1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 1998 Commission file number 2-78178
------------------ -------
Southern Michigan Bancorp, Inc.
-------------------------------
(Exact name of registrant as specified in its charter)
Michigan 38-2407501
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
51 West Pearl Street, Coldwater, Michigan 49036
- ----------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code -- (517) 279-5500
--------------
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No.
-
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $2.50 Par Value - 1,872,677 shares at October 31, 1998 (including
shares held by ESOP)
2
CONDENSED CONSOLIDATED BALANCE SHEETS
SOUTHERN MICHIGAN BANCORP, INC AND SUBSIDIARY
September 30 December 31
1998 1997
---------------------------------------
(Unaudited) (A)
(In thousands)
ASSETS
Cash and due from banks $17,192 $16,848
Federal funds sold 4,500 4,500
Investment securities available-for-sale 29,403 12,853
Investment securities held to maturity (market value of $29,405 in 1998
and $32,572 in 1997) 28,877 32,221
Loans 161,262 158,741
Less allowance for loan losses (1,985) (1,863)
---------------------------------------
159,277 156,878
Premises and equipment 6,969 5,588
Other assets 11,019 9,643
---------------------------------------
TOTAL ASSETS $257,237 $238,531
=======================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $31,963 $30,923
Interest bearing 192,068 176,142
---------------------------------------
224,031 207,065
Accounts payable and other liabilities 2,654 2,977
Other long-term borrowings 5,000 3,000
---------------------------------------
TOTAL LIABILITIES 231,685 213,042
Common stock subject to repurchase obligation in ESOP 6,481 4,899
Shareholders' equity:
Preferred stock, 100,000 shares authorized
Common stock, $2.50 par value:
Authorized--4,000,000 shares
Outstanding--1,721,950 shares (1997-1,772,839) 4,305 4,432
Capital surplus (deficit) (1,589) 1,914
Retained earnings 16,079 14,218
Net unrealized appreciation on available-for-sale securities
net of tax of $144 (1997--$13) 276 26
---------------------------------------
TOTAL SHAREHOLDERS' EQUITY 19,071 20,590
---------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $257,237 $238,531
=======================================
(A) The balance sheet at December 31, 1997 has been derived from the audited
consolidated financial statements at that date.
See notes to condensed consolidated financial statements.
-2-
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE
INCOME (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
-----------------------------------------------------------------------
(In thousands, except per share amounts)
Interest income:
Loans, including fees $4,070 $4,085 $12,090 $11,753
Investment securities:
Taxable 606 510 1,680 1,719
Tax exempt 297 213 794 636
Other 95 8 214 32
-----------------------------------------------------------------------
Total interest income 5,068 4,816 14,778 14,140
Interest expense:
Deposits 1,993 1,865 5,675 5,450
Other 128 43 291 135
-----------------------------------------------------------------------
Total interest expense 2,121 1,908 5,966 5,585
-----------------------------------------------------------------------
NET INTEREST INCOME 2,947 2,908 8,812 8,555
Provision for loan losses 150 145 450 295
-----------------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,797 2,763 8,362 8,260
Non-interest income:
Service charges on deposit accounts 252 215 712 627
Trust department 132 125 377 416
Security gains 0 5
Secondary market gains 168 34 571 165
Other 185 162 477 462
-----------------------------------------------------------------------
737 536 2,137 1,675
-----------------------------------------------------------------------
3,534 3,299 10,499 9,935
Non-interest expenses:
Salaries and benefits 996 1,067 3,262 3,182
Occupancy 186 186 540 531
Equipment 204 188 579 557
Other 826 772 2,442 2,402
-----------------------------------------------------------------------
2,212 2,213 6,823 6,672
-----------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 1,322 1,086 3,676 3,263
Federal income taxes 341 277 947 817
-----------------------------------------------------------------------
NET INCOME 981 809 2,729 2,446
Other comprehensive income, net of tax:
Change in unrealized gains on securities 258 32 250 (5)
-----------------------------------------------------------------------
COMPREHENSIVE INCOME $1,239 $841 $2,979 $2,441
=======================================================================
Basic and Diluted Earnings Per Share $0.52 $0.42 $1.43 $1.28
=======================================================================
Dividends Declared Per Share $0.16 $0.13 $0.46 $0.38
=======================================================================
See notes to condensed consolidated financial statements.
