EXHIBIT 13.1
March 28, 2002
To Our Stockholders
On behalf of all of us at Sturgis Bank & Trust Company ("Bank") and Sturgis
Bancorp, Inc. ("Company"), it is a pleasure to present the Bank's 2001 Annual
Report. It was a good year.
The U.S. banking industry was significantly affected by the decrease in interest
rates during 2001, and our Bank was not an exception. Residential mortgage rates
decreased to historic levels, prompting a significant refinancing wave. Although
the Bank had a record year for loan originations, net loans decreased $4.5
million. This decrease is directly connected to the sale of the refinanced loans
in the secondary market. The refinanced loans also provided the Bank with
greater liquidity, which was invested in short-term interest-bearing deposits.
The net income of the Bank was a record high of $2.8 million, or $0.90 per
share, an increase of over 53%. Two primary factors in the increase from 2001
are increases in net interest income and mortgage banking activities. Net
interest income increased from $8.6 million in 2000 to $9.5 million in 2001,
indicating the success of the Bank in asset/liability management through the
changes in market interest rates. Noninterest income from mortgage banking
activities increased from $224,930 in 2000 to $1.7 million in 2001. This
increase is due to the growth in loan sales from $13.9 million in 2000 to $74.3
million in 2001.
The Bank increased its provision for loan losses from $309,000 in 2000 to $1.0
million in 2001. This increase is in recognition of the gradual changing mix of
the Bank's loan portfolio to include a greater proportion of commercial loans.
The Bank's capital increased from $26.5 million at December 31, 2000 to $28.5
million at December 31, 2001. This increases book value per share from $8.55 to
$9.19 at December 31, 2000 and 2001, respectively.
We continue to be very excited about our Bank. Internet banking was added to our
customer service during 2001. Many customers are already using the Internet
services. Internet and telephone banking expand our customers' access to account
information to 24-hours.
Effective January 1, 2002 the Bank began operations as a subsidiary of the new
financial holding company you approved, Sturgis Bancorp, Inc. ("Company"). Your
shares of the Bank are now shares of the Company. In January, 2002, the Board of
Directors of the Company approved a program to repurchase up to 10% of the
issued and outstanding common stock of the Company in the open market and in
privately negotiated transactions. To date, we have been able to repurchase
115,200 shares at a total redemption price of approximately $1,050,000, or
approximately $9.10 per share.
The directors, officers, and staff of the Bank and the Company wish to thank you
for your continuing interest and support. As always, your comments are welcome.
Sincerely,
/s/ Leonard L. Eishen
- ------------------------
Leonard L. Eishen
President and Chief Executive Officer
CONTENTS
--------
Page
----
Selected Financial Data 2
Corporate Year in Review 3
Management's Discussion and Analysis of Financial
Condition and Results of Operations 5
Board of Directors of the Bank 19
Officers of the Bank 19
Corporate Information 20
Market Information 21
Independent Accountants 23
Form 10-K Report 23
Report of Independent Accountants and
Consolidated Financial Statements 24
1
SELECTED FINANCIAL DATA
At December 31,
---------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Total assets $279,789,272 $271,116,489 $251,596,319 $237,496,303 $201,309,641
Cash and investment securities 28,801,672 25,533,283 23,493,106 33,539,244 12,478,166
Loans and loans held for sale 223,528,816 224,191,073 206,295,022 182,110,622 170,078,239
Mortgage -backed securities 1,034,119 1,261,585 1,519,508 1,997,645 3,008,785
Allowance for loan losses 1,300,000 803,744 730,000 686,896 692,787
Deposits 177,602,660 173,855,324 163,679,849 172,439,561 124,824,620
Short-term borrowings 6,000,000 9,560,855 23,506,029 - 36,204,855
Long-term borrowings 64,076,863 57,849,521 35,607,361 38,661,629 21,297,144
Stockholders' equity 28,496,934 26,515,396 25,347,607 23,950,820 16,332,183
Bo Book Value per share 9.19 8.55 8.19 7.74 6.78
Shares outstanding (actual number) 3,101,534 3,101,534 3,094,886 3,094,779 2,408,602
Year Ended December 31,
-----------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Interest income $19,938,467 $19,138,924 $16,963,609 $15,890,135 $14,337,678
Interest expense 10,401,412 10,526,202 8,673,279 8,769,897 7,984,889
Provision for loan losses 1,056,194 309,000 104,000 173,913 338,314
Noninterest income 4,482,780 3,361,115 3,021,639 2,770,928 1,708,670
Noninterest expense 8,872,803 9,082,503 8,516,520 7,367,354 5,308,230
Federal income tax 1,302,901 765,468 688,000 635,000 713,000
Net income 2,787,937 1,816,866 2,003,449 1,714,899 1,701,915
Earnings per share (basic) 0.90 0.59 0.65 0.67 0.71
Earnings per share (diluted) 0.90 0.59 0.65 0.65 0.69
Cash dividends per share 0.26 0.22 0.19 0.18 0.17
Weighted average shares
outstanding (actual number):
Basic 3,101,534 3,099,630 3,094,854 2,565,069 2,403,360
Diluted 3,101,534 3,099,630 3,099,503 2,643,970 2,459,448
2
CORPORATE YEAR IN REVIEW
------------------------
On December 11, 2001, the shareholders of Sturgis Bank & Trust Company (the
"Bank") approved the reorganization of the Bank to become a wholly owned
subsidiary of Sturgis Bancorp, Inc. (the "Company"), a financial holding
company. The Company is a financial holding company under the Bank Holding
Company Act of 1956, as amended. This reorganization was approved at a special
meeting of the shareholders of the Bank on December 11, 2001. The necessary
affirmative vote of the holders of at least two-thirds (2/3) of the Bank's
common stock (of which 3,101,534 share were outstanding on October 30th, 2001,
the record date for the meeting) was obtained.
Prior to the special meeting of the shareholders of the Bank, the Company
received the necessary approvals from the Board of Governors of the Federal
Reserve and the Federal Deposit Insurance Corporation. On December 21, 2001, the
Michigan Department of Consumer and Industry Services, Office of Financial and
Insurance Services, Division of Financial Institutions approved the
consolidation to complete the consummation of the Company acquiring one hundred
percent of the issued and outstanding common stock of Sturgis Bank & Trust. This
reorganization became effective as of the opening of business on January 1,
2002.
With the consummation of the reorganization, each outstanding share of the
Bank's outstanding common stock, $1.00 par value, has been converted into one
share of the Company's common stock, $1.00 par value. The shareholders of the
Bank and their percentage of shareholder ownership, immediately prior to the
consummation of the reorganization are identical to those of the Company
immediately after consummation of the reorganization.
Based upon the reorganization of the Bank described above, the Company's common
stock was deemed registered under Section 12(g) of the Securities Exchange Act
of 1934, as amended, pursuant to Rule 12g-3(a) promulgated thereunder. The
Company filed a Form 8-K with the Securities and Exchange Commission as a
successor issuer to the Bank as required by paragraph (f) of Rule 12g-3 under
the Securities Exchange Act of 1934. Pursuant to paragraph (g) of Rule 12g-3
under the Exchange Act, the Company, as the successor issuer, is responsible for
making the necessary annual filings for the Bank, the predecessor issuer.
As a result of the above described reorganization, the meetings, events,
descriptions, financial information, and other information contained below for
events that took place in calendar year 2001 relate the Company while it
operated as the Bank and prior to the effective date of the reorganization
(effective January 1, 2002).
The Bank, a Michigan savings bank, was founded in 1905 as a state chartered
mutual savings and loan.
The original mission of the Bank was to promote personal savings and provide
financing for the purchase of homes. Today we remain committed to the same
objectives by offering consumer, educational, and property improvement loans,
along with a large selection of investment opportunities to our community. In
order to meet a growing demand for business loans, the Bank is conservatively
offering commercial loans to qualified customers.
3
The Bank has its main office in Sturgis and branch offices in Bronson,
Centreville, Climax, Coldwater, Colon, South Haven, Sturgis, Three Rivers and
White Pigeon, Michigan. The Bank's market area covers all of St. Joseph County
and parts of Cass, Branch, Calhoun, Van Buren, Allegan, Hillsdale and Kalamazoo
counties.
While the Bank's primary business has historically been and will continue to be
the origination of first mortgage loans on 1-4 family unit homes, it has
implemented strategies in the last few years that will put more emphasis on
originating commercial real estate and small business loans within its primary
market area. The Bank also intends to increase its emphasis on multi-family and
consumer lending products. The marketing of these loans will focus on the
existing customer base and new relationships within the Bank's primary market
area.
The Bank's Trust Department has approximately $98.0 million of assets under
administration as of December 31, 2001, a decrease of $4.2 million, or 4.1%,
during 2001. The decrease was due to market conditions.
In 2002 the Bank will:
* Offer trust services to its customers.
* Offer interest rates on savings accounts that are competitive in its
market.
* Emphasize originations of home and family related customer loans.
* Match asset and liability maturities to manage interest rate and
liquidity risks.
* Offer noninsured investment securities through Oakleaf Financial
Services, Inc., a wholly owned subsidiary of the Bank.
* Continue a caring attitude toward our customers and be responsive to
their needs and concerns.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report contains statements that constitute forward-looking
statements. These statements appear in several places in this report and include
statements regarding intent, belief, outlook, objectives, efforts, estimates or
expectations of the Bank, primarily with respect to future events and the future
financial performance of the Bank. Any such forward-looking statements are not
guarantees of future events or performance and involve risks and uncertainties,
and actual results may differ materially from those in the forward-looking
statement. Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement include, but are not limited
to, changes in interest rates and interest rate relationships; demand for
products and services; the degree of competition by traditional and
non-traditional competitors; changes in banking laws and regulations; changes in
tax laws; changes in prices, levies, and assessments; the impact of
technological advances; government and regulatory policy changes; the outcome of
any pending and future litigation and contingencies; trends in consumer behavior
and ability to repay loans; and changes of the world, national and local
economies. The Bank undertakes no obligation to update, amend or clarify
forward-looking statements as a result of new information, future events, or
otherwise.
RESULTS OF OPERATIONS
The Bank reported net income of $2.8 million or $0.90 per basic share for
the year ended December 31, 2001 as compared to net income of $1.8 million and
$2.0 million for the years ended December 31, 2000 and 1999, respectively. The
increase in net income from 2000 to 2001 was primarily due to the substantial
increase in mortgage banking activities.
INTEREST INCOME
2001 COMPARED TO 2000. Interest income increased $0.8 million from $19.1
million to $19.9 million. This increase is primarily due to the increases in
average loans outstanding from $217.3 million in 2000 to $224.6 million in 2001.
The average yield on interest-earning assets decreased from 8.20% in 2000 to
7.87% in 2001. This is primarily due to changes in the composition of
interest-earning assets. The Bank reduced investment securities and reinvested
proceeds from their maturity into interest-bearing deposits.
2000 COMPARED TO 1999. Interest income increased $2.1 million from $17.0
million to $19.1 million. This increase is primarily due to the increases in
average loans outstanding from $190.1 million in 1999 to $217.3 million in 2000.
The average yield on interest-earning assets increased from 7.94% in 1999 to
8.20% in 2000. This is primarily due to the changes in the composition of
interest-earning assets. The Bank reduced investment securities and
interest-bearing deposits and reinvested proceeds from their maturity into
higher-earning loans (i.e., commercial mortgage and commercial non-mortgage
loans).
5
INTEREST EXPENSE
2001 COMPARED TO 2000. Interest expense decreased $0.1 million from $10.5
million in 2000 to $10.4 million in 2001. This was primarily due to the decrease
in rates paid on average interest-bearing deposits and FHLB advances. The rate
paid on average interest-bearing liabilities decreased from 4.55% in 2000 to
4.24% in 2001.
2000 COMPARED TO 1999. Interest expense increased $1.8 million from $8.7
million in 1999 to $10.5 million in 2000. This was primarily due to the increase
in rates paid on average interest-bearing deposits and increases in average
deposits and FHLB advances. The rate paid on average interest- bearing
liabilities increased from 4.05% in 1999 to 4.55% in 2000, due to advances
comprising a greater percentage of the average total interest-bearing
liabilities.
