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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 March 31, 1999 Commission file number 2-78178
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Southern Michigan Bancorp, Inc.
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(Exact name of registrant as specified in its charter)
Michigan 38-2407501
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
51 West Pearl Street, Coldwater, Michigan 49036
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code -- (517) 279-5500
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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.
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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 - 1,857,130 shares at April 30, 1999 (including
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shares held by ESOP)
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CONDENSED CONSOLIDATED BALANCE SHEETS
SOUTHERN MICHIGAN BANCORP, INC AND SUBSIDIARY
March 31 December 31
1999 1998
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(Unaudited) (A)
(In thousands)
ASSETS
Cash and due from banks $ 13,849 $ 16,228
Federal funds sold 3,000 4,000
Investment securities available-for-sale 40,952 36,138
Investment securities held to maturity (market value of $23,896 in 1999
and $32,693 in 1998) 23,213 31,756
Loans, net 164,094 161,277
Premises and equipment 6,962 7,036
Other assets 11,151 10,416
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TOTAL ASSETS $263,221 $266,851
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LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 32,364 $ 34,751
Interest bearing 197,267 198,610
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229,631 233,361
Accounts payable and other liabilities 2,918 2,528
Other long-term borrowings 5,000 5,000
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TOTAL LIABILITIES 237,549 240,889
Common stock subject to repurchase obligation in ESOP 3,339 6,029
Shareholders' equity:
Preferred stock, 100,000 shares authorized
Common stock, $2.50 par value:
Authorized--4,000,000 shares
Issued--1,857,130 shares (1998 - 1,872,677)
Outstanding--1,752,797 shares (1998-1,721,950) 4,382 4,305
Capital surplus 5,931 3,863
Retained earnings 11,953 11,505
Net unrealized appreciation on available-for-sale securities
net of tax of $34 (1998--$134) 67 260
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TOTAL SHAREHOLDERS' EQUITY 22,333 19,933
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $263,221 $266,851
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(A) The balance sheet at December 31, 1998 has been derived from the audited
consolidated financial statements at that date.
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE
INCOME (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Three Months Ended
March 31
1999 1998
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(In thousands, except
per share amounts)
Interest income:
Loans, including fees $ 3,765 $ 3,841
Investment securities:
Taxable 633 537
Tax exempt 336 243
Other 25 36
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Total interest income 4,759 4,657
Interest expense:
Deposits 1,919 1,820
Other 118 85
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Total interest expense 2,037 1,905
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NET INTEREST INCOME 2,722 2,752
Provision for loan losses 150 150
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NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,572 2,602
Non-interest income:
Service charges on deposit accounts 245 214
Trust department 115 119
Security gains 0 0
Gain on sales of loans 142 222
Earnings on life insurance policies 39 38
Other 123 69
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664 662
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3,236 3,264
Non-interest expenses:
Salaries and benefits 1,086 1,136
Occupancy 213 181
Equipment 226 187
Other 719 735
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2,244 2,239
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INCOME BEFORE INCOME TAXES 992 1,025
Federal income taxes 211 268
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NET INCOME 781 757
Other comprehensive income, net of tax:
Change in unrealized gains on securities (193) (16)
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COMPREHENSIVE INCOME $ 588 $ 741
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Basic and Diluted Earnings Per Share $ 0.42 $ 0.39
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Dividends Declared Per Share $ 0.18 $ 0.15
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See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
Three Months Ended
March 31
1999 1998
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(In thousands)
OPERATING ACTIVITIES
Net income $ 781 $ 757
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 150 150
Provision for depreciation 149 115
Net change in:
Other assets (635) (261)
Accrued expenses and other liabilities 450 (180)
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Net cash provided by operating activities 895 581
INVESTING ACTIVITIES
Proceeds from maturity of investment securities 10,949 2,342
Purchases of investment securities (7,513) (7,246)
Decrease in federal funds sold 1,000 3,500
Net increase in loans (2,967) (1,871)
Net increase in premises and equipment (75) (401)
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Net cash provided by (used in) investing activities 1,394 (3,676)
FINANCING ACTIVITIES
Net increase (decrease) in deposits (3,730) 677
Increase in other borrowings 0 2,000
Common stock issued 0 147
Common stock repurchased and retired (545) 0
Cash dividends (393) (383)
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Net cash provided by (used in) financing activities (4,668) 2,441
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Decrease in cash and cash equivalents (2,379) (654)
Cash and cash equivalents at beginning of period 16,228 16,848
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,849 $ 16,194
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See notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
March 31, 1999
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 included 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, 1998.
Basic earnings per common share is net income divided by the weighted average
number of common shares outstanding during the period. ESOP shares are
considered outstanding for this calculation unless unearned. Diluted earnings
per common share includes the dilutive effect of additional potential common
shares issuable under stock options. Earnings and dividends per share are
restated for all stock splits and dividends through the date of issue of the
financial statements. The weighted average common shares outstanding for the
quarters ended March 31, 1999 and 1998 were 1,864,904 and 1,920,170,
respectively.
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FINANCIAL CONDITION
Total deposits declined 1.6% during the first quarter of 1999. The Company has
traditionally experienced a decline in deposits in the first quarter of the
year.
Loans have increased by 1.8% in the first three months of 1999. The loan growth
has occurred in the commercial and real estate mortgage portfolios. The
commercial growth is due to an increase in borrowers' seasonal demands. The real
estate mortgage increase is the result of additional construction loans and the
offering of a competitive in-house fixed rate product. There were no loans held
for sale as of March 31, 1999.
