortgage..................... 29 18 41 64 92
Personal................................. 174 141 155 157 169
-------- -------- -------- -------- --------
TOTAL RECOVERIES...................... 296 299 231 393 347
Net charge offs............................ 844 903 461 25 299
Provision charged to income................ 1,455 1,025 770 565 509
-------- -------- -------- -------- --------
ALLOWANCE FOR LOAN LOSSES -- DECEMBER 31........ $ 6,204 $ 5,593 $ 5,471 $ 5,162 $ 4,622
======== ======== ======== ======== ========
Ratio of net charge offs during the year to
average loans outstanding..................... .21% 0.23% 0.11% 0.01% 0.09%
======== ======== ======== ======== ========
Ratio of the allowance for loan losses to loans
outstanding at year end....................... 1.46% 1.38% 1.38% 1.28% 1.30%
======== ======== ======== ======== ========
</Table>
As shown in Table 4, the percentage of loans classified as nonperforming by
the Corporation as of December 31, 2003 and 2002 was 1.29% and 1.19% of total
loans, respectively. Average nonperforming loans for the peer group were 1.47%.
The peer group is a composite of financial information of all bank holding
companies with assets between $500 million and $1 billion; there were 388 bank
holding companies in the Corporation's peer group for the period indicated. The
Banks' policies, including a loan considered impaired under Statement of
Financial Accounting Standards No. 118, are to transfer a loan to nonaccrual
status whenever it is determined that interest should be recorded on the cash
basis instead of the accrual basis because of a deterioration in the financial
position of the borrower, or a determination that payment in full of interest or
principal cannot be expected, or the loan has been in default for a period of 90
days or more, unless it is both well secured and in the process of collection.
53
TABLE 4. NONPERFORMING LOANS
The following loans are all the credits which require classification for
state or federal regulatory purposes:
<Table>
<Caption>
DECEMBER 31
------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Nonaccrual loans.................................. $4,121 $2,484 $1,346 $ 382 $ 945
Accruing loans past due 90 days or more........... 1,380 1,840 1,219 1,484 618
Restructured loans................................ -- 479 -- -- --
------ ------ ------ ------ ------
TOTAL NONPERFORMING LOANS....................... $5,501 $4,803 $2,565 $1,866 $1,563
====== ====== ====== ====== ======
NONPERFORMING LOANS AS % OF LOANS................. 1.29% 1.19% 0.64% 0.46% 0.44%
====== ====== ====== ====== ======
</Table>
As of December 31, 2003, there were no other interest bearing assets which
required classification. Management is not aware of any recommendations by
regulatory agencies that, if implemented, would have a material impact on the
Corporation's liquidity, capital, or operations.
Management's internal analysis of the estimated range for the allowance was
$3,326 to $6,937 as of December 31, 2003. In management's opinion, the allowance
for loan losses of $6,204 is adequate as of December 31, 2003. Management has
allocated, as reflected in Table 5, the allowance for loan losses to the
following categories: 34.5% to commercial and agricultural loans; 25.5% to real
estate loans; 26% to installment loans; 9.1% to impaired loans; and 4.9%
unallocated. The above allocation is not intended to imply limitations on usage
of the allowance. The entire allowance is available to fund loan losses without
regard to loan type.
TABLE 5. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses has been allocated according to the amount
deemed to be reasonably necessary to provide for the possibility of losses being
incurred within the following categories:
<Table>
<Caption>
DECEMBER 31
---------------------------------------------------------------------------------------------
2003 2002 2001 2000
--------------------- --------------------- --------------------- ---------------------
% OF EACH % OF EACH % OF EACH % OF EACH
CATEGORY CATEGORY CATEGORY CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
--------- --------- --------- --------- --------- --------- --------- ---------
Commercial and
agricultural....... $2,140 27.6% $1,868 28.9% $2,081 26.7% $1,301 26.6%
Real estate
mortgage........... 1,584 56.4 1,649 56.9 1,408 59.8 1,559 60.0
Installment.......... 1,614 15.0 1,679 13.5 1,577 13.4 1,923 13.4
Impaired loans....... 622 1.0 103 0.7 56 0.1 -- --
Unallocated.......... 244 -- 294 -- 349 -- 379 --
------ ----- ------ ----- ------ ----- ------ -----
TOTAL.............. $6,204 100.0% $5,593 100.0% $5,471 100.0% $5,162 100.0%
====== ===== ====== ===== ====== ===== ====== =====
<Caption>
DECEMBER 31
---------------------
1999
---------------------
% OF EACH
CATEGORY
ALLOWANCE TO TOTAL
AMOUNT LOANS
--------- ---------
Commercial and
agricultural....... $1,502 26.9%
Real estate
mortgage........... 1,232 59.8
Installment.......... 1,555 13.3
Impaired loans....... -- --
Unallocated.......... 333 --
------ -----
TOTAL.............. $4,622 100.0%
====== =====
</Table>
NONINTEREST INCOME
Noninterest income consists of trust fees, service charges on deposit
accounts, fees for other financial services, gain on the sale of mortgage loans,
title insurance revenue, and other. As is the case for many financial
institutions, management believes fee income is increasingly important as a
source of net earnings and expects this trend to continue. There was a $2,642 or
32.6% increase in fees earned from these sources during 2003. Significant
changes during 2003 include a $119 increase from the sale of title insurance and
related services, a $900 increase in overdraft fees, a $1,095 increase in
mortgage servicing income, and a $329 increase in gains on the sale of real
estate mortgages. During 2003, the Corporation had an average investment of $10
million in bank-owned life insurance, a $500 increase over 2002. The average net
rate earned on the investment was approximately 4.8% in 2003 (versus 5.0% in
2002) and, because of their tax free accumulation
54
of earnings, they have a taxable equivalent rate of 7.3%. The rates on these
contracts are adjustable annually on their anniversary date. The investment is
placed with five separate insurance companies with S&P ratings of AA+ or better.