-3-
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Nine Months Ended
September 30
1998 1997
---------------------------------------
(In thousands)
OPERATING ACTIVITIES
Net income $2,729 $2,446
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 450 295
Provision for depreciation 361 380
Increase in other assets (1,507) (500)
Decrease in accounts payable and other liabilities (239) (200)
---------------------------------------
Net cash provided by operating activities 1,794 2,421
INVESTING ACTIVITIES
Proceeds from maturity of investment securities 11,784 12,737
Purchases of investment securities (24,609) (3,326)
Net increase in loans (2,849) (9,159)
Net increase in premises and equipment (1,742) (614)
---------------------------------------
Net cash used in investing activities (17,416) (362)
FINANCING ACTIVITIES
Net increase (decrease) in deposits 16,966 (6,535)
Increase in federal funds purchased 1,500
Increase in other borrowings 2,000
Common stock issued 251 290
Common stock repurchased and retired (2,299)
Cash dividends (952) (801)
---------------------------------------
Net cash provided by financing activities 15,966 (5,546)
---------------------------------------
Increase in cash and cash equivalents 344 (3,487)
Cash and cash equivalents at beginning of period 16,848 13,520
---------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $17,192 $10,033
=======================================
See notes to condensed consolidated financial statements.
-4-
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
September 30, 1998
NOTE A -- BASIS OF PRESENTATION
The accompanying year-end balance sheet data was derived from audited
consolidated financial statements, but does not include all disclosures required
by generally accepted accounting principles.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-K for the year ended December 31, 1997.
-5-
6
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FINANCIAL CONDITION
Total deposits have increased by 8.2% during the first nine months of 1998. A
complete overhaul of the Bank's personal checking accounts at the beginning of
1998 allowed the Bank to increase the number of deposit accounts. The Bank
experienced an increase not only in demand deposit accounts, but in other
deposit accounts as well as customers opened secondary accounts to supplement
their new checking accounts. Also contributing to the increase in deposits is
the recent turmoil in the stock market. An unknown amount of deposits may leave
the Bank's savings and money market accounts when customers regain confidence in
the stock market.
Loans have increased by 1.6% in the first nine months of 1998. The loan growth
has occurred in the commercial portfolio while the real estate mortgage
portfolio has declined. The commercial growth is due to an increase in
borrowers' seasonal demands and a healthy economy. The real estate mortgage
decline is due to many existing customers rewriting their adjustable rate loans
into fixed rate loans which are then sold to the secondary market. There were no
loans held for sale as of September 30, 1998.
Investment securities increased by 29.3% during the first nine months of 1998.
Funds received from increased Federal Home Loan Bank borrowings and funds
transferred from federal funds sold were invested in the securities portfolio.
The Bank opened a new branch office in Hillsdale, Michigan in October 1998 at an
approximate cost of $1,700,000. There were no significant fixed asset
commitments as of September 30, 1998.
CAPITAL RESOURCES
The Federal Reserve Board (FRB) has adopted risk-based capital guidelines
applicable to the Company. These guidelines require that bank holding companies
maintain capital commensurate with both on and off balance sheet credit risks of
their operations. Under the guidelines, a bank holding company must have a
minimum ratio of total capital to risk-weighted assets of 8.0 percent. In
addition, a bank holding company must maintain a minimum ratio of Tier 1 capital
equal to 4.0 percent of risk-weighted assets. Tier 1 capital includes common
shareholders' equity, qualifying perpetual preferred stock and minority interest
in equity accounts of consolidated subsidiaries less goodwill.
-6-
7
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Continued
As a supplement to the risk-based capital requirements, the FRB has also adopted
leverage capital ratio requirements. The leverage ratio requirements establish a
minimum ratio of Tier 1 capital to total assets less goodwill of 3 percent for
the most highly rated bank holding companies. All other bank holding companies
are required to maintain additional Tier 1 capital yielding a leverage ratio of
4 percent to 5 percent, depending on the particular circumstances and risk
profile of the institution.
The following table summarizes the Company's capital ratios as of September 30,
1998:
Tier 1 risk-based capital ratio 12.71%
Total risk-based capital ratio 13.76%
Leverage ratio 9.39%
The above table indicates that the Company's capital ratios are above the
regulatory minimum requirements.
During the nine month period ended September 30, 1998, the Company has
repurchased and retired 51,000 shares of outstanding common stock.