NET INTEREST INCOME
2001 COMPARED TO 2000. Net interest income for the year ended December 31,
2001 was $9.5 million compared to $8.6 million for the year ended December 31,
2000, an increase of $0.9 million or 10.5%. The increase was caused primarily by
increases in average interest-earning assets from $233.4 million in 2000 to
$253.2 million in 2001, and interest-bearing liabilities from $231.1 million in
2000 to $245.4 million in 2001. The Bank's interest rate spread decreased from
3.64% during 2000 to 3.63% during 2001. The Bank's net interest margin increased
from 3.69% for the year ended December 31, 2000 to 3.77% for the year ended
December 31, 2001, primarily due to an decrease in average rate paid on
interest-bearing liabilities.
2000 COMPARED TO 1999. Net interest income for the year ended December 31,
2000 was $8.6 million compared to $8.3 million for the year ended December 31,
1999, an increase of $0.3 million or 3.6%. The increase was caused primarily by
increases in average interest-earning assets from $213.6 million in 1999 to
$233.4 million in 2000, and interest-bearing liabilities from $214.3 million in
1999 to $231.1 million in 2000. The Bank's interest rate spread also decreased
from 3.89% during 1999 to 3.64% during 2000. The decrease in the spread is
primarily due to the higher cost of funds, as interest rates rose during 2000.
The Bank's net interest margin decreased from 3.88% for the year ended December
31, 1999 to 3.69% for the year ended December 31, 2000, primarily due to the
large increase in average rate paid on interest-bearing liabilities.
AVERAGE BALANCES, INTEREST RATES AND YIELDS. Net interest income is
affected by the difference ("interest rate spread") between rates of interest
earned on interest-earning assets and rates of interest paid on interest-bearing
liabilities and the relative amounts of interest-bearing liabilities and
interest-earning assets. When the total of interest-earning assets approximates
or exceeds the total of interest-bearing liabilities, any positive interest rate
spread will generate net interest income. Financial institutions have
traditionally used interest rate spreads as a measure of net interest income.
Another indication of an institution's net interest income is its "net yield on
interest-earning assets" or "net interest margin," which is net interest income
divided by average interest-earning assets.
6
AVERAGE BALANCES AND INTEREST RATES
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2001 2000
----------------------------------- ----------------------------------
AVERAGE INTEREST AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------------------------------- ----------------------------------
Interest-Earning Assets:
Loans $224,638,896 $18,276,561 8.14% $217,267,415 $18,097,475 8.33%
Mortgage-backed securities 1,143,720 74,935 6.55% 1,388,320 87,076 6.27%
Investment securities (1) 7,768,763 537,388 6.92% 13,443,781 880,876 6.55%
Interest-bearing deposits 19,691,832 1,049,583 5.33% 1,280,132 73,497 5.74%
----------------------------------- ----------------------------------
Total interest-earning assets $253,243,211 $19,938,467 7.87% $233,379,648 $19,138,924 8.20%
=================================== ==================================
Interest-Bearing Liabilities:
Deposits $177,212,048 $6,369,577 3.59% $173,688,056 $ 6,886,005 3.96%
FHLB advances 68,153,648 4,031,835 5.92% 57,435,331 3,640,197 6.34%
----------------------------------- ----------------------------------
Total interest-bearing liabilities $245,365,696 $10,401,412 4.24% $231,123,387 $10,526,202 4.55%
=================================== ==================================
Net interest income $ 9,537,055 $ 8,612,722
============= =============
Interest rate spread 3.63% 3.64%
===== =====
Net interest-earning assets $ 7,877,515 $ 2,256,261
============ ============
Net interest margin 3.77% 3.69%
===== =====
(1) Yield on investment securities is reported on an actual and not a tax equivalent basis
1999
-----------------------------------
AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
-----------------------------------
Interest-Earning Assets:
Loans $190,083,571 $15,591,033 8.20%
Mortgage-backed securities 1,715,275 97,324 5.67%
Investment securities (1) 15,885,369 964,495 6.07%
Interest-bearing deposits 5,894,198 310,757 5.27%
-----------------------------------
Total interest-earning assets $213,578,412 $16,963,609 7.94%
===================================
Interest-Bearing Liabilities:
Deposits $172,914,335 $ 6,363,972 3.68%
FHLB advances 41,418,668 2,309,307 5.58%
-----------------------------------
Total interest-bearing liabilities $214,333,003 $ 8,673,280 4.05%
===================================
Net interest income $ 8,290,329
=============
Interest rate spread 3.89%
=====
Net interest-earning assets (liabilities) ($754,591)
============
Net interest margin 3.88%
=====
(1) Yield on investment securities is reported on an actual and not a tax
equivalent basis
The following table presents information regarding the average yields received
on loans and other assets and the rates paid on deposits and borrowings at the
dates indicated. Non-accruing loans have been included in the table as loans
carrying a zero yield.
7
AT DECEMBER 31,
2001 2000 1999
WEIGHTED AVERAGE YIELD:
Loans 7.58% 8.42% 8.00%
Mortgage-backed securities 6.61% 7.30% 6.40%
Investments(1) 5.90% 6.12% 5.87%
Interest-bearing deposits 4.26% 6.71% 4.65%
All interest-earning assets 7.33% 8.27% 7.91%
WEIGHTED AVERAGE COST:
Deposits 2.77% 4.16% 3.71%
Borrowings 5.68% 6.45% 5.04%
All interest-bearing liabilities 3.59% 4.80% 4.06%
INTEREST RATE SPREAD 3.74% 3.47% 3.85%
(1) Yield on investment securities is reported on an actual and not a tax
equivalent basis.
8
RATE/VOLUME ANALYSIS. The following table sets forth certain
information regarding changes in interest income and interest expense of the
Bank for the periods indicated. For each category of interest-earning asset and
interest-bearing liability, information is provided on changes attributable to:
(i) changes in volume (change in volume multiplied by the prior year rate) and
(ii) changes in rate (change in rate multiplied by the prior year volume).
Rate/volume variances have been allocated proportionately to the change due to
rate and the change due to volume.
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
2001 VS 2000 2000 VS 1999
------------ ------------
INCREASE (DECREASE) DUE TO: INCREASE (DECREASE) DUE TO:
Interest Income: VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
Loan portfolio $568,692 ($389,606) $179,086 $2,329,358 $177,084 $2,506,442
MBS portfolio (16,259) 4,118 (12,141) (10,718) 470 (10,248)
Investment portfolio (395,707) 52,219 (343,488) (49,011) (34,608) (83,619)
Other interest-earning assets 980,972 (4,886) 976,086 (170,618) (66,642) (237,260)
------------------------------------- ------------------------------------
Total interest-earning assets 1,137,698 (338,155) 799,543 2,099,011 76,304 2,175,315
------------------------------------- ------------------------------------
Interest Expense:
Deposits 143,333 (659,761) (516,428) (89,190) 611,223 522,033
FHLB advances 608,968 (217,330) 391,638 1,032,174 298,716 1,330,890
------------------------------------- ------------------------------------
Total interest-bearing liabilities 752,301 (877,091) (124,790) 942,984 909,939 1,852,923
------------------------------------- ------------------------------------
Net Interest Income $385,397 $538,936 $924,333 $1,156,027 ($833,635) $322,392
===================================== ====================================
YEAR ENDED DECEMBER 31,
1999 VS 1998
INCREASE (DECREASE) DUE TO:
Interest Income: VOLUME RATE TOTAL
------ ---- -----
Loan portfolio $791,820 ($56,196) $735,624
MBS portfolio (41,425) (11,001) (52,426)
Investment portfolio 642,346 (155,675) 486,671
Other interest-earning assets (25,451) (70,944) (96,395)
-------------------------------------
Total interest-earning assets 1,367,290 (293,816) 1,073,474
-------------------------------------
Interest Expense:
Deposits 1,289,947 (566,730) 723,217
FHLB advances (749,830) (70,005) (819,835)
-------------------------------------
Total interest-bearing liabilities 540,117 (636,735) (96,618)
-------------------------------------
Net Interest Income $827,173 $342,919 $1,170,092
=====================================
PROVISION FOR LOAN LOSSES
2001 COMPARED TO 2000. The provision for loan losses was $1,056,194 for
the year ended December 31, 2001 and $309,000 for the year ended December 31,
2000, an increase of $747,194. The increase is due to management's assessment of
market conditions, the general recession in the economy, and the changing mix of
historically residential loan portfolio to higher risk commercial loan
portfolio.
2000 COMPARED TO 1999. The provision for loan losses was $309,000 for the
year ended December 31, 2000 and $104,000 for the year ended December 31, 1999,
an increase of $205,000. The increase is due to the higher risk of losses with
the Bank's expanding commercial loan portfolio. The provision for loan losses
was based upon management's assessment of relevant factors, including types and
amounts of non-performing loans, historical and anticipated loss experience on
such types of loans, and current economic conditions.
The allowance for loan losses as a percentage of total loans has increased
from 2000 to 2001. This increase is due to the increasing exposure of the Bank
to commercial lending. Because of the Bank's continuing growth in commercial
loans, the Bank will continue to fund the allowance for loan losses due to
higher risks related to commercial lending, especially as the Bank establishes a
history of net charge-offs related to its commercial loans.
9
NONINTEREST INCOME
2001 COMPARED TO 2000. Noninterest income was $4.5 million in 2001
compared to $3.4 million in 2000, an increase of $1.1. Fees and service charges
decreased to $1.4 million in 2001 compared to $1.9 million in 2000, mostly due
to amortization of mortgage servicing rights. Noninterest income from gain on
sale of mortgage loans increased to $1.7 million in 2001 compared to $224,930 in
2000, due to a increase in loans sold from $13.9 million in 2000 to $74.3
million in 2001. The Bank typically sells long-term fixed-rate mortgages to
manage interest rate risk. The increase in loan sales was the result of higher
customer demand for fixed-rate mortgages, due to the decrease in rates from 2000
to 2001. Trust fee income increased to $492,803 in 2001 compared to $465,737 in
2000 due to the growth in the Bank's Trust Department. Commission income from
Oakleaf Financial Services, Inc., the Bank's investment subsidiary, increased
from $691,776 in 2000 to $796,688 in 2001.
2000 COMPARED TO 1999. Noninterest income was $3.4 million in 2000
compared to $3.0 million in 1999, an increase of $339,476. Fees and service
charges increased to $1.9 million in 2000 compared to $1.6 million in 1999,
mostly due to the increase in deposit account fees. Noninterest income from gain
on sale of mortgage loans decreased to $224,930 in 2000 compared to $608,557 in
1999, due to a decrease in loans sold from $23.2 million in 1999 to $13.9
million in 2000. The Bank typically sells long-term fixed-rate loans to manage
interest rate risk. The decrease in loan sales was the result of lower customer
demand for fixed-rate mortgages, due to the increase in rates from 1999 to 2000.
Trust fee income increased to $465,737 in 2000 compared to $405,309 in 1999 due
to the growth in the Bank's Trust Department. Commission income from Oakleaf
Financial Services, Inc., the Bank's investment subsidiary, increased from
$363,138 in 1999 to $691,776 in 2000, due to the acquisition of McKillen
Financial, Inc. in January 2000.
NONINTEREST EXPENSE
2001 COMPARED TO 2000. Noninterest expense was $8.9 million in 2001,
compared to $9.1 million in 2000, a decrease of $209,700 or 2.2%. The largest
components of this decrease were professional fees, contributions and deposit
account expenses. In 2000, the professional fees included expenses of
approximately $370,000 for the proposed merger with Southern Michigan Bancorp,
Inc. The merger with Southern Michigan Bancorp, Inc. was terminated on October
4, 2000.