Due to the decrease in interest rates during 2003 income earned declined from
this investment $19 in 2003.
Included in noninterest income is a $2,091 gain from the sale of $195,168
in mortgages during 2003 versus a $1,762 gain on the sale of $192,407 during
2002. The Corporation has established a policy that all 30-year fixed rate
mortgage loans will be sold. During 2003, most 15-year fixed rate mortgage loans
granted were sold on the secondary market. These loans were sold without
recourse, with servicing retained.
Noninterest income increased $1,905 in 2002 when compared to 2001.
Significant changes in 2002 include a $643 increase from the sale of title
insurance and related services, a $161 increase in overdraft fees, a $138
increase in mortgage servicing fees, a $711 increase in gains on the sale of
residential real estate mortgages and a $245 increase in income from bank-owned
life insurance.
NONINTEREST EXPENSES
Noninterest expenses increased $2,806 or 13.5% during 2003. Noninterest
expenses net of noninterest income divided by average total assets equalled
1.95% in 2003, 2.03% in 2002, and 2.21% in 2001. The decrease in the 2003 ratio
was primarily a result of the $329 increase in the gains on the sale of real
estate mortgages, a $900 increase in overdraft fees, and a $1,095 increase in
mortgage servicing income.
The largest component of noninterest expenses is salaries and employee
benefits, which increased $2,038 or 1.8%. Salaries increased $1,155 due to
increases in staffing and normal merit and promotional salary increases.
Employee benefits increased $883 in 2003. A significant portion of the increase
was related to an 11.8% increase in medical insurance expenses, and a 53.6%
increase in pension expense. Footnote G in the Corporation's Notes to
Consolidated Financial Statements include the required disclosures regarding the
benefit obligations, plan assets, and funding status of the Corporation's
Defined Benefit Pension Plan. Over the last three years the plan has experienced
an accumulated loss of $469 on the Plan's investments. The entire loss is
related to the general decline in market value of stock equity investments. Over
the same time period, the actuarial assumption for the long term rate of return
on the assets held by the Plan should have produced a return of $1.27 million.
Essentially, the actual loss combined with the change in actuarial assumptions
related to the benefit obligation has produced a $2.7 million underfunding of
the Plan's assets as of December 31, 2003. This shortfall will significantly
increase the Corporation's pension expense in future periods. The Corporation's
Board of Directors approved a change in investment advisors. During 2003 the
Plan experienced a 9.9% return on beginning Plan assets.
Occupancy and furniture and equipment expenses increased $332 or 9% in
2003. The majority of this increase is related to building depreciation,
property taxes, service contracts and equipment depreciation. All other
operating expenses increased $436. The most significant increases were related
to director fees, consultant fees, and donations. The Corporation contributed
approximately $870 to the Isabella Bank and Trust Community Foundation. (See
Note J to the Consolidated Financial Statements).
Noninterest expense increased $2,077 or 11.1% in 2002. During 2002,
salaries and benefits increased $1,517, occupancy and furniture and equipment
expenses increased $461, all other operating expenses increased $660, and the
amortization of the acquisition intangibles decreased by $561.
FEDERAL INCOME TAXES
Federal income tax expense for 2003 was $2,035 or 22% of pre-tax income
compared to $2,286 or 24.8% of pre-tax income in 2002 and $2,205 or 26.7% in
2001. The decrease in income tax expense as a percentage of income in 2002 is
attributable to an increase in nontaxable municipal income and other tax exempt
income as a percentage of the Corporation's pretax net income. A reconcilement
of federal income tax expense and the amount computed at the federal statutory
rate of 34% is found in Note F, Federal Income Taxes, in the accompanying
consolidated financial statements.
55
ANALYSIS OF CHANGES IN THE STATEMENT OF FINANCIAL CONDITION
Total assets were $664,079 at December 31, 2003, an increase of $11,362 or
1.74% over year end 2002. Asset growth was primarily funded by a $6,251 increase
in deposits, and a $5,479 increase in shareholders' equity. A discussion of
changes in balance sheet amounts by major categories follows.