RESULTS OF OPERATIONS
Net Interest Income
- -------------------
Net interest income increased by $39,000 and $257,000 for the three and nine
month periods ended September 30, 1998 compared to the same periods in 1997.
This increase is due to the reinvestment of funds held in overnight federal
funds accounts into higher yielding loans and securities.
Provision for Loan Losses
- -------------------------
The provision for loan losses is based on an analysis of outstanding loans. In
assessing the adequacy of the allowance, management reviews the characteristics
of the loan portfolio in order to determine the overall quality and risk
profile. Some factors considered by management in determining the level at which
the allowance is maintained include a continuing evaluation of those loans
identified as being subject to possible problems in collection, results of
examinations by regulatory agencies, current economic conditions and historical
loan loss experience.
-7-
8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Continued
The provision for loan losses increased by $5,000 and $155,000 for the three and
nine month periods ended September 30,1998 compared to the same periods in 1997.
This increase occurred to provide for loan growth and increased charge-offs and
delinquencies, primarily as a result of increased customer bankruptcies. The
allowance for loan losses is being maintained at a level, which in management's
opinion, is adequate to absorb possible loan losses in the loan portfolio as of
September 30, 1998.
Non-interest Income
- -------------------
Non-interest income, which includes service charges on deposit accounts, trust
fee income, security gains and losses and other miscellaneous charges and fees,
increased by $201,000 and $462,000 for the three and nine month periods ended
September 30, 1998 compared to the same periods in 1997. This increase is due
primarily to gains recognized on the sale of real estate mortgage loans. In
order to reduce the risk associated with changing interest rates, the Bank
regularly sells fixed rate real estate mortgage loans on the secondary market.
The Bank recognizes a profit at the time of sale and receives a fee in order to
service the loans. During this period of relatively low interest rates, the Bank
has generated large volumes of fixed rate mortgage loans.
Non-interest Expense
- --------------------
Non-interest expenses decreased by $1,000 the three month period ended September
30, 1998 compared to the same period in 1997 as the result of fewer employees
during the third quarter of 1998 compared to the third quarter of 1997. It is
anticipated that most of the open positions will be filled in the fourth quarter
of 1998 and that the number of employees at the end of 1998 will be comparable
to 1997.
Non-interest expenses increased by $151,000 during the nine month period ended
September 30, 1998 compared to the same period in 1997. The primary expense
categories that increased in 1998 were salaries and benefits, advertising
expenditures and mortgage servicing amortization. Salaries and benefits
increased due to a higher average number of employees for year to date 1998
compared to 1997 and normal cost of living adjustments. Advertising expenditures
increased as the Bank revamped its checking account products. Mortgage servicing
amortization increased as the number of real estate mortgage loans sold to the
secondary market increased.
-8-
9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Continued
Year 2000
- ---------
The Company has developed a plan to assess Year 2000 issues. As part of the
plan, the Company has identified all critical business processes and established
a priority schedule for assessment of each process. The Company is in the
process of testing hardware and software for Year 2000 compliance and expects to
complete the testing of critical business systems by December 31, 1998.
The Company has initiated formal communications with all of its critical vendors
and service providers to determine the extent to which the Company is vunerable
to any failure of those third parties to remedy their own Year 2000 issues.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be remedied in a timely manner or that there
will be no adverse effect on the Company's systems. Critical companies include
power companies and phone systems. Therefore, the Company could possibly be
negatively impacted to the extent that other entities not affiliated with the
Company are unsuccessful in properly addressing this issue. The Company expects
to have vendor and service provider reports on their Year 2000 issues by March
1999.
Once the testing of critical business systems and vendor communications phases
are complete, the Company will implement contingency plans as necessary. The
contingency plans are expected to be implemented and tested by September 1999.
The Company will incur remediation and testing costs relating to Year 2000
issues through the Year 2000, but does not anticipate that material incremental
costs will be incurred in any single period. The costs of the project and the
date on which the Company plans to complete Year 2000 modifications are based
upon management's best estimates. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk and to a lesser
extent liquidity risk. Interest rate risk arises when the maturity or repricing
characteristics of assets differ significantly from the maturity or the
repricing characteristics of liabilities. Accepting this risk can be an
important source of profitability and shareholder value, however, excessive
levels of interest rate risk could pose a significant threat to the Company's
earnings and capital base. Accordingly, effective risk management that maintains
interest rate risk at prudent levels is essential to the Company's safety and
soundness.