2000 COMPARED TO 1999. Noninterest expense was $9.1 million in 2000,
compared to $8.5 million in 1999, an increase of $565,983 or 7.1%. The largest
components of this increase were professional fees, compensation, payroll taxes
and employee benefits. The professional fees included proposed merger-related
expenses of approximately $370,000 in 2000. Compensation, payroll taxes and
employee benefits were $4.0 million in 2000 compared to $3.7 million in 1999.
This increase was primarily due to annual salary adjustments that became
effective in January 2000 and the expansion of Oakleaf Financial Services, Inc.,
when McKillen Financial was acquired. Amortization of intangibles increased from
$565,698 in 1999 to $587,979 in 2000, due to the amortization of goodwill
resulting from the acquisition of McKillen Financial. Office occupancy and
equipment expense did not significantly change due to the consolidation of two
branch offices.
10
The effective federal income tax rates were 31.8% in 2001, 29.6% in 2000
and 25.6% in 1999. This increase is primarily due to an increase in taxable
income as a result of temporary book/tax timing differences associated with
depreciation, deferred loan fees, mortgage servicing rights and bad debt
expense.
CASH FLOWS
OPERATING. Cash flows from operating activities are most significantly
affected by net income, loans originated for sale and proceeds from the sale of
loans. Loans originated for sale were $77.3 million, $14.4 million, and $19.1
million for the years ended December 31, 2001, 2000, and 1999, respectively. The
increase in loans originated for sale in 2001 is primarily due to the low
residential mortgage rates. Proceeds from sales of loans were $74.3 million,
$13.9 million, and $23.2 million for the years ended December 31, 2001, 2000,
and 1999, respectively. Because the Bank generally has a policy of selling
long-term fixed rate mortgage loans, the volume of loan sales varies with
customer demand for these loans.
INVESTING. Cash flows from investing activities are most significantly
affected by loans made to customers net of principal payments, changes in the
Bank's investment portfolio, increases in interest-bearing deposits in banks,
and the acquisition of bank owned life insurance. For the year ended December
31, 2001 there was a decrease in loans of $3.4 primarily due to loan sales.
Loans made to customers, net of principal payments, were $17.6 million and $28.3
million for the years ended December 31, 2000 and 1999, respectively. Investment
purchases and maturities also affect cash flows from investing activities. The
Bank's management maintains investments at levels that provide the Bank with
optimal return, risk, and liquidity. The Bank increased its holdings of
interest-bearing deposits in banks by $8.2 million to $15.0 million at December
31, 2001 from $6.9 million at December 31, 2000. The Bank purchased $6.0 million
of bank-owned life insurance in 2001. The increase in holdings of
interest-bearing deposits and the purchase of bank-owned life insurance were
funded by borrowings from FHLB advances and deposits.
FINANCING. Cash flows from financing activities are mostly affected by
changes in deposits and FHLB advances. Deposits increased $3.7 million and $10.2
million for the years ended December 31, 2001, and 2000, respectively. Deposits
decreased $8.8 million for the year ended December 31, 1999. The Bank also used
FHLB advances for financing its operating and investing activities. The FHLB
advances increased $2.7 million, $8.3 million, and $20.5 million for the years
ended December 31, 2001, 2000, and 1999, respectively.
FINANCIAL CONDITION
ASSETS. The Bank's total assets at December 31, 2001 were $279.8 million
compared to $271.1 million at December 31, 2000, an increase of $8.7 million or
3.2%. The increase was primarily in interest-bearing deposits in banks and the
purchase of bank owned life insurance.
LOANS. The Bank's net loans decreased to $219.1 million at December 31,
2001
11
from $223.6 million at December 31, 2000. This decrease was primarily due to
loans refinanced with the decrease in market rates. During 2001 and 2000, the
Bank sold new residential originations of 10-year and longer term fixed-rate
mortgages to the secondary market. The demand for fixed-rate mortgage loans in
2001 was higher due to low interest rates during the period. The proceeds from
sales of loans (all fixed-rate, residential mortgages) were $74.3 million and
$13.9 million for 2001 and 2000, respectively. The mortgage loans originated for
sale ($77.3 million during 2001 and $14.4 million during 2000) were primarily
funded by the secondary mortgage market sales. At December 31, 2001, outstanding
loan commitments were $9.7 million and $15.9 million on fixed and variable-rate
loans, respectively. These loan commitments will be funded by interest-bearing
deposits, maturing assets, and additional FHLB borrowings, if needed. The
decision to sell fixed-rate mortgages with original maturities of 10 years or
greater protects the Bank from the interest rate risk inherent in holding these
longer fixed-rate loans and provides a source of liquidity to fund loan demand.
Mortgage loans serviced for others increased by $37.5 million to $133.1
million at December 31, 2001 from $95.6 million at December 31, 2000. This
servicing portfolio consists of loans originated by the Bank and sold in the
secondary mortgage market with servicing retained by the Bank. The Bank has no
purchased mortgage servicing portfolio.
SECURITIES - HELD-TO-MATURITY. Investment securities consisting of U.S
treasury and agency securities, municipal obligations, and mortgage-backed
securities were $3.9 million at December 31, 2001 compared to $7.3 million at
December 31, 2000, a decrease of $3.4 million or 53.4%. The decrease was due to
maturing U.S. treasury and agency securities. The funds were invested in
interest-bearing deposits in banks.
PREMISES AND EQUIPMENT. The Bank's premises and equipment, net of
accumulated depreciation were $6.4 million at December 31, 2001 compared to $7.1
million at December 31, 2000, a decrease of $718,154. The primary reasons for
the decrease was the sale of our Constantine and South Haven (Broadway Street)
branch properties, and depreciation in excess of purchases.
GOODWILL. Goodwill, net of accumulated amortization, was $5.1 million at
December 31, 2001 compared to $5.7 million at December 31, 2000, a decrease of
$574,864. This decrease is the result of amortization expense. Oakleaf Financial
Services, Inc., a wholly owned subsidiary of the Bank, paid goodwill of $475,000
in 2000 to purchase McKillen Financial Services, Inc. The Bank recorded
amortization expense of $574,864 for the year ended December 31, 2001 compared
to $587,979 for the year ended December 31, 2000.
DEPOSITS AND BORROWED FUNDS. Deposits were $177.6 million at December 31,
2001 compared to $173.9 million at December 31, 2000, an increase of $3.7
million or 2.1%. The increase is primarily in demand and savings account
deposits, which are at lower cost than certificates of deposit.
12
The Bank has an available line of credit with the Federal Home Loan Bank
of Indianapolis ("FHLB") which provides for advances up to $10.0 million and
matures on March 1, 2002. All borrowings from FHLB are collateralized by FHLB
stock and substantially all mortgage loans.
Long-term advances were $64.1 million at December 31, 2001 compared to
$57.9 million at December 31, 2000 an increase of $6.2 million. Short-term
advances were $6.0 million at December 31, 2001 compared to $9.6 million at
December 31, 2000 an decrease of $3.6 million.
The Bank's certificates of deposit decreased from $85.6 million at
December 31, 2000 to $80.8 million at December 31, 2001. The Bank has been
replacing its certificates of deposit with borrowings from FHLB. In the falling
interest rate market of 2001, the Bank was able to refinance certificates with
FHLB advances at a lower total expense through this strategy. The Bank will
continue to manage the rates offered on its time deposits and use borrowed funds
when that strategy enhances net interest income.
CAPITAL
The stockholders' equity of the Bank was $28.5 million at December 31,
2001 compared to $26.5 million at December 31, 2000, an increase of $2.0 million
or 7.5%. The primary components of the increase were net income of $2.8 million
less dividends paid of $806,399. The stockholders' equity was 10.19% of total
assets at December 31, 2001.
ASSET/LIABILITY MANAGEMENT
The primary component of the Bank's earnings is net interest income. The
Bank's asset/liability management strategy is to maximize net interest income
over time by reducing the impact of fluctuating interest rates. This is
accomplished by matching the mix and maturities of its assets and liabilities.
At the same time the Bank's asset/liability strategies for managing interest
rate risk must also accommodate customer demands for particular types of deposit
and loan products. The Bank uses various asset/liability management techniques
in an attempt to maintain a profitable mix of financial assets and liabilities,
provide deposit and loan products that meet the needs of its market area, and
maintain control over interest rate risk resulting from changes in interest
rates.
Net interest income, the primary component of the Bank's net income, is
derived from the difference or "spread" between the yield on interest-earning
assets and the cost of interest-bearing liabilities. The Bank has sought to
reduce its exposure to changes in interest rates by matching more closely the
effective maturities and repricings of its interest-sensitive assets and
liabilities. At the same time, the Bank's asset/liability management strategies
must also accommodate customer demands for particular types of deposit and loan
products.
While much of the Bank's asset/liability management efforts involve
strategies that increase the rate sensitivity of its loans and investments, such
as the sale of long-term fixed rate loans, originations of adjustable rate loans
and purchases of adjustable rate mortgage-backed securities or relatively short
average life fixed-rate investments, it also uses certain techniques to reduce
the rate sensitivity of its deposits and borrowed money.
13
Those techniques include attracting longer-term certificates of deposit when the
market will permit, emphasizing core deposits, which are less sensitive to
changes in interest rates, and borrowing through long-term FHLB advances. The
Bank's asset/liability management strategy will appropriately change when market
rates change.
The Bank measures its exposure to interest rate fluctuations primarily by
using a computer modeling system designed for savings institutions such as the
Bank. The model uses assumptions which management believes are reasonable for
the analysis. These assumptions include (but are not limited to) prepayment and
decay rates based on nine interest rate scenarios. It allows the Bank to adjust
its asset-liability mix based on the interest rate risk identified. The analysis
estimates the changes in the market value of the Bank's equity using interest
rate change scenarios ranging from +4% to -4%, in 1% increments from current
market rates. At December 31, 2001, the following table illustrates the interest
rate sensitivity of the Bank's equity to changes in market interest rates.
(In Thousands of Dollars)
-----------------------
Book value of stockholders' equity $28,497
4% increase in market rates 39,139
3% increase in market rates 41,067
2% increase in market rates 42,880
1% increase in market rates 44,672
No change (current market value of equity) 46,346
1% decrease in market rates 47,324
2% decrease in market rates 46,535
3% decrease in market rates 43,549
4% decrease in market rates 40,576
As the table shows, the Bank's book value of equity is less than estimated
market value in all of the scenarios. That indicates that the Bank is able to
withstand fluctuations in market interest rates without posting a significant
threat to either the Bank's stockholders' equity or the federal deposit
insurance system, and therefore, the Bank can be deliberate in its actions to
adjust the asset-liability mix. The Bank would meet the regulatory minimum
capital requirements in all of the interest-rate scenarios.
The Bank has an Asset-Liability Management Committee (ALCO) that meets as
needed. The purpose of this Committee is to communicate, coordinate, and monitor
asset-liability management procedures. The Committee establishes and monitors
the volume and mix of both assets and funding sources. The objective is to
manage assets and funding sources to produce results consistent with the Bank's
liquidity requirements, capital adequacy, growth, and profitability goals. To
accomplish this objective, the ALCO uses internal budget variance reports,
forecasts for changes in interest rates and consumer deposit activity, as well
as forecasts of loan demand in each of the Bank's loan types, investment
maturities and new investment alternatives, and various other internal and
external reports.