INVESTMENT SECURITIES
The primary objective of the Corporation's investing activities is to
provide for safety of the principal invested. Secondary considerations include
the need for earnings, liquidity, and the Corporation's overall exposure to
changes in interest rates. During 2003, the Corporation's net holdings of
investment securities increased $11,499. Table 6 shows the carrying value of
investment securities available for sale and held to maturity. Securities held
to maturity, which are stated at amortized cost, consist mostly of local
municipal bond issues, and U.S. Agencies. Securities not classified by
management as held to maturity are classified as available for sale and are
stated at fair value.
TABLE 6. INVESTMENT PORTFOLIO
The following is a schedule of the carrying value of investment securities
available for sale and held to maturity:
<Table>
<Caption>
DECEMBER 31
------------------------------
2003 2002 2001
-------- -------- --------
Available for sale
U.S. Treasury and U.S. government agencies......... $ 89,934 $ 90,974 $ 53,047
States and political subdivisions.................. 76,656 64,607 47,141
Commercial paper................................... 3,242 2,328 2,330
-------- -------- --------
TOTAL......................................... $169,832 $157,909 $102,518
======== ======== ========
Held to maturity
States and political subdivisions.................. $ 9 $ 74 $ 148
U.S. Treasury and U.S. government agencies......... 1,303 1,662 3,306
-------- -------- --------
TOTAL......................................... $ 1,312 $ 1,736 $ 3,454
======== ======== ========
</Table>
Excluding those holdings of the investment portfolio in U.S. Treasury and
U.S. government agency securities, there were no investments in securities of
any one issuer which exceeded 10% of shareholders' equity. The Corporation has a
policy prohibiting investments in securities that it deems are unsuitable due to
their inherent credit or market risks. Prohibited investments include stripped
mortgage backed securities, zero coupon bonds, nongovernment agency asset backed
securities, and structured notes.
56
The following is a schedule of maturities of each category of investment
securities (at carrying value) and their weighted average yield as of December
31, 2003:
TABLE 7. SCHEDULE OF MATURITIES OF INVESTMENT SECURITIES AND
WEIGHTED AVERAGE YIELDS
<Table>
<Caption>
MATURING
------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
BUT WITHIN BUT WITHIN
WITHIN ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS
--------------- --------------- ----------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- ------- ----- -------- ------ ------- ------
Available for sale
U.S. Treasury and U.S. government
agencies............................ $39,493 3.54% $35,799 2.92% $ 510 2.39% $ -- --%
States and political subdivisions..... 8,097 3.67 39,496 3.25 27,532 4.45 1,531 3.48
Mortgage backed....................... 9 5.54 475 3.13 7,486 4.40 6,162 4.51
Corporate & other securities.......... 1,276 4.62 1,966 3.28 -- -- -- --
------- ---- ------- ---- ------- ---- ------ ----
TOTAL............................. $48,875 3.59% $77,736 3.10% $35,528 4.41% $7,693 4.30%
======= ==== ======= ==== ======= ==== ====== ====
Held to maturity
States and political subdivisions..... $ 1,108 4.76% $ 195 5.00% $ -- --% $ -- --%
Mortgage backed....................... 9 5.54 -- -- -- --
------- ---- ------- ---- ------- ---- ------ ----
TOTAL............................. $ 1,117 4.76% $ 195 5.13% $ -- --% $ -- --%
======= ==== ======= ==== ======= ==== ====== ====
</Table>
LOANS
The largest component of earning assets is loans. The proper management of
credit and market risk inherent in loans is critical to the financial well-being
of the Corporation. To control these risks, the Corporation has adopted strict
underwriting standards. The standards include prohibitions against lending
outside the Corporation's defined market area, lending limits to a single
borrower, and strict loan to collateral value limits. The Corporation also
monitors and limits loan concentrations extended to volatile industries. The
Corporation has no foreign loans and there were no concentrations greater than
10% of total loans that are not disclosed as a separate category in Table 8.
TABLE 8. LOAN PORTFOLIO
<Table>
<Caption>
DECEMBER 31
----------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Commercial.............................. $ 71,699 $ 66,326 $ 58,424 $ 60,301 $ 55,247
Agricultural............................ 50,548 53,223 48,523 47,298 40,449
Real estate mortgage.................... 240,145 230,409 237,650 242,042 212,724
Installment............................. 63,782 54,522 53,267 54,038 47,426
-------- -------- -------- -------- --------
TOTAL LOANS........................ $426,174 $404,480 $397,864 $403,679 $355,846
======== ======== ======== ======== ========
</Table>
Total loans increased $21,694 in 2003. The increase was primarily in real
estate mortgages and installment loans. As of December 31, 2003, as a percentage
of total loans, commercial loans were 16.82%, agricultural were 11.86%, real
estate mortgages were 56.35%, and installments were 14.97%.