-9-
10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK--Continued
The Company measures the impact of changes in interest rates on net interest
income through a comprehensive analysis of the Bank's interest rate sensitive
assets and liabilities. Interest rate sensitivity varies with different types of
interest-earning assets and interest-bearing liabilities. Overnight federal
funds and mutual funds on which rates change daily and loans which are tied to
the prime rate or a comparable index differ considerably from long-term
investment securities and fixed-rate loans. Similarly, certificates of deposit
and money market investment accounts are much more interest sensitive than
passbook savings accounts. The shorter term interest rate sensitivities are key
to measuring the interest sensitivity gap, or excess interest-earning assets
over interest-bearing liabilities. In addition to reviewing the interest
sensitivity gap, the Company also analyzes projected changes in market interest
rates and the resulting effect on net interest income.
Liquidity management involves the ability to meet the cash flow requirements of
customers who may be either depositors wanting withdraw funds or borrowers
needing assurance that sufficient funds will be available to meet their credit
needs. Certain portions of the Bank's liabilities may be short-term or due on
demand, while most of its assets may be invested in long-term loans or
investments. Accordingly, the Company seeks to have in place sources of cash to
meet short-term demands. These funds can be obtained by increasing deposits,
borrowing or selling assets. Also, Federal Home Loan Bank advances and
short-term borrowings provide additional sources of liquidity for the Company.
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates as of September 30,
1998. The Company had no derivative financial instruments, or trading portfolio,
as of that date. The expected maturity date values for loans receivable were
calculated without adjusting the instrument's contractual maturity date for
expectations of prepayments. Investment securities are reported at the earlier
of maturity date or anticipated call date. Expected maturity date values for
interest-bearing core deposits were not based upon estimates of the period over
which the deposits would be outstanding, but rather the opportunity for
repricing. Similarly, with respect to its variable rate instruments, the Company
believes that repricing dates, as opposed to expected maturity dates, may be
more relevant in analyzing the value of such instruments and are reported as
such in the following table. Company borrowings are also reported based on
conversion or repricing dates.
-10-
11
Fair
Principal Amount Maturing in: Value
------------------------------------------------------------------------------
09/30/99 09/30/00 09/30/01 09/30/02 09/30/03 Thereafter Total 09/30/98
---------------------------------------------------------------------------------------
Rate sensitive assets:
Fixed interest rate loans $10,473 $6,594 $7,754 $11,570 $10,689 $11,627 $58,707 $63,044
Average interest rate 9.85% 10.67% 10.12% 9.96% 9.80% 9.93% 10.05%
Variable interest rate loans 78,848 8,799 5,441 1,677 5,281 2,509 102,555 102,555
Average interest rate 8.94% 9.01% 9.04% 9.36% 9.11% 8.95% 9.05%
Fixed interest rate securities 21,038 10,433 6,076 5,675 5,939 9,119 58,280 58,808
Average interest rate 5.99% 6.08% 6.15% 6.12% 6.11% 8.38% 6.61%
Other interest bearing assets 4,500 4,500 4,500
Average interest rate 5.46% 5.46%
Rate sensitive liabilities:
Interest bearing demand deposits $79,363 $79,363 $79,363
Average interest rate 2.90% 2.90%
Savings deposits 36,268 3,271 1,345 584 0 3,680 45,148 45,148
Average interest rate 2.30% 5.29% 5.31% 5.30% 5.31% 3.29%
Time deposits 48,683 11,099 6,034 1,741 0 0 67,557 67,920
Average interest rate 5.39% 5.59% 5.77% 5.84% 5.50%
Fixed interest rate borrowings 5,000 5,000 5,000
Average interest rate 5.47% 5.47%
-11-
12
PART II - OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 6. Exhibits and Reports on Form 8-K
a. Listing of Exhibits: Financial Data Schedule
b. There were no reports on Form 8-K filed in the third quarter of 1998.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southern Michigan Bancorp, Inc.
-------------------------------
(Registrant)
NOVEMBER 12, 1998 /S/ JERRY L. TOWNS
- ----------------- ------------------
Date Jerry L. Towns, President and
Chief Executive Officer
NOVEMBER 12, 1998 /S/ JAMES T. GROHALSKI
- ----------------- -----------------------
Date James T. Grohalski, Executive
Vice-President (Principal
Financial and Accounting
Officer)
-12-
13
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ------- --- -----------
EX. 27 Financial Data Schedule