14
Static Gap Analysis: The management of interest rate sensitivity
includes monitoring the maturities and repricing opportunities of
interest-earning assets and interest-bearing liabilities. The following table
summarizes the interest rate repricing gaps for selected maturity periods as of
December 31, 2001:
(In Thousands)
1 Mo. 2-3 Mos. 4-6 Mos. 7-9 Mos. 10-12 Mos. >1-5 Yrs. >5 Yrs. Total
--------------------------------------------------------------------------------------
Non-loan interest-earning assets $9,384 $1,314 $1,284 $1,486 $1,300 $8,055 $764 $23,587
Loans 44,127 13,116 17,755 16,824 14,969 93,896 18,427 219,114
--------------------------------------------------------------------------------------
Total interest-earning assets 53,511 14,430 19,039 18,310 16,269 101,951 19,191 242,701
--------------------------------------------------------------------------------------
Savings accounts 1,112 2,224 3,336 3,385 3,385 18,661 5,972 38,075
Checking accounts 1,348 2,934 4,401 4,920 4,920 21,254 9,630 49,407
Certificates & Term IRA's 5,561 9,050 17,312 7,552 7,393 32,114 1,803 80,785
Other IB liabilities (FHLB advances) 0 29,745 657 0 1,966 27,709 10,000 70,077
--------------------------------------------------------------------------------------
Total interest-bearing liabilities 8,021 43,953 25,706 15,857 17,664 99,738 27,405 238,344
--------------------------------------------------------------------------------------
Interest-bearing assets less
interest-bearing liabilities 45,490 (29,523) (6,667) 2,453 (1,395) 2,213 (8,214) 4,357
Asset (liability) gap 45,490 (29,523) (6,667) 2,453 (1,395) 2,213 (8,214) 4,357
Cumulative asset gap 45,165 15,967 9,300 11,753 10,358 12,571 4,357
Cumulative gap as a percentage
of cumulative earning assets 85.0% 23.5% 10.7% 11.2% 8.5% 5.6% 1.8%
Total interest-earning assets exceeded interest-bearing liabilities by
$4.4 million at December 31, 2001. This difference was funded mainly through
non-interest-bearing liabilities. The above table shows that total assets
maturing or repricing within one year exceed liabilities maturing or repricing
within one year by $10.4 million. However, the repricing and cash flows of
certain categories of assets and liabilities are subject to competitive and
other influences that are beyond the control of the Bank. As a result, certain
assets and liabilities indicated as maturing or repricing within a stated period
may, in fact, mature or reprice in other periods or at different volumes.
Simulation: The Bank recognizes the limitations of static gap analysis
as a tool for managing its interest rate risk. The Bank also uses a
computer-based earnings simulation model to estimate the effects of various
interest rate environments on the balance sheet structure and net interest
income. These simulation techniques involve changes in interest rate
relationships,
15
asset and liability mixes, and prepayment options inherent in financial
instruments, as well as interest rate levels in order to quantify risk. The
Bank's sensitivity is estimated by first forecasting the next twelve months of
net interest income under an assumed environment of constant market interest
rates. Next, immediate parallel interest rate shocks are constructed in the
model. The rate shocks reflect changes of equal magnitude to all market interest
forecast under each of the rate shock scenarios. The resulting change in net
interest income is an indication of the sensitivity change in net earnings to
directional changes in market interest rates. This model is based solely on
parallel changes in market rates and does not reflect the levels of interest
rate risk that may arise from other factors such as changes in the spreads
between key market rates or in the shape of the Treasury yield curve. The net
interest income simulation model includes on-balance sheet loan, investment,
deposit, and debt instruments as well as off-balance sheet interest rate swaps.
The Bank's Board of Directors compares net interest income sensitivity
and has established tolerance limits for fluctuation. Throughout 2001, the
forecasted exposure was within the Bank's established policy limits.
Net Interest Income Sensitivity: Change in Projected Results vs. Constant Rates
Year-End 2001 12 Month Projection
Rate Shock Amount
(2.00%) (1.00%) 0.00% 1.00% 2.00%
------------------------------------------------------
Percent Change in net interest
income vs constant rates (4.06%) (1.04%) 0.00% (0.56%) (2.53%)
ALCO Policy (6.00%) (3.00%) 0.00% (4.00%) (8.00%)
EFFECT OF INTEREST RATE FLUCTUATIONS
The Bank's consolidated results of operations depend to a large extent
on the level of its net interest income, which is the difference between
interest income earned on its loan and investment portfolios versus the interest
paid on deposits and borrowed funds. If the cost of funds increases faster than
the yield on its interest-earning assets, net interest income will be reduced.
The Bank measures its interest rate risk primarily using simulation analysis.
While the Bank uses various tools to monitor interest rate risk, it is
unable to predict future fluctuations in interest rates or the specific impact
thereof. The market value of most of the Bank's financial assets is sensitive to
fluctuations in market interest rates. Fixed-rate investments including mortgage
loans and mortgage-backed securities decline in value as interest rates rise.
Adjustable-rate loans and securities generally have less market value volatility
than do fixed-rate products.
16
LIQUIDITY
The Bank maintains certain levels of liquid assets (the most liquid of
which are cash and cash equivalents and investment securities) in order to meet
demands from loan commitments, savings withdrawals and other obligations. The
Bank manages liquidity by maintaining a portion of its liquid assets in
overnight accounts and by keeping various maturities in its portfolio of
investment securities. The primary sources of liquidity are loan repayments and
sales, maturing investments, deposit accounts, and FHLB borrowings.
The Bank's liquidity ratio (liquid assets to net withdrawable deposits
plus short-term borrowings) was 12.97% at December 31, 2001.
ACQUISITIONS
In January 2000, Oakleaf Financial Service, Inc., previously SFB
Agency, Inc., acquired McKillen Financial, Inc., an investment brokerage firm,
for $475,000. (See Note 15 of the Notes to Consolidated Financial Statements).
This acquisition has been accounted for using the purchase method and operations
have been included in the Bank's consolidated financial statements.
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, Statement of Financial Accounting Standard No. 133 (FAS
133), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES was issued
and became effective for fiscal years beginning after June 2000. FAS 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. The accounting for derivatives had no effect on the bank.
In June 2001, Statement of Financial Accounting Standards No. 142 (FAS
142), GOODWILL AND OTHER INTANGIBLE ASSETS was issued and is effective for
fiscal years beginning after December 15, 2001. Under FAS 142, identifiable
intangible assets that meet certain criteria will continue to be amortized over
their estimated useful lives. However, goodwill and non-identifiable intangible
assets will no longer be amortized. Instead, these assets will be evaluated for
impairment on an annual basis. If an asset is deemed to be impaired, the asset
will be written down through an adjustment to current earnings. As a result of
adopting FAS 142, the Bank will no longer be amortizing goodwill.
RECENT LEGISLATION
Financial Services Modernization - Gramm-Leach-Bliley Act of 1999
In 1999, the Gramm-Leach-Bliley Act of 1999 was passed by Congress and
was signed into law by the President on November 12, 1999. This Act represents a
broad reform of federal regulation of financial services. Enactment of this Act
makes it easier for affiliations between banks, securities firms and insurance
companies to take place and provides for functional regulation of these
entities.
17
While this new Act repeals certain pre-existing legislation preventing
cross-industry affiliations and provides a framework for achieving the Act's
purposes, many details of implementing the changes authorized by the Act will be
the subject of regulations to be adopted in the future by the Federal Reserve
Board, the Securities and Exchange Commission, and other relevant federal
agencies.
Although the Act is designed to increase competition and could have a
long-range impact on the competition of the Bank, the management of the Bank
believes that there will be no immediate impact on the Bank's performance.
18
DIRECTORS OF THE BANK
Raymond H. Dresser, Jr. Chairman, Dresser, Dresser, Haas & Caywood, P.C.
Retained Counsel
Eric L. Eishen Executive Vice President and Chief Operating
Officer
Leonard L. Eishen President and Chief Executive Officer
Lawrence A. Franks President, Burr Oak Tool and Gauge Company, Inc.
Donald L. Frost President, LTI Printing, Inc.
James A. Goethals Chairman of the Board
President, Sturgis Foundry Corporation - Retired
Gary J. Malloy President, Sturgis Machining, Inc.
Philip G. Ward President Emeritus, Glen Oaks Community College
OFFICERS OF THE BANK
Leonard L. Eishen President, Chief Executive Officer
Eric L. Eishen Executive Vice President, Chief Operating Officer
Brian P. Hoggatt Vice President, Chief Financial Officer, Treasurer
Tracey L. Parker First Vice President, Retail Lending
Ronald W. Scheske Senior Vice President, Commercial Accounts
David E. Watters Vice President, Senior Trust Officer
Donald G. Baldwin Vice President, Operations, Compliance Officer
Debora L. Capman Vice President, Trust Officer
Emily D. Haller Vice President, Human Resources
Steven A. Haller Vice President. Branch Administrator
Jason J. Hyska Vice President
Robert F. McClary Vice President
Gary E. Metz Vice President
Kurt G. Miller Vice President, Commercial Loan Manager
Larry W. Miller Vice President
Verlan G. Miller Vice President
Christine M. Moline Vice President, Private Banking
David L. Pierce Vice President
Joyce L. Waltke Corporate Secretary
Jose D. Albarran Assistant Vice President
Sandra J. Cagle Assistant Vice President
Trudy R. Gloy Assistant Vice President
Stacie L. Ogg Assistant Vice President
Jason A. Wagner Assistant Vice President
19
BANK CORPORATE INFORMATION
LOCATION ADDRESS CITY, ST ZIP TELEPHONE FAX
-------- ------- ------------ --------- ---
Sturgis (Main Office) 113-125 East Chicago Road Sturgis, MI 49091 (616) 651-9345 (616) 651-5512
(616) 651-8263
BRANCH OFFICES
Bronson 863 West Chicago Road Bronson, MI 49028 (517) 369-7322 (517) 369-2347
Centreville 158 West Main Centreville, MI 49032 (616) 467-8525 (616) 467-4180
Climax 125 North Main Climax, MI 49034 (616) 746-4256 (616) 746-4108
Coldwater 290 East Chicago Road Coldwater, MI 49036 (517) 278-5634 (517) 278-5613
Colon 110 South Blackstone Street Colon, MI 49040 (616) 432-3229 (616) 432-2971
South Haven 1121 LaGrange Street South Haven, MI 49090 (616) 637-8444 (616) 637-5560
Sturgis 1001 South Centerville Road Sturgis, MI 49091 (616) 651-9379 (616) 651-1514
Sturgis 1501 East Chicago Road Sturgis, MI 49091 (616) 651-9345 (616) 651-5609
Three Rivers 115 North Main Street Three Rivers, MI 49093 (616) 273-8481 (616) 273-1732
White Pigeon 122 West Chicago Road White Pigeon, MI 49099 (616) 483-9668 (616) 483-2725
20
MARKET INFORMATION
Shares of common stock of the Company were held by 422 shareholders of record as
of December 31, 2001 according to the Company's transfer agent (as of December
31, the shares were still technically of the Bank and were traded under the
symbol "STUR"). The Company's shares are traded in the over-the-counter market
by a limited number of brokers under the symbol of "STBI". There has been no
well-established public trading market for these shares, trading activity has
been infrequent, and previous price information had not been regularly
published. After the October 1994 secondary public offering, the Company's
common stock began to be listed on the National Association of Securities
Dealers, Inc. Over the Counter Bulletin Board, an electronic bulletin board
maintained by the National Association of Securities Dealers, Inc. However,
there can be no assurance that an active and liquid trading market for the
common stock will develop.
The range of high and low trade prices for each quarterly period during the past
two years is presented below:
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
----------------------- ------------------
HIGH LOW HIGH LOW
First quarter $ 6.50 $ 4.88 $ 8.75 $ 5.00
Second quarter 7.00 5.84 6.75 5.250
Third quarter 8.99 6.27 7.13 5.50
Fourth quarter 9.49 7.25 7.06 5.00
The trade prices listed above are based on actual transactions obtained from
public Internet sources obtained by the Bank.
The following table summarizes cash dividends paid per share of common stock for
each quarterly period during 2001 and 2000.
2001 2000
-------------------
First quarter $.06 $.05
Second quarter .06 .05
Third quarter .07 .06
Fourth quarter .07 .06
-------------------
$.26 $.22
On December 11, 2001, the shareholders of the Bank approved the reorganization
of the Bank to become a wholly owned subsidiary of Sturgis Bancorp, Inc., a
financial holding company. Sturgis Bancorp, Inc. is a financial holding company
under the Bank Holding Company Act of 1956, as amended (the "Company"). This
reorganization was approved at a special meeting of the shareholders of the Bank
on December 11, 2001. The necessary affirmative vote of the
21
holders of at least two-thirds (2/3) of the Bank common stock (of which
3,101,534 shares were outstanding on October 30th, 2001 the record date for the
meeting) was obtained. Prior to the special meeting of the shareholders of the
Bank and the Company received the necessary approvals from the Board of
Governors of the Federal Reserve and the Federal Deposit Insurance Corporation.