DEPOSITS
Total deposits increased $6,251 and were $567,707 at year end 2003, a 1.11%
increase over 2002. Average deposits increased 4.2% in 2003 and 9.3% in 2002.
During 2003, average noninterest bearing deposits increased 3.6%, interest
bearing demand deposits increased 15%, savings deposits increased 4%, and time
deposits
57
increased .14%. Time deposits over $100 as a percentage of total deposits
equaled 11.9% and 12.5% as of December 31, 2003 and 2002, respectively.
TABLE 9. AVERAGE DEPOSITS
<Table>
<Caption>
2003 2002 2001
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
Noninterest bearing demand
deposits........................ $ 61,651 $ 59,518 $ 56,904
Interest bearing demand
deposits........................ 113,206 0.93% 98,478 1.43% 81,260 2.41%
Savings deposits.................. 141,227 0.94 135,792 1.62 121,202 2.69
Time deposits..................... 247,516 3.73 247,182 4.44 235,481 5.72
-------- -------- --------
TOTAL........................... $563,600 $540,970 $494,847
======== ======== ========
</Table>
TABLE 10. MATURITIES OF TIME CERTIFICATES OF DEPOSIT OVER $100,000
<Table>
<Caption>
DECEMBER 31
---------------------------
2003 2002 2001
------- ------- -------
Maturity
Within 3 months....................................... $18,068 $21,900 $22,259
Within 3 to 6 months.................................. 11,475 15,928 11,418
Within 6 to 12 months................................. 8,184 18,624 11,496
Over 12 months........................................ 29,945 13,858 14,252
------- ------- -------
TOTAL.............................................. $67,672 $70,310 $59,425
======= ======= =======
</Table>
Within the banking industry there is agreement that competition from mutual
funds and annuities has had a significant impact on deposit growth. In response,
the Corporation's subsidiaries now offer mutual funds and annuities to its
customers. The Corporation's trust department also offers a variety of financial
products in addition to traditional estate services.
CAPITAL
The capital of the Corporation consists solely of common stock, capital
surplus, retained earnings, and accumulated other comprehensive income. Total
capital increased approximately $5,479 in 2003. The Corporation offers a
dividend reinvestment and employee stock purchase plan. Under the provisions of
these Plans, the Corporation issued 70,340 shares of common stock generating
$2,008 of capital during 2003, and 52,473 shares of common stock generating
$1,524 of capital in 2002. The Board of Directors authorized management to
repurchase up to $2.0 million of common stock shares. A total of 3,219 shares
were repurchased in 2003 at an average price of $34.50 per share. Accumulated
other comprehensive income decreased $726 and consists of $863 decrease in
unrealized gain on available for sale investment securities reduced by a gain of
$137 related to the recognition of an additional minimum pension liability.
The Federal Reserve Board's current recommended minimum primary capital to
assets requirement is 6.0%. The Corporation's primary capital to assets, which
consists of shareholders' equity plus the allowance for loan losses less
acquisition intangibles, was 10.8% at year end 2003. There are no commitments
for significant capital expenditures.
The Federal Reserve Board has established a minimum risk based capital
standard. Under this standard, a framework has been established that assigns
risk weights to each category of on and off-balance-sheet items to arrive at
risk adjusted total assets. Regulatory capital is divided by the risk adjusted
assets with the resulting ratio compared to the minimum standard to determine
whether a corporation has adequate capital. The minimum standard is 8%, of which
at least 4% must consist of equity capital net of goodwill. The following
58
table sets forth the percentages required under the Risk Based Capital
guidelines and the Corporation's values at December 31, 2003:
Percentage of Capital to Risk Adjusted Assets:
<Table>
<Caption>
REQUIRED IBT BANCORP
-------- -----------
Equity Capital.............................................. 4.00% 14.68%
Secondary Capital........................................... 4.00 1.25
---- -----
Total Capital............................................. 8.00% 15.93%
==== =====
</Table>
IBT Bancorp's secondary capital includes only the allowance for loan
losses. The percentage for the secondary capital under the required column is
the maximum amount allowed from all sources.
The Federal Reserve also prescribes minimum capital requirements for the
Corporation's subsidiary Banks. At December 31, 2003, the Banks exceeded these
minimums. For further information regarding the Banks' capital requirements,
refer to Note M of the Financial Statements, Regulatory Capital Matters.
LIQUIDITY
Liquidity management is designed to have adequate resources available to
meet depositor and borrower discretionary demands for funds. Liquidity is also
required to fund expanding operations, investment opportunities, and payment of
cash dividends. The primary sources of the Corporation's liquidity are cash and
cash equivalents and available for sale investment securities.
As of December 31, 2003 and 2002, cash and cash equivalents equaled 4.7%
and 8.3%, respectively, of total assets. Net cash provided from operations was
$20,538 in 2003 and $6,122 in 2002. Net cash provided by financing activities
equaled $5,511 in 2003 and $49,491 in 2002. The Corporation's investing
activities used cash amounting to $49,268 in 2003 and $56,638 in 2002. The
accumulated effect of the Corporation's operating, investing, and financing
activities on cash and cash equivalents was a $23,219 decrease in 2003 and a
$1,025 decrease in 2002.
