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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 September 30, 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
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 - 1,823,939 shares at October 31, 1999 (including
shares held by ESOP)
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CONDENSED CONSOLIDATED BALANCE SHEETS
SOUTHERN MICHIGAN BANCORP, INC AND SUBSIDIARY
September 30 December 31
1999 1998
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(Unaudited) (A)
(In thousands)
ASSETS
Cash and due from banks $ 13,777 $ 16,228
Federal funds sold 4,000
Investment securities available-for-sale 54,127 36,138
Investment securities held to maturity (market value of $28,793 in 1998) 31,756
Loans, net 186,177 161,277
Premises and equipment 6,792 7,036
Other assets 11,578 10,416
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TOTAL ASSETS $ 272,451 $266,851
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LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 32,248 $ 34,751
Interest bearing 196,692 198,610
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228,940 233,361
Accounts payable and other liabilities 2,846 2,528
Other long-term borrowings 15,000 5,000
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TOTAL LIABILITIES 246,786 240,889
Common stock subject to repurchase obligation in ESOP 3,891 6,029
Shareholders' equity:
Preferred stock, 100,000 shares authorized
Common stock, $2.50 par value:
Authorized--4,000,000 shares
Issued--1,832,706 shares (1998-1,872,677)
Outstanding--1,714,802 shares (1998-1,721,950) 4,287 4,305
Capital surplus 4,715 3,863
Retained earnings 12,959 11,505
Net unrealized appreciation on available-for-sale securities
net of tax of $96 (1998--$95) (187) 260
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TOTAL SHAREHOLDERS' EQUITY 21,774 19,933
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 272,451 $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 Nine Months Ended
September 30 September 30
1999 1998 1999 1998
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(In thousands, except per share amounts)
Interest income:
Loans, including fees $4,358 $4,015 $ 12,084 $11,820
Investment securities:
Taxable 516 606 1,706 1,680
Tax exempt 255 297 878 794
Other 0 95 41 214
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Total interest income 5,129 5,013 14,709 14,508
Interest expense:
Deposits 1,918 1,993 5,712 5,675
Other 204 128 462 291
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Total interest expense 2,122 2,121 6,174 5,966
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NET INTEREST INCOME 3,007 2,892 8,535 8,542
Provision for loan losses 258 150 594 450
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NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,749 2,742 7,941 8,092
Non-interest income:
Service charges on deposit accounts 269 253 777 714
Trust department 19 132 359 377
Security gains 0 0 0 0
Secondary market gains 182 198 557 726
Other 49 45 150 129
128 131 386 339
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647 759 2,229 2,285
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Non-interest expenses: 3,396 3,501 10,170 10,377
Salaries and benefits 1,184 1,067 3,349 3,332
Occupancy 222 186 629 540
Equipment 239 204 706 579
Other 799 722 2,281 2,250
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2,444 2,179 6,965 6,701
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INCOME BEFORE INCOME TAXES 952 1,322 3,205 3,676
Federal income taxes 214 341 717 947
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NET INCOME 738 981 2,488 2,729
Other comprehensive income, net of tax:
Change in unrealized gains on securities 45 258 (447) 250
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COMPREHENSIVE INCOME $ 783 $1,239 $ 2,041 $ 2,979
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Basic and Diluted Earnings Per Share $ 0.37 $ 0.52 $ 1.34 $ 1.43
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Dividends Declared Per Share $ 0.19 $ 0.16 $ 0.56 $ 0.46
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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
Nine Months Ended
September 30
1999 1998
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(In thousands)
OPERATING ACTIVITIES
Net income $ 2,488 $ 2,390
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 594 400
Provision for depreciation 501 312
Increase in other assets (932) (665)
(Increase) decrease in accounts payable and other liabilities 363 (475)
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Net cash provided by operating activities 3,014 1,962
INVESTING ACTIVITIES
Proceeds from maturity of investment securities 27,078 10,146
Purchases of investment securities (13,988) (22,133)
Increase (decrease) in federal funds sold 4,000 (5,300)
Net increase in loans (25,494) (1,647)
Net increase in premises and equipment (257) (1,469)
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Net cash used in investing activities (8,661) (20,403)
FINANCING ACTIVITIES
Net increase (decrease) in deposits (4,421) 21,329
Increase in other borrowings 10,000 2,000
Common stock issued 0 251
Common stock repurchased and retired (1,304) (2,299)
Cash dividends (1,079) (952)
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Net cash provided by financing activities 3,196 20,329
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Increase in cash and cash equivalents (2,451) 1,888
Cash and cash equivalents at beginning of period 16,228 16,848
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 13,777 $ 18,736
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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
September 30, 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 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, 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
nine months ended September 30, 1999 and 1998 were 1,853,311 and 1,902,076,
respectively.