On December 21, 2001, the Michigan Department of Consumer and Industry Services,
Office of Financial and Insurance Services, Division of Financial Institutions
approved the consolidation to complete the consummation of the Company acquiring
one hundred percent of the issued and outstanding common stock of the Bank.
This reorganization became effective as of the opening of business on January 1,
2002. The Company is a legal entity separate and distinct from its subsidiaries.
Substantially all of the Company's revenues will result from dividends paid to
it by the Bank and from earnings on investments. There are statutory and
regulatory requirements applicable to the payment of dividends by the Bank as
well as by the Company to its shareholders.
Under the Michigan Savings Bank Act, the Company may not declare a cash dividend
or a dividend of any kind except out of net income then on hand after deducting
all losses and bad debts, and then only if it will have a surplus amounting to
not less than 20% of its capital after the payment of the dividend. Moreover,
the Bank may not declare or pay any cash dividend or dividend in kind until the
cumulative dividends on its preferred stock, if any, have been paid in full.
Further, if the surplus of the Bank is at any time less than the amount of its
capital, before the declaration of a cash dividend or dividend in kind, it must
transfer to surplus not less than 10% of its net income for the preceding 6
months (in the case of quarterly or semi-annual dividends) or the preceding two
consecutive 6 month periods (in the case of annual dividends).
Pursuant to the Michigan Business Corporation Act, the Company may not make
distributions to its shareholders if, after giving effect to the distribution,
the corporation would not be able to pay its debts as they become due in the
usual course of business, or the corporation's total assets would be less than
the sum of it total liabilities plus, unless the corporation's articles of
incorporation permit otherwise, the amount that would be needed, if the
corporation were to be dissolved at the time of the distribution, to satisfy the
preferential rights upon dissolution of shareholders whose preferential rights
are superior to those receiving the distribution.
The payment of dividends by the Company and its subsidiaries may also be
affected or limited by other factors, such as the requirements to maintain
adequate capital above regulatory guidelines. In addition, if, in the opinion of
the applicable regulatory authority, a bank under its jurisdiction is engaged in
or is about to engage in an unsafe or unsound practice (which, depending on the
financial condition of the Bank, could include the payment of dividends), such
authority may require, after notice and hearing, that such bank cease and desist
from such practice or prohibit the payment of future dividends. The Federal
Reserve has indicated that paying dividends that deplete a bank's capital base
to an inadequate level would be an unsafe and unsound banking practice. The
Federal Reserve, the FDIC and the Division of Financial Institutions of the
Michigan Department of Consumer & Industry Services Office of Financial and
Insurance Services ("DFI") have issued policy statements which provide that bank
holding companies and insured banks should generally only pay dividends out of
current operating earnings.
22
INDEPENDENT ACCOUNTANTS
-----------------------
The Company has employed the accounting firm of Plante & Moran, LLP as
Independent Accountants for the years ended December 31, 2001, 2000 and 1999.
There have been no disagreements on accounting or financial disclosure matters
within this time period.
FORM 10-K REPORT
----------------
A copy of the Company's Annual Report on Form 10-K, as filed with the Securities
Exchange Commission, for the year ended December 31, 2001, as well as other
filings of the Company may be obtained by contacting Leonard L. Eishen at
Sturgis Bank & Trust Company, 113-125 East Chicago Road, Sturgis, Michigan
49091, telephone number (616) 651-9345 or through the Securities and Exchange
Commission Edgar System at WWW.SEC.GOV. Copies of the Bank's filings with the
FDIC under the Securities Exchange Act of 1934 can be obtained from Sturgis Bank
& Trust Company by contacting Leonard L. Eishen at Sturgis Bank & Trust Company,
113-125 E Chicago Road, Sturgis, Michigan 49091, telephone number (616) 651-9345
or, for a nominal fee from Ms. Marcia Fields at the FDIC telephone number (202)
898-8913 or fax number (202) 898-3909.
23
[LOGO] PLANTE PLANT & MORAN, LLP
MORAN Suite 700
107 W. Michigan Ave.
Kalamazoo, MI 49007
Tel: 616.385.1858
Fax: 616.385.2936
www.plantemoran.com
Independent Auditor's Report
To the Board of Directors
Sturgis Bank & Trust Co. and Subsidiaries
Sturgis, Michigan
We have audited the accompanying consolidated balance sheet of Sturgis Bank &
Trust Co. and subsidiaries (collectively, the "Bank") as of December 31, 2001
and 2000 and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each year in the three-year period ended
December 31 2001. These consolidated financial statements are the responsibility
of the Bank'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 audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the 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 Sturgis
Bank & Trust Co. and subsidiaries as of December 31, 2001 and 2000 and the
consolidated results of their operations and their cash flows for each year in
the three-year period ended December 31, 2001 in conformity with accounting
[LOGO] PLANTE PLANT & MORAN, LLP
MORAN Suite 700
107 W. Michigan Ave.
Kalamazoo, MI 49007
Tel: 616.385.1858
Fax: 616.385.2936
www.plantemoran.com
principles generally accepted in the United States of America.
Kalamazoo, Michigan
February 8, 2002, except for Note 16, as to
which the date is March 11, 2002
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ----------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31
--------------------------------------
2001 2000
--------------- ---------------
ASSETS
Cash and due from banks $ 10,629,027 $ 12,186,572
Interest-bearing deposits in banks 15,042,616 6,880,000
Other short-term investments 259,735 392,349
Securities- Held-to-maturity (Note 2) 3,904,413 7,335,947
Federal Home Loan Bank stock, at cost 4,115,400 3,497,500
Loans held for sale 4,414,906 617,000
Loans, net (Note 3) 219,113,940 223,574,073
Real estate owned 451,173 103,500
Bank owned life insurance 6,002,959 -
Accrued interest receivable 1,724,681 1,867,206
Investment in limited partnerships 224,080 242,080
Premises and equipment, net (Note 5) 6,370,160 7,088,314
Goodwill, net of accumulated amortization (Note 13) 5,109,419 5,684,283
Originated mortgage servicing rights (Note 4) 1,281,208 841,096
Other assets 1,145,555 806,569
--------------- ---------------
Total assets $ 279,789,272 $ 271,116,489
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 9,335,727 $ 9,837,187
Interest bearing (Note 6) 168,266,933 164,018,137
Federal Home Loan Bank advances (Note 7) 70,076,863 67,410,376
Deferred federal income taxes (Note 8) 248,333 250,000
Accrued interest payable 993,783 1,029,141
Other liabilities 2,370,699 2,056,252
--------------- ---------------
Total liabilities 251,292,338 244,601,093
STOCKHOLDERS' EQUITY E(Notes 10 and 11) Common stock - $1 par value:
Authorized - 4,000,000 shares
Issued and outstanding - 3,101,534 shares 3,101,534 3,101,534
Additional paid-in capital 20,435,912 10,435,912
Retained earnings 4,959,488 12,977,950
--------------- ---------------
Total stockholders' equity 28,496,934 26,515,396
--------------- ---------------
Total liabilities and stockholders' equity $ 279,789,272 $ 271,116,489
See Notes to Consolidated
Financial Statements
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31
--------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
INTEREST INCOME
Loans $ 18,276,561 $ 18,097,475 $ 15,591,033
Mortgage-backed securities 74,935 87,076 97,324
Investments 537,388 880,876 964,495
Interest-bearing deposits 1,049,583 73,497 310,757
-------------- -------------- --------------
Total interest income 19,938,467 19,138,924 16,963,609
INTEREST EXPENSE
Deposits 6,369,577 6,886,005 6,363,972
FHLB advances 4,031,835 3,640,197 2,309,307
-------------- -------------- --------------
Total interest expense 10,401,412 10,526,202 8,673,279
-------------- -------------- --------------
NET INTEREST INCOME 9,537,055 8,612,722 8,290,330
PROVISION FOR LOAN LOSSES (Note 3) 1,056,194 309,000 104,000
-------------- -------------- --------------
NET INTEREST INCOME - After provision for loan losses 8,480,861 8,303,722 8,186,330
NONINTEREST INCOME
Service charges and other fees 1,393,620 1,883,043 1,574,321
Commission income 796,688 691,776 363,138
Mortgage banking activities 1,749,788 224,930 608,557
Trust fee income 492,803 465,737 405,309
Other income 49,881 95,629 70,314
-------------- -------------- --------------
Total noninterest income 4,482,780 3,361,115 3,021,639
NONINTEREST EXPENSES
Salaries and employee benefits (Note 9) 4,011,629 4,015,290 3,730,898
Occupancy and equipment 1,408,876 1,370,974 1,333,996
Deposit insurance premiums 33,601 35,532 102,151
Deposit account expenses 227,384 328,544 473,613
Service bureau expense 592,805 569,490 577,528
Professional services 367,586 606,206 371,135
Amortization of intangibles 574,864 587,979 565,698
Other 1,656,058 1,568,488 1,361,501
-------------- -------------- --------------
Total noninterest expenses 8,872,803 9,082,503 8,516,520
-------------- -------------- --------------
INCOME - Before income tax expense 4,090,838 2,582,334 2,691,449
INCOME TAXES (Note 8) 1,302,901 765,468 688,000
-------------- -------------- --------------
NET INCOME $ 2,787,937 $ 1,816,866 $ 2,003,449
============== ============== ==============
BASIC EARNINGS PER SHARE $ 0.90 $ 0.59 $ 0.65
============== ============== ==============
DILUTED EARNINGS PER SHARE $ 0.90 $ 0.59 $ 0.65
============== ============== ==============
See Notes to Consolidated
Financial Statements
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- -----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Paid- Retained Stockholders'
Common Stock in Capital Earnings Equity
------------ ------------ ------------- --------------
BALANCE- January 1, 1999 $ 3,094,779 $ 10,428,377 $ 10,427,664 $ 23,950,820
Exercise of stock options (Note 10) 107 555 - 662
Net income for the year ended December 31, 1999 - - 2,003,449 2,003,449
Expenses from the sale of common stock (Note 10) - (19,300) - (19,300)
Cash dividends ($.19 per share) - - (588,024) (588,024)
------------ ------------ ------------- --------------
BALANCE- December 31, 1999 3,094,886 10,409,632 11,843,089 25,347,607
Exercise of stock options (Note 10) 6,648 26,280 - 32,928
Net income for the year ended December 31, 2000 - - 1,816,866 1,816,866
Cash dividends ($.22 per share) - - (682,005) (682,005)
------------ ------------ ------------- --------------
BALANCE- December 31, 2000 3,101,534 10,435,912 12,977,950 26,515,396
Transfer of retained earnings to additional paid-in capital - 10,000,000 (10,000,000) -
Net income for the year ended December 31, 2001 - - 2,787,937 2,787,937
Cash dividends ($.26 per share) - - (806,399) (806,399)
------------ ------------ ------------- --------------
BALANCE- December 31, 2001 $ 3,101,534 $ 20,435,912 $ 4,959,488 $ 28,496,934
See Notes to Consolidated
Financial Statements
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31
-------------------------------------------------
2001 2000 1999
-------------- ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,787,937 $ 1,816,866 $ 2,003,449
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation 670,844 701,580 702,413
Amortization of ntangi bles 1,100,901 673,265 618,179
Provision for loan losses 1,056,194 309,000 104,000
Deferred income tax expense (benefit) (1,667) - 194,000
Premiums and discounts on investment and
mortgage-backed securities 3,040 20,233 34,873
Gain on sale of loans (783,640) (114,610) (359,213)
Proceeds from the sale of loans held for sale 74,319,076 13,883,962 23,217,127
Loans originated for sale (77,333,342) (14,356,352) (19,149,144)
Loss on disposal of premises and equipment 74,110 109,764 -
Loss of equity in limited partnership 18,000 18,000 18,000
Income from bank owned life insurance (2,959) - -
Changes in assets and liabilities:
(Increase) decrease in accrued interest and other assets (1,510,283) 100,315 (1,135,449)
Increase (decrease) in accrued interest and other liabilities 230,202 (121,863) 962,738
-------------- ------------ -------------
Net cash provided by operating activities 628,413 3,040,160 7,210,973
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest-bearing deposits in banks (8,162,616) (6,880,000) -
Proceeds from maturities of securities held-to-maturity 4,630,000 7,230,000 3,205,000
Purchases of securities held-to-maturity (1,425,000) (1,675,000) (3,045,000)
Principal reductions of mortgage-backed securities 223,494 252,154 467,392
Purchase of Federal Home Loan Bank stock (617,900) (274,700) -
Proceeds (purchase) of other securities 132,614 66,539 8,587,138
Net (increase) decrease in loans 3,403,939 (17,618,051) (28,278,203)
Purchases of premises and equipment (381,990) (720,115) (311,681)
Proceeds from the sale of premises and equipment 355,190 25,026 -
Purchased goodwil from the acquisition of investment broker - (475,000) -
Purchase of bank owned life insurance (6,000,000)
Cash (refunded) received in acquisitions of branches - - (50,320)
-------------- ------------ -------------
Net cash used in investing activities (7,842,269) (20,069,147) (19,425,674)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand and savings account deposits 8,608,837 (60,555) (1,643,868)
Net increase (decrease) in certificates of deposit (4,861,501) 10,236,030 (7,115,844)
Repayment of FHLB advances (36,433,513) (24,557,840) (3,054,268)
Proceeds from FHLB advances 39,100,000 32,854,826 23,506,029
Increase (decrease) in advances for taxes and insurance 48,887 1,783 (145,558)
Expenses from sale of common stock - - (19,300)
Dividends paid (806,399) (682,005) (588,024)
Exercise of stock options - 32,928 662
-------------- ------------ -------------
Net cash provided by fnanci ng activities 5,656,311 17,825,167 10,939,829
-------------- ------------ -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,557,545) 796,180 (1,274,872)
CASH AND CASH EQUIVALENTS - Beginning of year 12,186,572 11,390,392 12,665,264
-------------- ------------ -------------
CASH AND CASH EQUIVALENTS - End of year $ 10,629,027 $ 12,186,572 $ 11,390,392
============== ============ =============
See Notes to Consolidated
Financial Statements
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION - The consolidated financial
statements include the accounts of Sturgis Bank & Trust Co. (the Bank)
and its wholly owned subsidiaries, Oakleaf Financial Services, Inc.