In addition to cash and cash equivalents, investment securities available
for sale are another source of liquidity. Securities available for sale equaled
$169,832 as of December 31, 2003 and $157,909 as of December 31, 2002. In
addition to these primary sources of liquidity, the Corporation has the ability
to borrow in the federal funds market and at both the Federal Reserve Bank and
the Federal Home Loan Bank. The Corporation's liquidity is considered adequate
by the management of the Corporation.
INTEREST RATE SENSITIVITY
Interest rate sensitivity management aims at achieving reasonable stability
in the net interest margin through periods of changing interest rates. Interest
rate sensitivity is determined by the amount of earning assets and interest
bearing liabilities repricing within a specific time period, and their relative
sensitivity to a change in interest rates. One tool used by management to
measure interest rate sensitivity is gap analysis. As shown in Table 11, the gap
analysis depicts the Corporation's position for specific time periods and the
cumulative gap as a percentage of total assets.
Investment securities and other investments are scheduled according to
their contractual maturity. Fixed rate loans are included in the appropriate
time frame based on their scheduled amortization. Variable rate loans are
included in the time frame of their earliest repricing. Of the $426,174 in total
loans, $88,615 are variable rate loans. Time deposit liabilities are scheduled
based on their contractual maturity except for variable rate time deposits in
the amount of $2,145 that are included in the 0 to 3 month time frame. Money
market accounts reprice monthly and are included in the 0 to 3 month time frame.
Passbook savings, statement savings, and NOW accounts have no contractual
maturity date and are believed to be predominantly noninterest rate sensitive by
management. These accounts have been classified in the gap table according to
their estimated withdrawal rates based upon management's analysis of deposit
59
runoff over the past five years. Management believes this runoff experience is
consistent with its expectation for the future. As of December 31, 2003, the
Corporation had $22,703 more in liabilities than assets maturing within one
year. A negative gap position results when more liabilities, within a specified
time frame, mature or reprice than assets.
TABLE 11. INTEREST RATE SENSITIVITY
The following table shows the time periods and the amount of assets and
liabilities available for interest rate repricing as of December 31, 2003. For
purposes of this analysis, nonaccrual loans and the allowance for loan losses
are excluded.
<Table>
<Caption>
0 TO 3 4 TO 12 1 TO 5 OVER
MONTHS MONTHS YEARS 5 YEARS
-------- -------- -------- -------
Interest Sensitive Assets
Fed funds sold............................ $ 5,300 $ -- $ -- $ --
Investment securities..................... 5,851 44,417 78,786 42,090
Loans..................................... 126,181 63,150 207,638 25,084
-------- -------- -------- -------
TOTAL.................................. $137,332 $107,567 $286,424 $67,174
======== ======== ======== =======
Interest Sensitive Liabilities
Borrowed funds............................ $ 1,525 $ 56 $ 6,000 $10,472
Time deposits............................. 43,864 67,811 126,162 841
Savings................................... 83,213 4,799 40,227 15,469
Interest bearing demand................... 58,650 7,684 46,001 5,225
-------- -------- -------- -------
TOTAL.................................. $187,252 $ 80,350 $218,390 $32,007
======== ======== ======== =======
Cumulative gap.............................. $(49,920) $(22,703) $ 45,331 $80,498
Cumulative gap as a % of assets............. (7.52)% (3.42)% 6.83% 12.12%
</Table>
TABLE 12. LOAN MATURITY AND INTEREST RATE SENSITIVITY
The following table shows the maturity of commercial and agricultural loans
outstanding at December 31, 2003. Also provided are the amounts due after one
year, classified according to the sensitivity to changes in interest rates.
<Table>
<Caption>
DUE IN
--------------------------------------
1 YEAR 1 TO 5 OVER 5
OR LESS YEARS YEARS TOTAL
------- ------- ------- --------
Commercial and agricultural.................... $62,889 $57,859 $1,499 $122,247
======= ======= ====== ========
Interest Sensitivity:
Loans maturing after one year that have:
Fixed interest rates...................... $42,506 $1,284
Variable interest rates................... 15,353 215
------- ------
TOTAL................................... $57,859 $1,499
======= ======
</Table>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Corporation's primary market risks are interest rate risk and, to a
lesser extent, liquidity risk. The Corporation has no foreign exchange risk,
holds limited loans outstanding to oil and gas concerns, holds no trading
account assets, nor does it utilize interest rate swaps or derivatives in the
management of its interest rate risk. Any changes in foreign exchange rates or
commodity prices would have an insignificant impact, if
60
any, on the Corporation's interest income and cash flows. The Corporation does
have a significant amount of loans extended to borrowers in agricultural
production. Their cash flow and their ability to service their debt is largely
dependent on the commodity prices for corn, soybeans, sugar beets, milk, beef,
and a variety of dry beans. The Corporation mitigates these risks by using
conservative price and production yields when calculating a borrower's available
cash flow to service their debt.