Investment securities decreased by 5.5% during the first quarter of 1999. Funds
received from maturing securities were used to support the increase in loans.
There were no significant fixed asset commitments as of March 31, 1999.
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.
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.
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The following table summarizes the Company's capital ratios as of March 31,
1999:
Tier 1 risk-based capital ratio 13.87%
Total risk-based capital ratio 12.75%
Leverage ratio 9.31%
The above table indicates that the Company's capital ratios are above the
regulatory minimum requirements.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income decreased by $30,000 for the three month period ended March
31, 1999 compared to the same period in 1998. This decrease is due to shrinking
net interest margins as a result of competitive pressures to decrease loan
rates.
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.
The first quarter 1999 provision for loan losses remained at 1998 levels. The
1999 provision was set to provide for loan growth and continued losses occurring
as a result of increase 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 March 31, 1999.
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 $2,000 during the first quarter of 1999 compared to the same period
in 1998. A decline in gains recognized on the sale of real estate mortgage loans
to the secondary market was offset by increases in deposit account service
charges and ATM fees.
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Non-interest Expense
Non-interest expenses increased by $5,000 for the three month period ended March
31, 1999 compared to the same period in 1998. Declines in salaries and benefits
and advertising expenditures were offset by increased equipment costs as the
Company continues its technological upgrades. Federal income taxes declined by
$57,000 as the Company increased its nontaxable income.
Year 2000
The Company has developed a plan to assess Year 2000 issues. The concern is
whether or not computers, elevators, telephone systems and other electronic
items will recognize the Year 2000 as a valid date. For banks, this is a concern
not only for the bank's operations, but for those of their customers and
vendors. As part of the Year 2000 plan, the Company has identified all critical
business processes and established a priority schedule for assessment of each
process.
The Company has completed the testing of critical hardware systems (mainframe
computer and personal computers) and critical software (mainframe operating
software, trust systems, Microsoft operating systems and systems providing
connectivity of network hardware). As part of its Year 2000 plan, the Company
has initiated formal communications with its critical service providers to
determine the extent to which the Company is vulnerable to any failure of those
third parties to remedy their own Year 2000 issues. Critical service providers
include phone companies and energy providers. This review of service providers
will be completed by June 30, 1999. There can be no assurance 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.
Therefore, the Company could be negatively impacted to the extent that other
entities not affiliated with the Company are unsuccessful in properly addressing
Year 2000 issues.
A key step in the Company's Year 2000 plan is the development of a Remediation
Contingency Plan to mitigate risks associated with a failure to successfully
complete renovation, validation and implementation of the Company's Year 2000
plan. As a part of the Remediation Contingency Plan, the Company has provided
for alternate software vendors for those that are not Year 2000 compliant. The
Remediation Contingency Plan will provide for alternate service providers for
those that are not Year 2000 compliant by June 30, 1999. Also by June 30, 1999,
the Company will have in place an expanded Business Resumption Plan. This Plan
will be an addition to the Company's current Business Resumption Plan and will
specifically address Year 2000 issues and the interruption of the Company's
business operations by such things as a power outage. The Business Resumption
Plan will include the identification of the Company's
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core business processed and a specific recovery plan for the possible failure of
each core business process. A sustained power outage or similar disruption will
have an adverse effect on the Company's operations; however, management is not
aware of any facts which would indicate that such disruptions are likely.
The Company has identified all significant customers whose own Year 2000
compliance status may pose a risk to the Company and determined the actions
these customers are taking to avoid significant disruptions that could result
from the Year 2000 date change.
The Company's Board of Directors reviews the status of the Year 2000 issues on a
monthly basis. The Company will continue to incur remediation and testing costs
relating to Year 2000 issues through the Year 2000, but does not anticipate that
any 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.
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.
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.
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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 March 31,
1999. 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.
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Principal Amount Maturing in: Fair
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03/31/00 03/31/01 03/31/02 03/31/03 03/31/04 Thereafter Total 03/31/99
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Rate sensitive assets:
Fixed interest rate loans 8,517 6,275 8,883 9,059 12,359 13,796 58,889 63,459
Average interest rate 9.41% 10.06% 9.88% 9.88% 9.31% 8.59% 9.52%
Variable interest rate loans 52,388 9,222 4,691 4,182 17,634 19,212 107,329 107,329
Average interest rate 8.38% 8.83% 9.11% 9.09% 8.51% 8.17% 8.68%
Fixed interest rate securities 23,956 14,350 11,069 6,031 3,244 5,515 64,165 64,848
Average interest rate 5.10% 5.70% 5.35% 5.35% 5.57% 5.41% 5.39%
Other interest bearing assets 3,000 3,000 3,000
Average interest rate 4.69% 4.69%
Rate sensitive liabilities:
Interest bearing demand deposits 76,189 76,189 76,189
Average interest rate 3.05% 3.05%
Savings deposits 36,343 2,244 860 6,479 45,926 45,926
Average interest rate 2.75% 5.40% 5.35% 5.45% 3.30%
Time deposits 59,332 9,971 4,490 1,359 75,152 75,450
Average interest rate 4.94% 5.50% 5.49% 5.68% 5.31%
Fixed interest rate borrowings 5,000 5,000 5,000
Average interest rate 5.71% 5.71%
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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 first quarter of 1999.
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)
MAY 14, 1999 JAMES T. GROHALSKI
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Date James T. Grohalski, President
and Chief Executive Officer
(Principal Financial and
Accounting Officer)
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INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
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EX 27 FINANCIAL DATA SCHEDULE