(previously SFB Agency), Ludington Service Corporation, First Michiana
Development Corporation of Sturgis, and Oak Mortgage, LLC. All
significant intercompany transactions and balances have been eliminated
in consolidation.
The Bank formed Sturgis Bancorp, Inc., a holding company on January 1,
2002. Effective January 1, 2002, the Bank will become a wholly owned
subsidiary of the holding company.
USE OF ESTIMATES - The accounting and reporting policies of the Bank
and its subsidiaries conform to accounting principles generally
accepted in the United States of America. Management is required to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could
differ from these estimates and assumptions.
NATURE OF OPERATIONS - The Bank, a state-chartered stock savings bank
and member of the Federal Home Loan Bank System (FHLB), is required to
maintain an investment in the capital stock of the FHLB. The Bank
operates predominately in the south-central portion of Michigan's lower
peninsula. The Bank's primary services include accepting deposits,
making commercial and mortgage loans, engaging in mortgage banking
activities, and providing investment brokerage advisory services.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK - Most of the Bank's
activities are with customers located within Michigan. Note 2 discusses
the types of securities the Bank invests in. Note 3 discusses the types
of lending that the Bank engages in. The Bank's loan portfolio is
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
concentrated in residential first-mortgage loans. The Bank is not
dependent upon any single industry or customer for its banking
opportunities.
CASH AND CASH EQUIVALENTS - For the purpose of the consolidated
statements of cash flows, cash and cash equivalents include cash and
amounts due from banks.
INTEREST-BEARING DEPOSITS IN BANKS - Interest-bearing deposits in banks
mature within three years and are carried at cost.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SECURITIES - Debt securities that management has the positive intent
and ability to hold to maturity are classified as "held to maturity"
and recorded at amortized cost.
Purchase premiums and discounts are recognized in interest income using
the interest method over the terms of the securities. Declines in the
fair value of held to maturity securities below their cost that are
deemed to be other that temporary are reflected in earnings as realized
losses.
FEDERAL HOME LOAN BANK STOCK - The Bank's minimum investment in the
stock of the Federal Home Loan Bank of Indianapolis (FHLB) is an amount
equal to at least one percent of the unpaid principal balances of the
Bank's residential mortgage loans or 0.3 percent of its total assets,
whichever is greater. Purchases and sales of stock are made directly
with the FHLB at par value and are recorded at cost.
LOANS HELD FOR SALE - Loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair
value in the aggregate. Net unrealized losses, if any, are recognized
in a valuation allowance by charges to income.
LOANS - The Bank grants mortgage, commercial and consumer loans to
customers. Loans are reported at their outstanding unpaid principal
balances adjusted for charge-offs, the allowance for loan losses, and
any deferred fees or costs on originated loans. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of
certain direct origination costs, are deferred and recognized as an
adjustment of the related loan yield using the interest method.
The accrual of interest on loans is discontinued at the time the loan
is 90 days delinquent unless the credit is well-secured and in process
of collection. In all cases, loans are placed on nonaccrual or
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
charged-off at an earlier date if collection of principal or interest
is considered doubtful.
All interest accrued but not collected for loans that are placed on
nonaccrual or charged off is reversed against interest income. The
interest on these loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are
returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are
reasonably assured.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
a 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.
A loan is considered impaired when, based on current information and
events, it is probable that the Bank 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 circumstances surrounding the loan and the borrower, including
length of the delay, the reasons for the delay, the borrower's prior
payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
basis for commercial 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 homogeneous loans are collectively evaluated for
impairment. Accordingly, the Bank does not separately identify
individual consumer and residential loans for impairment disclosures.
CREDIT RELATED FINANCIAL INSTRUMENTS - In the ordinary course of
business, the Bank has entered into commitments to extend credit,
including commitments under commercial letters of credit and standby
letters of credit. Such financial instruments are recorded when they
are funded.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADOPTION OF FAS 133 - On January 1, 2001, the Bank adopted Statement of
Financial Accounting Standards No. 133 (FAS 133), "Accounting for
Derivative Instruments and Hedging Activities." FAS 133 requires that
all derivative instruments be recorded on the balance sheet at their
fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and,
if it is, the type of hedge transaction. The accounting for derivatives
had no effect on the financial statements.
ADOPTION OF FAS 142 - On January 1, 2002, the Bank will adopt Statement
of Financial Accounting Standards No. 142 (FAS 142), accounting for
"Goodwill and Other Intangible Assets". Under FAS 142, identifiable
intangible assets that meet certain criteria will continue to be
amortized over their estimated useful lives. However, goodwill and
non-identifiable intangible assets will no longer be amortized.
Instead, these assets will be evaluated for impairment on an annual
basis. If an asset is deemed to be impaired, the asset will be written
down through an adjustment to current earnings. As a result of adopting
FAS 142, the Bank will no longer be amortizing goodwill.
REAL ESTATE OWNED - Assets acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair value
at the date of the foreclosure, establishing a new cost basis.
Subsequent to foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of carrying amount
or fair value less cost to sell. Revenue and expenses from operations
and changes in the valuation allowance are included in net expenses
from foreclosed assets.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
INVESTMENT IN LIMITED PARTNERSHIP - The Bank has an investment in a
Michigan limited partnership that is structured to generate low income
housing tax credits and an investment in a Michigan partnership
structured to generate commissions from the sale of title insurance.
Both of these investments are accounted for using the equity method
whereby the Bank annually records its proportionate share of
partnership losses as an adjustment to the carrying value of the
investment.
PREMISES AND EQUIPMENT - Land is carried at cost. Premises and
equipment are carried at cost, less accumulated depreciation computed
on the straight-line method over the estimated useful lives of the
assets.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL - Goodwill is currently being amortized using accelerated
methods over fifteen years. Beginning in January of 2002, the Bank will
no longer amortize goodwill in accordance with FAS 142. Amortization of
goodwill amounted to $574,864, $587,979 and $565,698 for the years
ended December 31, 2001, 2000 and 1999, respectively.
On an ongoing basis, management assesses the recoverability of the
goodwill. If an assessment of the goodwill indicates that its
recoverability is impaired, a charge to expense is recorded for the
amount of the impairment.
SERVICING - Servicing assets are recognized as separate assets when
rights are acquired through purchase or through sale of financial
assets. Capitalized servicing rights are reported in other assets and
are amortized into noninterest income in proportion to, and over the
period of, the estimated future net servicing income of the underlying
financial assets. 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.
INCOME TAXES - Deferred tax assets and liabilities are recognized for
temporary differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized.
The Bank has qualified under provisions of the Internal Revenue Code
which permit it to deduct from taxable income a provision for bad debts
in excess of such provision charged to income in the consolidated
financial statements. Accordingly, retained earnings at December 31,
2001 and 2000 includes approximately $918,000 for which no provision
for federal income taxes has been made. Unrecognized deferred taxes on
this amount is approximately $312,000. If, in the future, this portion
of retained earnings is used for any purpose other than to absorb bad
debt losses, federal income taxes would be imposed at the then
applicable rates.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK COMPENSATION PLANS - The Bank has chosen to measure compensation
cost for employee stock compensation plans using the intrinsic value
based method of accounting, whereby compensation cost is the excess, if
any, of the quoted market price of the stock at the grant date (or
other measurement date) over the amount an employee must pay to acquire
the stock. Stock options issued under the Bank's stock option plan have
no intrinsic value at the grant date, and no compensation cost is
recognized for them. The fair value based method of accounting for
employee stock compensation plans, measures compensation cost at the
grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. The Bank has
provided pro forma disclosures of net income and earnings per share and
other disclosures, as if the fair value based method of accounting has
been applied. The pro forma disclosures include the effects of all
awards granted on or after January 1, 1995. (See Note 10.)
EARNINGS PER SHARE - Basic earnings per share represents income
available to common stockholders divided by the weighted-average number
of common shares outstanding during the period. Diluted earnings per
share reflects additional common shares that would have been
outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the Bank relate
solely to outstanding stock options, and are determined using the
treasury stock method.
Earnings per share have been computed based on the following:
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
-------------- ------------- -------------
Net Income $ 2,787,937 $ 1,816,866 $ 2,003,449
============== ============= =============
Weighted average number of common
shares outstanding 3,101,534 3,099,630 3,094,854
Effect of dilutive options - - 4,649
-------------- ------------- -------------
Weighted average number of common
shares outstanding used to calculate
diluted earnings per share 3,101,534 3,099,630 3,099,503
============== ============= =============
All weighted-average number of common shares outstanding have been retroactively
adjusted for stock splits. Supplemental Cash Flow Information
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CLASSIFICATION - Certain amounts in the 2000 and 1999 financial
statements have been reclassified to conform to the 2001
presentation.