Interest rate risk ("IRR") is the exposure of the Corporation's net
interest income, its primary source of income, to changes in interest rates. IRR
results from the difference in the maturity or repricing frequency of a
financial institution's interest earning assets and its interest bearing
liabilities. IRR is the fundamental method in which financial institutions earn
income and create shareholder value. Excessive exposure to IRR could pose a
significant risk to the Corporation's earnings and capital.
The Federal Reserve, the Corporation's primary Federal regulator, has
adopted a policy requiring the Board of Directors and senior management to
effectively manage the various risks that can have a material impact on the
safety and soundness of the Corporation. The risks include credit, interest
rate, liquidity, operational, and reputational. The Corporation has policies,
procedures and internal controls for measuring and managing these risks.
Specifically, the IRR policy and procedures include defining acceptable types
and terms of investments and funding sources, liquidity requirements, limits on
investments in long term assets, limiting the mismatch in repricing opportunity
of assets and liabilities, and the frequency of measuring and reporting to the
Board of Directors.
The Corporation uses several techniques to manage IRR. The first method is
gap analysis. Gap analysis measures the cash flows and/or the earliest repricing
of the Corporation's interest bearing assets and liabilities. This analysis is
useful for measuring trends in the repricing characteristics of the balance
sheet. Significant assumptions are required in this process because of the
imbedded repricing options contained in assets and liabilities. A substantial
portion of the Corporation's assets are invested in loans and mortgage backed
securities. These assets have imbedded options that allow the borrower to repay
the balance prior to maturity without penalty. The amount of prepayments is
dependent upon many factors, including the interest rate of a given loan in
comparison to the current interest rate for residential mortgages, the level of
sales of used homes, and the overall availability of credit in the market place.
Generally, a decrease in interest rates will result in an increase in the
Corporation's cash flows from these assets. Investment securities, other than
those that are callable, do not have any significant imbedded options. Savings
and checking deposits may generally be withdrawn on request without prior
notice. The timing of cash flow from these deposits is estimated based on
historical experience. Time deposits have penalties that discourage early
withdrawals.
The second technique used in the management of IRR is to combine the
projected cash flows and repricing characteristics generated by the gap analysis
and the interest rates associated with those cash flows to project future
interest income. By changing the amount and timing of the cash flows and the
repricing interest rates of those cash flows, the Corporation can project the
effect of changing interest rates on its interest income. Based on the
projections prepared for the year ended December 31, 2003 the Corporation's net
interest income would decrease during a period of decreasing interest rates.
The following tables provide information about the Corporation's assets and
liabilities that are sensitive to changes in interest rates as of December 31,
2003 and 2002. The Corporation has no interest rate swaps, futures contracts, or
other derivative financial options. The principal amounts of assets and time
deposits maturing were calculated based on the contractual maturity dates.
Savings and NOW accounts are based on management's estimate of their future cash
flows.
61
QUANTITATIVE DISCLOSURES OF MARKET RISK
<Table>
<Caption>
FAIR VALUE
2004 2005 2006 2007 2008 THEREAFTER TOTAL 12/31/03
-------- ------- ------- ------- ------- ---------- -------- ----------
Rate sensitive assets
Other interest bearing assets.... $ 5,400 $ 99 -- -- -- -- $ 5,499 $ 5,499
Average interest rates......... 1.03% 2.67% -- -- -- -- 1.06%
Fixed interest rate securities... $ 50,268 $33,303 $24,377 $14,790 $ 6,316 $42,090 $171,144 $171,181
Average interest rates......... 3.61% 2.87% 3.09% 3.18% 3.69% 4.42% 3.56%
Fixed interest rate loans........ $ 99,216 $71,181 $69,309 $24,607 $43,471 $29,775 $337,559 $340,558
Average interest rates......... 6.74% 7.11% 6.17% 6.57% 6.10% 4.97% 6.45%
Variable interest rate loans..... $ 62,619 $ 6,722 $ 6,227 $ 4,802 $ 6,724 $ 1,521 $ 88,615 $ 88,615
Average interest rates......... 5.54% 5.62% 5.52% 5.49% 5.06% 4.55% 5.49%
Rate sensitive liabilities
Borrowed funds................... $ 1,552 $ 1,053 $ 53 $ 53 $ 5,053 $10,289 $ 18,053 $ 19,118
Average interest rates......... 0.86% 5.01% 4.16% 4.16% 5.08% 4.35% 4.29%
Savings and NOW accounts......... $154,489 $22,778 $18,518 $15,160 $14,018 $36,305 $261,268 $261,268
Average interest rates......... 0.76% 0.76% 0.78% 0.69% 0.48% 0.43% 0.70%
Fixed interest rate time