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FINANCIAL CONDITION
Total deposits have declined by 1.9% during the first nine months of 1999.
Deposits levels have fluctuated during 1999 as customers review their
investments in lieu of recent stock market fluctuations. The Company
traditionally experiences an increase in deposits in the fourth quarter of the
year but it is not known if such an increase will occur in 1999 because of
customers' Year 2000 concerns.
Net loans have increased by 15.4% in the first nine months of 1999. The loan
growth has occurred in the commercial and real estate mortgage portfolios. The
commercial growth is due to economic growth in the Company's market area and
increased efforts to competitively price loans. 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
September 30, 1999.
Investment securities decreased by 20.3% during the first nine months of 1999.
Funds received from maturing securities were used to support the increase in
loans.
There were no significant fixed asset commitments as of September 30, 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. The following table summarizes the Company's capital
ratios as of September 30, 1999:
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Tier 1 risk-based capital ratio 11.93%
Total risk-based capital ratio 13.03
Leverage ratio 9.35
The above table indicates that the Company's capital ratios are above the
regulatory minimum requirements.
The Company has repurchased and retired 39,971 shares of outstanding common
stock during the first nine months of 1999.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income increased by $115,000 for the three month period and
decreased $7,000 for the nine month period ended September 30, 1999 compared to
the same periods in 1998. The increase in the third quarter is due to increased
loan volume and the stability of funding costs for the quarter. The decrease for
the nine month period is due to competitive pressures to lower loan rates and
increase deposit rates, as well as the need for more expensive funding sources.
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 provision for loan losses increased by $108,000 and $144,000 for the three
and nine month periods ended September 30,1999 compared to the same periods in
1998. This increase occurred to provide for loan growth and increased
charge-offs and delinquencies, primarily as a result of increased customer
bankruptcies. A large commercial borrower discontinued business operations
during the second quarter of 1999. As a result, approximately $135,000 in loans
to this borrower were charged-off. Management is liquidating the collateral and
holds approximately $70,000 in non earning assets related to this borrower. The
provision for loan losses will continue to be recorded at a higher level than in
1998 to provide for additional potential losses from this borrower and the
significant loan growth experienced to date in 1999. 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, 1999.
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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,
decreased by $112,000 and $56,000 for the three and nine month periods ended
September 30, 1999 compared to the same periods in 1998. This decrease is due
primarily to a decline in gains recognized on the sale of real estate mortgage
loans to the secondary market. As fixed rate mortgage rates have increased, the
number of new loans and refinancing activities have declined.
Non-interest Expense
Non-interest expenses increased by $265,000 for the three and nine month periods
ended September 30, 1999 compared to the same periods in 1998. Salaries and
benefits expenditures increased in the third quarter of the year as additional
loan department employees were added to assist with the increased loan volume.
Occupancy costs are higher than 1998 as a result of the addition of the new
Hillsdale branch and increasing maintenance on the Bank's older properties.
Equipment costs increased as a result of equipment additions for the new
Hillsdale branch and technological upgrades to the Bank's mainframe and personal
computers. The Company has seen a decline in income taxes as its nontaxable
income has increased.
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. 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.
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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 and service providers for those that are not Year
2000 compliant. The Company also has in place an expanded Business Resumption
Plan. This Plan is in addition to the Company's current Business Resumption Plan
and specifically addresses Year 2000 issues and the interruption of the
Company's business operations by such things as a power outage. The Business
Resumption Plan includes the identification of the Company's core business
processes 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
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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.
There have been no significant changes in the distribution of the Company's
financial instruments that are sensitive to changes in interest rates during the
third quarter of 1999.
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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 third quarter of 1999.
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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.
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(Registrant)
NOVEMBER 12, 1999 /s/ 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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Exhibit Index
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Exhibit No. Description
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27 Financial Data Schedule