SUPPLEMENTAL CASH FLOW INFORMATION
2001 2000 1999
-------------- ------------- -------------
Cash paid for:
Interest $ 10,436,770 $ 10,449,594 $ 8,701,841
Income taxes 1,730,136 386,000 948,656
Noncash investing and financing activities:
Loans transferred to real estate owned 847,550 352,274 755,000
Tax benefit of stock options exercised - 4,010 197
NOTE 2 - SECURITIES
The amortized cost and estimated fair value of held-to-maturity
securities are as follows at December 31, 2001 and 2000:
2001
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------- ----------- ------------ -------------
U.S. Treasury and agency
securities $ 549,996 $ 5,707 $ - $ 555,703
Obligations of states and
political subdivisions 2,320,298 39,876 (680) 2,359,494
Mortgage-backed securities 1,034,119 9,748 (4,922) 1,038,945
------------- --------- ---------- -------------
Total investment securities $ 3,904,413 $ 55,331 $ (5,602) $ 3,954,142
============= ========= ========== =============
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 2 - SECURITIES (CONTINUED)
2000
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------- ----------- ------------ -------------
U.S. Treasury and agency
securities $ 4,439,731 $ 7,747 $ (11,462) $ 4,436,016
Obligations of states and
political subdivisions 1,634,631 25,146 (150) 1,659,627
Mortgage-backed securities 1,261,585 8,062 (788) 1,268,859
------------- ---------- ----------- -------------
Total investment securities $ 7,335,947 $ 40,955 $ (12,400) $ 7,364,502
============= ========== =========== =============
The amortized cost and fair value of securities, by contractual
maturity (except for mortgage-backed securities), at December 31, 2001,
are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
------------- ------------
Held to maturity securities:
Due in one year or less $ 605,853 $ 608,656
Due in one through five years 1,501,070 1,527,388
Due after five years through ten years 763,372 779,154
Due after ten years - -
------------- ------------
Total 2,870,295 2,915,198
Mortgage-backed securities 1,034,119 1,038,945
------------- ------------
Total $ 3,904,414 $ 3,954,143
============= ============
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 3 - LOANS
A summary of the balances of loans follows:
2001 2000
-------------- --------------
Mortgage loans on real estate:
Residential 1-4 family $ 151,766,803 $ 163,175,572
Commercial 34,872,863 26,215,726
Construction 8,371,916 5,092,171
195,011,582 194,483,469
-------------- --------------
Commercial Loans 12,906,602 12,780,883
Consumer installment loans:
Consumer and installment 15,299,376 18,189,077
Other 571,739 420,711
-------------- --------------
15,871,115 18,609,788
-------------- --------------
Subtotal 223,789,299 225,874,140
Less:
Allowance for loan losses 1,300,000 803,744
Unearned interest 26,013 35,043
Undisbursed portion of loans in process 3,257,555 1,212,498
Deferred loan origination and other fees 91,791 248,782
-------------- --------------
Loans, net $ 219,113,940 $ 223,574,073
============== ==============
An analysis of the allowance for loan losses follows:
2001 2000 1999
----------- --------- ----------
BALANCE - Beginning of year $ 803,744 $ 730,000 $ 686,896
Provision for loan losses 1,056,194 309,000 104,000
Loans charged off (607,217) (838,500) (142,891)
Recoveries of loans previously
charged off 47,279 603,244 81,995
----------- --------- ----------
BALANCE - End of year $ 1,300,000 $ 803,744 $ 730,000
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 3 - LOANS (CONTINUED)
The following is a summary of information pertaining to impaired loans:
2001 2000
------------- ------------
Impaired loans with a valuation
allowance $ 1,071,876 $ 858,671
============= ============
Valuation allowance related to
impaired loans $ 91,881 $ 18,552
============= ============
2001 2000 1999
--------------- ---------------- ----------------
Average investment in
impaired loans $ 965,274 $ 607,345 $ 399,533
=========== ============ ===========
Interest income recognized
on impaired loans $ 24,115 $ 45,228 $ 54,481
=========== ============ ===========
Interest income recognized ona
cash basis on impaired loans $ 24,115 $ 30,977 $ 49,861
=========== ============ ===========
No additional funds are committed to be advanced in connection with
impaired loans.
NOTE 4 - SERVICING
Loans serviced for others are not included in the accompanying
consolidated balance sheet. The unpaid principal balance of mortgages
and other loans serviced for others were $134,800,000 and $98,100,000
at December 31, 2001 and 2000, respectively.
The following summarizes mortgage servicing rights capitalized and
amortized:
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------- ------------ ------------
Mortgage servicing rights - Beginning $ 841,096 $ 745,890 $ 496,548
Mortgage servicing rights capitalized 966,148 180,492 301,823
Mortgage servicing rights amortized (526,036) (85,286) (52,481)
------------- ------------ ------------
Mortgage servicing rights - Ending $ 1,281,208 $ 841,096 $ 745,890
============= ============ ============
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 5 - PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and
equipment follows:
2001 2000
----------------- ---------------
Land $ 666,993 $ 786,468
Land improvements 40,489 36,732
Office buildings 5,633,932 5,571,174
Furniture, fixtures and equipment 4,185,924 3,740,269
Construction in progress 48,269 581,935
------------- -------------
Total bank premises and equipment 10,575,607 10,716,578
Less accumulated depreciation (4,205,447) (3,628,264)
------------- -------------
Net carrying amount $ 6,370,160 $ 7,088,314
============= =============
NOTE 6 - DEPOSITS
Interst bearing deposits at December 31 are summarized as follows:
2001 2000
-------------- ---------------
Passbook and savings deposits $ 38,075,301 $ 35,512,231
NOW accounts 49,406,921 42,859,694
Time:
$100,000 and over 15,096,975 14,644,500
Under $100,000 65,687,736 71,001,712
Total interest-bearing $ 168,266,933 $ 164,018,137
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 6 - DEPOSITS
Interest bearing deposit balances at December 31 are summarized as
follows:
$100,000 and
Over Under $100,000
--------------- ---------------
2002 $ 9,411,089 $ 36,882,950
2003 3,329,309 15,094,797
2004 716,184 4,348,651
2005 1,017,229 6,040,352
2006 207,240 1,738,278
2007 and thereafter 415,924 1,582,708
--------------- ---------------
Total $ 15,096,975 $ 65,687,736
=============== ===============
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis ("FHLB") are
collateralized by FHLB stock, all non-employee residential mortgage
loans, certain U.S. Treasury and agency securities and mortgage-backed
securities issued or guaranteed by the Federal Home Loan Mortgage
Corporation, the Federal National Mortgage Association or the
Government National Mortgage Association. Total short-term advances,
including advances under a separate line of credit with the FHLB,
consisted of approximately $6,000,000 at December 31, 2001 at an
interest rate of 5.12% with an average balance for the year of
approximately $9,468,255 and an average interest rate of 5%. Total
short-term advances, including advances under a separate line of credit
with the FHLB, consisted of approximately $9,560,000 at December 31,
2000 at variable interest rates ranging from 6.16% to 6.30% at December
31, 2000 with an average balance for the year of approximately
$9,675,000 and an average interest rate of 6.81%.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
In addition to advances received under a master "Advances, Pledge and
Security Agreement" with the FHLB, the Bank also has an available line
of credit with the FHLB which provides for additional funds of up to
$10,000,000 at December 31, 2001 and expires in March, 2002. Advances
outstanding under the line of credit bear interest at a rate of
approximately 50 basis points over the rate paid by the FHLB on their
time deposits (an effective rate of 1.82% and 6.30% at December 31,
2001 and 2000, respectively). Included in the above total short-term
advances is an oustanding balance on the line of credit of $0 at
December 31, 2001 and approximately $7,460,000 at December 31, 2000.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES (CONTINUED)
The Bank had approximately $64,076,863 and $57,850,000 in long-term
advances from FHLB at December 31, 2001 and 2000, respectively.
Interest rates range from 4.20% to 7.34% with maturities ranging from
February 2002 to December 2011.
Annual payments of FHLB long-term advances are as follows:
2002 $ 16,367,374
2003 7,377,466
2004 3,428,740
2005 2,557,211
2006 3,346,072
2007 and thereafter 31,000,000
Total $ 64,076,863
The advances are subject to prepayment penalties subject to the
provisions and conditions of the credit policy of the Federal Home Loan
Bank.
NOTE 8 - FEDERAL INCOME TAXES
Sturgis Bank & Trust Co. and subsidiaries file a consolidated federal
income tax return. The following is a summary of the provision for
income taxes for the three years ended December 31:
2001 2000 1999
------------- ---------- -----------
Current expense $ 1,304,568 $ 765,468 $ 494,000
Deferred (benefit) expense (1,667) - 194,000
------------- ---------- -----------
Total income tax expense $ 1,302,901 $ 765,468 $ 688,000
============= ========== ===========
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 8 - FEDERAL INCOME TAXES (CONTINUED)
A reconciliation of the difference between total federal income tax
expense and the amount computed by applying the statutory tax rates to
income before income taxes is as follows:
2001 2000 1999
------------- ---------- -----------
Amount computed at statutory rates $ 1,390,885 $ 877,994 $ 915,100
Dividends received deduction (9,351) (14,944) (10,150)
Tax-exempt interest income (37,903) (28,054) (40,300)
Low income housing tax credits (75,000) (75,000) (75,000)
Other, net 34,270 5,472 (101,650)
------------- ---------- -----------
Total $ 1,302,901 $ 765,468 $ 688,000
============= ========== ===========
The details of the net deferred tax asset (liability) are as follows:
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
2001 2000
---------- ----------
Deferred tax assets:
Investments $ 33,333 $ 34,819
Allowance for loan losses 364,089 223,701
Amortization 124,008 112,962
Other 39,467 74,885
---------- ----------
Total deferred tax assets 560,897 446,367
Deferred tax liabilities:
Deferred loan fees (248,490) (329,631)
Mortgage servicing rights (435,610) (285,973)
Depreciation (94,368) (80,763)
Other (30,762) -
---------- ----------
Total deferred tax liabilities (809,230) (696,367)
Valuation allowance - -
---------- ----------
Net deferred tax labi lity $ (248,333) $ (250,000)
========== ==========
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 9 - RETIREMENT BENEFITS
The Bank is a participant in the multi-employer Financial Institutions
Retirement Fund (FIRF or the Plan), which covers substantially all of
its officers and employees. The defined benefit Plan, for all full-time
employees with one year of service, provides benefits based on basic
compensation and years of service. The Bank's contributions are
determined by FIRF and generally represent the normal cost of the Plan.
Specific Plan assets and accumulated benefit information for the Bank's
portion of the Fund are not available. Under the Employee Retirement
Income Security Act (ERISA), a contributor to a multi-employer pension
plan may be liable in the event of complete or partial withdrawal for
the benefit payments guaranteed under ERISA. The Bank has no present
intention to withdraw from the Fund. The expense of the Plan allocated
to the Bank for the years ended December 31, 2001, 2000 and 1999
amounted to $177,753, $185,326 and $130,523, respectively.
NOTE 10 - COMMON STOCK AND OPTIONS
In October 1998, the Bank sold 632,500 shares of its common stock in a
secondary public offering. Proceeds from the sale, net of costs
associated with the offering, totaled approximately $6 million.
Included in the Consolidated Statement of Changes in Equity for the
year ended December 31, 1999 is an adjustment for $19,300 of offering
costs incurred in this secondary public offering.
Effective May 1998, two of the Bank's three stock options plans,
formerly referred to as the "Director Plan" and the "Employee Plan",
expired. The remaining stock option plan, referred to as the "New
Director Plan", which expired on December 31, 1999, provided for the
granting of options to the Bank's directors. Options granted expire ten
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
years and one day following the date of grant unless an individual
ceases to be a director prior to that time for reasons other than death
or disability, in which case the options expire thirty days after
cessation of director status. If cessation of director status results
from death or disability, the options expire ninety days after
cessation of director status.
Options granted under the former Director Plan expire under the same
terms as the New Director Plan. Options granted under the former
Employee Plan expire five years after the date of grant, unless
employment is terminated prior to that time for reasons other than
death or disability, in which case the options expire 30 days after
termination or employment. If employment with the Bank is terminated by
reason of death or disability, the options expire ninety days after
termination of employment. One-third of the granted shares are
exercisable after one year, two-thirds after two years and one hundred
percent after three years.