deposits....................... $110,188 $52,683 $33,216 $27,802 $11,803 $ 841 $236,533 $243,094
Average interest rates......... 2.33% 4.73% 4.48% 4.20% 3.47% 7.95% 3.46%
Variable interest rate time
deposits....................... $ 1,048 $ 448 $ -- $ 182 $ 467 $ -- $ 2,145 $ 2,145
Average interest rates......... 1.24% 1.24% -- -- 3.52% -- 1.63%
</Table>
<Table>
<Caption>
FAIR VALUE
2003 2004 2005 2006 2007 THEREAFTER TOTAL 12/31/02
-------- ------- ------- ------- ------- ---------- -------- ----------
Rate sensitive assets
Other interest bearing assets.... $ 25,950 -- -- -- -- -- $ 25,950 $ 25,950
Average interest rates......... 1.25% -- -- -- -- -- 1.25%
Fixed interest rate securities... $ 30,393 $50,671 $23,853 $12,169 $ 6,514 $36,045 $159,645 $159,712
Average interest rates......... 4.00% 3.77% 3.32% 4.06% 4.17% 4.76% 4.01%
Fixed interest rate loans........ $ 98,028 $86,180 $83,675 $27,107 $21,906 $20,160 $337,056 $338,585
Average interest rates......... 7.80% 7.69% 7.40% 7.57% 7.07% 5.89% 7.49%
Variable interest rate loans..... $ 45,756 $ 9,646 $ 4,541 $ 3,297 $ 3,689 $ 495 $ 67,424 $ 67,424
Average interest rates......... 6.13% 6.11% 5.95% 5.95% 5.52% 5.30% 6.07%
Rate sensitive liabilities
Borrowed funds................... $ 3,263 $ 1,094 $ 94 $ 5,094 $ 93 $ 8,155 $ 17,793 $ 18,507
Average interest rates......... 0.88% 5.07% 5.23% 5.08% 5.20% 5.30% 4.41%
Savings and NOW accounts......... $150,280 $20,646 $16,779 $13,749 $12,706 $32,928 $247,088 $247,088
Average interest rates......... 1.42% 1.25% 1.49% 1.57% 1.15% 0.91% 1.34%
Fixed interest rate time
deposits....................... $131,911 $32,404 $37,843 $26,984 $20,473 $ 59 $249,674 $255,167
Average interest rates......... 3.08% 4.85% 5.79% 4.89% 4.61% 7.20% 4.04%
Variable interest rate time
deposits....................... $ 816 $ 449 $ 9 -- $ 314 -- $ 1,588 $ 1,588
Average interest rates......... 2.03% 2.03% -- -- 3.82% -- 2.37%
</Table>
FORWARD LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Corporation intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain
62
assumptions and describe future plans, strategies and expectations of the
Corporation, are generally identifiable by use of the words "believe," "expect,"
"intend," "anticipate," "estimate," "project," or similar expressions. The
Corporation's ability to predict results or the actual effect of future plans or
strategies is inherently uncertain. Factors which could have a material adverse
effect on the operations and future prospects of the Corporation and the
subsidiaries include, but are not limited to, changes in interest rates, general
economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government including policies of the U.S. Treasury and the
Federal Reserve Board, the quality or composition of the loan or investment
portfolios, demand for loan products, deposit flows, competition, demand for
financial services in the Corporation's market area, and accounting principles,
policies and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements and undue reliance should not be placed on
such statements. Further information concerning the Corporation and its
business, including additional factors that could materially affect the
Corporation's financial results, is included in the Corporation's filings with
the Securities and Exchange Commission.
COMMON STOCK AND DIVIDEND INFORMATION
There is no established market for the Corporation's common stock or public
information with respect to its market price. There are occasional sales by
shareholders of which management of the Corporation is aware. From January 1,
2002 through December 31, 2003 there were, so far as management knows, 195 sales
of the Corporation's common stock. These sales involved 88,254 shares. The
prices were reported to management in only some of the transactions and
management cannot confirm the prices which were reported during this period. The
highest known price paid for the Corporation's stock was $36.36 per share in the
fourth quarter of 2003, and the lowest price was $29.09 per share in the first
quarter of 2002. The following is a summary of all known transfers since January
1, 2002. All of the information has been adjusted to reflect the 10% stock
dividend paid February 19, 2004.
<Table>
<Caption>
NUMBER NUMBER
PERIOD OF SALES OF SHARES LOW HIGH
- ------ -------- --------- ------ ------
2002
First Quarter..................................... 27 6,624 $29.09 $30.91
Second Quarter.................................... 31 32,134 30.00 30.00
Third Quarter..................................... 31 12,692 30.00 30.00
Fourth Quarter.................................... 24 6,897 30.00 30.00
2003
First Quarter..................................... 28 12,448 31.82 34.55
Second Quarter.................................... 17 12,227 36.36 36.36
Third Quarter..................................... 21 11,198 36.36 36.36
Fourth Quarter.................................... 16 2,860 36.36 36.36
</Table>
The following table sets forth the cash dividends paid for the following
quarters, adjusted for the 10% stock dividend paid on February 19, 2004.
<Table>
<Caption>
2003 2002
----- -----
First Quarter............................................... $0.10 $0.09
Second Quarter.............................................. 0.10 0.09
Third Quarter............................................... 0.10 0.09
Fourth Quarter.............................................. 0.30 0.28
----- -----
TOTAL..................................................... $0.60 $0.55
===== =====
</Table>
IBT Bancorp's authorized common stock consists of 10,000,000 shares, of
which 4,403,404 shares are issued and outstanding as of December 31, 2003. As of
year end 2003, there were approximately 1,840 shareholders of record.
63
SUPERVISION AND REGULATION
IBT Bancorp is subject to supervision and regulation by the Federal Reserve
Board, under the Bank Holding Company Act of 1956, as amended. A bank holding
company and its subsidiaries are able to conduct only the business of commercial
banking and activities closely related or incidental to it.
Isabella Bank and Trust and Farmers State Bank of Breckenridge are
chartered by the State of Michigan and are supervised and regulated by the
Michigan Office of Financial and Insurance Services, Division of Financial
Institutions. The Banks are members of the Federal Reserve System and their
deposits are insured by the Federal Deposit Insurance Corporation to the extent
provided by law. IBT Title is licensed and supervised by the State of Michigan.
IMPACT OF INFLATION
The majority of assets and liabilities of financial institutions are
monetary in nature. Generally, changes in interest rates have a more significant
impact on earnings of the Corporation than inflation. Although influenced by
inflation, changes in rates do not necessarily move in either the same magnitude
or direction as changes in the price of goods and services. Inflation does
impact the growth of total assets, creating a need to increase equity capital at
a higher rate to maintain an adequate equity to assets ratio, which in turn
reduces the amount of earnings available for cash dividends.
64
SHAREHOLDERS' INFORMATION
ANNUAL MEETING
The Annual Meeting of Shareholders will be held at 7:00 p.m., Tuesday,
April 27, 2004, Holiday Inn, 5665 E. Pickard Street, Mt. Pleasant, Michigan.
FINANCIAL INFORMATION AND FORM 10-K
Copies of the 2003 Annual Report, IBT Bancorp Form 10-K, and other
financial information not contained herein may be obtained, without charge, by
writing to:
Mary Ann Breuer
Secretary/Treasurer
IBT Bancorp
200 East Broadway
Mt. Pleasant, Michigan 48858
MISSION STATEMENT
The mission of IBT Bancorp shall be:
To create an operating environment that will provide shareholders with
sustained growth in their investment while maintaining our independence and
subsidiaries' autonomy.
EQUAL EMPLOYMENT OPPORTUNITY
The equal employment opportunity clauses in Section 202 of the Executive
Order 11246, as amended; 38 USC 2012, Vietnam Era Veterans Readjustment Act of
1974; Section 503 of the Rehabilitation Act of 1973, as amended; relative to
equal employment opportunity and implementing rules and regulations of the
Secretary of Labor are adhered to and supported by IBT Bancorp, and its
subsidiaries.
65
IBT BANCORP PROXY
200 EAST BROADWAY
MT. PLEASANT, MI 48858
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby appoints Gerald D. Cassel, Ronald E. Schumacher, and
William T. Strickler as Proxies, each with the power to appoint his substitute,
and hereby authorizes them to represent and to vote as designated below, all the
shares of Common Stock of IBT Bancorp held of record by the undersigned on March
1, 2004 at the annual meeting of shareholders to be held April 27, 2004 or any
adjournments thereof.
ELECTION OF DIRECTORS:
FOR ALL NOMINEES LISTED BELOW | | WITHHOLD AUTHORITY TO VOTE | |
EXCEPT AS MARKED TO THE FOR ALL NOMINEES LISTED
CONTRARY BELOW
(INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, CIRCLE
THE NOMINEE'S NAME IN THE LIST BELOW.)
JAMES C. FABIANO DAVID W. HOLE DALE WEBURG
(CONTINUED AND TO BE SIGNED ON OTHER SIDE)
This proxy, when properly executed, will be voted in the manner directed herein
by the undersigned shareholder. IF NO DIRECTION IS MADE, THIS PROXY WILL BE
VOTED TO ELECT ALL NOMINEES. The shares represented by this proxy will be voted
in the discretion of the proxies on any other matters which may come before the
meeting.
Please sign exactly as name appears below. When shares are held by joint
tenants, both should sign. When signing as attorney, executor, administrator,
trustee or guardian, please give full title as such. If a corporation, please
sign full corporate name by the President or other authorized officer. If a
partnership, please sign in partnership name by authorized person.
Dated:__________________________, 2004 ______________________________
Please mark, sign, date and return Signature
Proxy card promptly using the
enclosed envelope. ______________________________
Signature (if held jointly)