NOTE 10 - COMMON STOCK AND OPTIONS (CONTINUED)
The following is a summary of the activity with respect to the Bank's
stock option plans for the years ended December 31, 2001, 2000, and
1999:
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
Weighted-
Average
Number of Exercise Price
Shares Per Share
----------- -----------------
Outstanding - January 1, 1999 142,060 $ 12.87
Granted 3,000 10.00
Cancelled (7,503) 13.08
Exercised (107) 4.35
---------- ------------
Outstanding - December 31, 1999 137,450 12.81
Granted - -
Cancelled (4,400) 11.69
Exercised (6,648) 4.35
---------- ------------
Outstanding - December 31, 2000 126,402 13.28
Granted - -
Cancelled (2,551) 13.56
Exercised - -
---------- ------------
Outstanding - December 31, 2001 123,851 $ 13.27
========== ============
At December 31, 2001, 2000, and 1999, options exercisable under the
Bank's stock options plans totaled 123,851, 94,272, and 63,478 shares,
respectively, and had weighted-average exercise prices per share of
$13.27, $12.93, and $11.77, respectively. For options outstanding at
December 31, 2001, the exercise price per share ranged from $9.00 to
$14.29 and the weighted-average remaining contractual life of the
options was approximately 78 months.
NOTE 10 - COMMON STOCK AND OPTIONS (CONTINUED)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes Option-Pricing Model with the following
weighted average assumptions used for options granted during 2000 and
1999:
Risk free interest rate - 5.67% Volatility rate - 28.03% to 29.49%
Expected life 4 to 6 years - Employee Plan Expected dividends - 1.33%
to 1.65% Expected life 6 to 7 years - Directo and New Director Plans
The Bank applies APB Opinion 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation cost
has been recognized. Had compensation cost for the Bank's stock option
plan been determined based on the fair value at the grant dates for
awards under the plan consistent with the method prescribed by FASB
Statement No. 123, the Bank's net income and earnings per share would
have been adjusted to the pro forma amounts indicated below:
Year ended December 31
--------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
Net Income As reported $ 2,787,937 $ 1,816,866 $ 2,003,449
Pro forma $ 2,570,856 $ 1,577,212 $ 1,764,320
Earnings Per Share As reported $ 0.90 $ 0.59 $ 0.65
Pro forma $ 0.83 $ 0.51 $ 0.57
Earnings Per Share As reported $ 0.90 $ 0.59 $ 0.65
Assuming Dilution Pro forma $ 0.83 $ 0.51 $ 0.57
NOTE 11 - MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to regulatory capital requirements administered by
federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
actions by regulators that, if undertaken, could have a direct material
effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk
weightings, and other factors.
NOTE 11 - MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios, which
are shown in the table below. Management believes, as of December 31,
2001 and 2000, that the Bank met all capital adequacy requirements to
which they are subject.
As of December 31, 2001, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well-capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well-capitalized, minimum capital amounts and ratios
must be maintained as shown in the following table. Management believes
that no conditions or events since that notification have changed the
Bank's capital category.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
For Capital
Actual Adequacy Purposes To be Well-capitalized
------------------- ------------------------ -------------------------
Amount Ratio Amount Ratio Amount Ratio
-------- --------- ---------- -------- ---------- ----------
AS OF DECEMBER 31, 2001:
Total capital (to risk-
weighted assets) $ 24,559 13.3% $ 14,739 > 8.0% $ 18,424 > 10.0%
Tier1 capital (to risk-
weighted assets) $ 23,259 12.6% $ 7,370 > 4.0% $ 11,054 > 6.0%
Tier1 capital (to adjusted
assets) $ 23,259 8.6% $ 10,859 > 4.0% $ 13,574 > 5.0%
Tangible capital (to tangible
assets) $ 23,259 8.5% $ 8,237 > 3.0% N/A N/A
AS OF DECEMBER 31, 2000:
Total capital (to risk-
weighted assets) $ 21,552 12.4% $ 13,870 > 8.0% $ 17,338 > 10.0%
Tier I capital (to risk-
weighted assets) $ 20,749 12.0% $ 6,935 > 4.0% $ 10,403 > 6.0%
Tier1 capital (to adjusted
assets) $ 20,749 8.1% $ 10,238 > 4.0% $ 12,797 > 5.0%
Tangible capital (to tangible
assets) $ 20,749 7.8% $ 7,960 > 3.0% N/A N/A
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 12 - OFF-BALANCE SHEET ACTIVITIES
CREDIT RELATED FINANCIAL INSTRUMENTS - The Bank is a party to credit
related financial instruments with off-balance sheet risk in the normal
course of business to meet the financing need of its customer. These
financial instruments include commitments to extend credit, standby
letters of credit and commercial letters of credit. Such commitments
involve, to varying degrees, elements of credit and interest rate risk
in excess of the amount recognized in the consolidated balance sheets.
The Bank's exposure to credit loss is represented by the contractual
amount of these commitments. The Bank follows the same credit policies
in making commitments as it does for on-balance sheet instruments.
At December 31, 2001 and 2000, the following financial instruments were
outstanding whose contract amounts represent credit risk:
Contract Amount
-----------------------------------
2001 2000
--------------- ----------------
Commitments to grant loans $ 5,575,000 $ 2,055,000
Unfunded commitments under lines of credit 20,000,000 13,100,000
Commercial and standby letters of credit 135,000 400,000
Commitments to extend credit are agreements to lend a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. The commitments
for equity lines of credit may expire without being drawn upon.
Therefore, the total commitment amounts do not necessarily represent
future cash requirements. The amount of collateral obtained, if it is
deemed necessary by the Bank, is based on management's credit
evaluation of the customer.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
Unfunded commitments under commercial lines of credit, revolving
credit lines and overdraft protection agreements are commitments for
possible future extensions of credit to existing customers. These lines
of credit are collateralized and usually do not contain a specified
maturity date and may be drawn upon to the total extent to which the
Bank is committed.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 12 - OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
Commercial and standby letters of credit are conditional commitments
issued by the Bank to guarantee the performance of a customer to a
third party. Those letters of credit are primarily used to support
public and private borrowing arrangements. Essentially all letters
of credit issued have expiration dates within one year.
Collateral Requirements - To reduce credit risk related to the use
of credit-related financial instruments, the Bank might deem it
necessary to obtain collateral. The amount and nature of the
collateral obtained is based on the Bank's credit evaluation of the
customer. Collateral held varies but may include cash, securities,
accounts receivable, inventory, property, plant and equipment and
real estate.
If the counterparty does not have the right and ability to redeem
the collateral or the Bank is permitted to sell or repledge the
collateral on short notice, the Bank records the collateral in its
balance sheet at fair value with a corresponding obligation to
return it.
NOTE 13 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to
principal officers, directors and affiliates. A summary of the
related party loan transactions for the years ended December 31,
2001 and 2000 is as follows:
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
2001 2000
-------------- ------------
Related party loans outstanding at the beginning
of the year $ 878,827 $ 914,858
Advances 1,344,656 385,042
Principal repayments (1,052,540) (421,073)
-------------- ------------
Related party loans outstanding at the end
of the year $ 1,170,943 $ 878,827
============== ============
Deposits from related parties held by the Bank at December 31,
2001 and 2000 amounted to $14,000,000 and $12,000,000,
respectively.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that
would be exchanged between willing parties, other than in a forced
liquidation. Fair value is best determined based upon quoted market
prices. However, in many instances, there are no quoted market
prices for the Bank's various 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.
Accordingly, the fair value estimates may not be realized in an
immediate settlement of the instrument. SFAS 107 excludes certain
financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value
amounts presented may not necessarily represent the underlying fair
value of the Bank.
The following methods and assumptions were used by the Bank in
estimating fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS - The carrying amounts of cash and
short-term instruments approximate fair values.
INTEREST-BEARING DEPOSITS IN BANKS - The carrying amounts of
interest-bearing deposits maturing within ninety days approximate
their fair values. Fair values of other interest-bearing deposits
are estimated using discounted cash flow analyses based on current
rates for similar types of deposits.
SECURITIES - Fair values for securities, excluding Federal Home Loan
Bank stock, are based on quoted market prices. The carrying value of
Federal Home Loan Bank stock approximates fair value based on the
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
redemption provisions of the Federal Home Loan Bank. If quoted
market prices are not available, fair values are based on quoted
market prices of comparable investment.
MORTGAGE LOANS HELD FOR SALE - Fair values of mortgage loans held for
sale are based on quoted market prices.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
LOANS RECEIVABLE - For variable-rate loans that reprice frequently
and with no significant change in credit risk, fair values are based
on carrying values, as adjusted for estimated credit losses. Fair
values for other loans (e.g., commercial real estate and investment
property mortgage loans, commercial and industrial loans) are
estimated using discounted cash flow analyses, using interest rates
currently being offered for loans with similar terms to borrowers of
similar credit quality. Fair values for non-performing loans are
estimated using discounted cash flow analyses or underlying
collateral values, where applicable.
DEPOSIT LIABILITIES - The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, passbook savings, and
certain types of money market accounts) are, by definition, equal to
the amount payable on demand at the reporting date (i.e., their
carrying amounts). The carrying amounts of variable-rate, fixed term
money market accounts and certificates of deposit approximate their
fair values at the reporting date. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities
on time deposits.
FEDERAL HOME LOAN BANK ADVANCES - The carrying amount of short-term
FHLB advances is a reasonable estimate of their fair value due to
their variable interest rates and short-term maturities. The
estimated fair value of long-term FHLB is determined by discounting
the future cash flows of outstanding advances using rates currently
available on advances from the FHLB with similar characteristics.
ACCRUED INTEREST - The carrying amounts of accrued interest
approximate fair value.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
OFF-BALANCE SHEET INSTRUMENTS - The fair value of loan commitments
and standby letters of credit, valued on the basis of fees currently
charged for commitments for similar loan terms to new borrowers with
similar credit profiles, is not considered material.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values, and related carrying or notional amounts,of
the Bank's financial instruments are as follows (000s omitted):
2001 2000
--------------------------- -----------------------------
Carrying Estimated Carrying Estimated Fair
Amount Fair Value Amount Value
------------ ------------ ------------ ----------------
Financial assets:
Cash and cash equivalents $ 10,629 $ 10,629 $ 11,698 $ 11,698
Interest-bearing deposits in banks 15,043 15,461 7,657 7,657
Other short-term investments 260 260 105 105
Hold-to-maturity investment securities 3,904 3,912 7,336 7,365
FHLB stock 4,115 4,115 3,498 3,498
Loans held for sale 4,415 4,453 617 622
Loans in portfolio 219,214 226,385 223,574 226,098
Accrued interest receivable 1,725 1,725 1,867 1,867
Financial liabilities:
Deposits 177,603 169,008 173,855 171,052
Accrued interest payable 994 994 1,029 1,029
FHLB advances 70,077 69,721 67,410 69,198
NOTE 15 - ACQUISITIONS
In January 2000, Oakleaf Financial Service, Inc. (a wholly-owned
subsidiary), previously SFB Agency, acquired McKillen Financial
Services in a business combination accounted for as a purchase.
McKillen Financial Services is primarily engaged in providing
investment advisory services. The total cost of the acquisition was
$475,000, which, since no tangible assets were purchased, has been
allocated to goodwill.
McKillen Financial Services primary source of income is from
commissions. The following summarized pro forma (unaudited)
information assumes the acquisition had occurred on January 1, 1999
and includes only the income classification affected by the
acquisition.
STURGIS BANK & TRUST CO. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2001, 2000 AND 1999
NOTE 15 - ACQUISITIONS (CONTINUED)
December 31,
1999
-------------
Noninterest income - Commission income $ 693,023
=============
Net income $ 2,085,650
=============
Earnings per share:
Basic $ 0.67
=============
Diluted $ 0.67
The above amounts reflect adjustments for amortization of goodwill.
December 31, 2001 and 2000 proforma information has been omitted from
the above table since the results of operations of McKillen Financial
Services are reflected in the consolidated statements of income.
NOTE 16 - STOCK REDEMPTION PROGRAM
During January 2002, the Board of Sturgis Bancorp, Inc. (the
"Corporation") approved a program to repurchase up to 10 percent of the
Corporation's issued and outstanding common stock in the open market
and in privately negotiated transactions. Through March 11, 2002, the
Corporation has redeemed 115,200 shares at a total redemption price of
approximately $1,050,000.