EXHIBIT 13.1
ANNUAL REPORT TO STOCKHOLDERS
41
March 25, 2004
To My Fellow Shareholders,
On behalf of the Directors and Employees of Sturgis Bancorp, Inc. and Sturgis
Bank & Trust Company I am pleased to provide a copy of our 2003 Annual Report.
In this Annual Report you will find many key ratios and measures of performance.
I encourage you to study this information and participate as a shareholder. If
you do not understand information contained in this report, or have suggestions,
do not hesitate to contact me at (269)651-9345.
Our core values include community service and building long-term value for our
shareholders. Those of you banking with us understand our commitment to sound
performance and community service. Community service includes not only
philanthropic endeavors, but also includes economic development. Our Bank is the
leader in residential finance and we are now expanding our expertise to include
a larger focus on commercial banking products. Our dedication to community
banking has given us a competitive advantage in our market and our brand is well
established. We plan on building on these successes over the coming year by
focusing on building the core franchise. This commitment to community is the
foundation that will lead to our continued performance.
I am proud to announce we will be celebrating our 100th year of operation in
2005. Our Bank was founded as a Building & Loan Association in 1905 to provide
savings products and finance homes. We continue to be committed to residential
financing, but we are now so much more then a simple Building & Loan. In
addition to residential financing, we offer a wide array of financial products
and services to the communities we service. We now offer commercial loans,
consumer loans, trust services, brokerage services, certificates of deposit,
checking and savings accounts. We have added these products and services to
diversify our operations and meet the changing demands of our market. We
encourage our shareholders to consider our products and services when choosing
your financial partners. After all, you are contributing to your own success,
when you do business with YOUR Bank. I assure you, we will provide excellent
service as well as competitive products.
In 2003 we experienced a good year. We had victories and challenges. Even though
our assets declined by 3.2%, our franchise (as measured by customer
relationships) grew. The primary increase in customer relationships was from our
mortgage banking activity. Loans serviced for others grew by 21.6%. These loans
are primarily long-term fixed rate loans originated by the Bank and sold to the
Federal Home Loan Mortgage Corporation and the Federal Home Loan Bank of
Indianapolis. The loans were sold in an effort to control market and interest
rate risks. We are currently experiencing the lowest rate cycle in over 40
years. In our opinion, this is not the right time to book long-term fixed rate
loans. Such assets will decline in value as market interest rates increase. This
is a long-term strategy. If you have invested in our Company with a long-term
investment horizon, I believe this strategy makes sense to you. This is one
example of how we manage
the Bank with long-term health and earnings in mind. Business strategies that
provide short-term success, at the expense of long-term health, is not our style
of conducting business.
Net income was down 6.6% from 2002. This was primarily caused by the Bank's
exposure to declining interest rates. The Bank's net interest income decreased
by 8.5% in 2003. Over the last several years the Bank has positioned itself for
rising interest rates. The sustained low rates have caused pressure on the net
interest margin for many banks. Our Bank has been no exception. Non interest
income was up 6.6%. This was primarily related to our mortgage banking activity
for 2003. The Bank has diversified operations over the last few years in an
effort to diversify the income stream and reduce reliance on one primary source.
We believe we have positioned the Bank for long-term shareholder value.
We believe driving economic growth is part of our mission. Pursuing this part of
our mission occasionally exposes the Bank to credit losses. During 2003, a
single large commercial credit defaulted on its debt covenants. This event
required the Bank to allocate resources through a provision for loan losses.
However, we do not believe the remaining portfolio poses more risk than is
acceptable for a bank with our capital position. We have added additional staff
in our commercial loan department to monitor levels of risk in the portfolio and
we will provide allocations to our loan loss reserve as we determine appropriate
for the risk profile contained. We will continue to search out sources of
economic growth for our community and be part of the growth process.
In summary, our Bank continues to produce sound core earnings and we are focused
on growing shareholder value, being a responsible corporate citizen and
providing a work environment based on integrity and service. We look forward to
our continuing role as the leading financial institution in St. Joseph County
and continuing our contributions to the success of all of the communities in our
market.
Sincerely,
/s/ Eric. L. Eishen,
- --------------------
Eric. L. Eishen,
President and CEO
CONTENTS
--------
Page
----
Selected Financial Data 2
Corporate Year in Review 3
Management's Discussion and Analysis of Financial
Condition and Results of Operations 4
Directors and Officers of the Bancorp 27
Directors and Officers of the Bank 28
Bank Corporate Information 29
Market Information 30
Independent Accountants 31
Form 10-K Report 31
Report of Independent Accountants and
Consolidated Financial Statements 33
SELECTED FINANCIAL DATA
-----------------------
At December 31,
---------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Total assets $287,337,593 $296,684,457 $279,789,272 $271,116,489 $251,596,319
Cash and investment securities 29,079,322 39,767,645 28,801,672 25,533,283 23,493,106
Loans and loans held for sale 216,849,239 219,480,856 223,528,846 224,191,073 206,295,022
Mortgage -backed securities 11,720,452 8,912,723 1,034,119 1,261,585 1,519,508
Allowance for loan losses 2,294,157 1,920,037 1,300,000 803,744 730,000
Deposits 199,920,213 202,563,796 179,129,827 173,855,324 163,679,849
Short-term borrowings 5,875,538 6,671,907 6,000,000 9,560,855 23,506,029
Long-term borrowings 49,929,132 57,709,489 64,076,863 57,849,521 35,607,361
Stockholders' equity 29,158,351 27,452,528 28,496,934 26,515,396 25,347,607
Bo Book Value per share 10.38 9.81 9.19 8.55 8.19
Shares outstanding (actual number) 2,808,535 2,799,535 3,101,534 3,101,534 3,094,886
Year Ended December 31,
-----------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Interest income $15,245,598 $17,410,692 $19,938,467 $19,138,924 $16,963,609
Interest expense 7,017,273 8,414,100 10,401,412 10,526,202 8,673,279
Provision for loan losses 819,709 1,494,916 1,056,194 309,000 104,000
Noninterest income 5,750,442 5,392,666 4,482,780 3,361,115 3,021,639
Noninterest expense 9,577,955 8,986,026 8,872,803 9,082,503 8,516,520
Federal income tax 976,014 1,117,929 1,302,901 765,468 688,000
Net income 2,605,089 2,790,387 2,787,937 1,816,866 2,003,449
Earnings per share (basic) 0.93 0.95 0.90 0.59 0.65
Earnings per share (diluted) 0.93 0.95 0.90 0.59 0.65
Cash dividends per share 0.35 0.28 0.26 0.22 0.19
Dividend payout ratio 37.73% 29.47% 28.89% 37.29% 29.23%
Equity/Assets ratio 10.15% 9.25% 10.19% 9.78% 10.07%
Return on assets 0.89% 0.95% 1.00% 0.69% 0.83%
Return on equity 9.16% 9.96% 10.14% 6.99% 8.16%
Weighted average shares
outstanding (actual number):
Basic 2,808,461 2,949,874 3,101,534 3,099,630 3,094,854
Diluted 2,811,468 2,952,239 3,101,534 3,099,630 3,099,503
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 "Bancorp"), a financial holding
company. The Bancorp is a financial holding company under the Bank Holding
Company Act of 1956, as amended. This reorganization was effective January 1,
2002. As a result, historical information in this Annual Report for periods
before the January 1, 2002 effective date relate to the Bank. Throughout this
Annual Report Sturgis Bancorp, Inc. will be referred to as Bancorp and Sturgis
Bank & Trust Company will be referred to as the Bank.
The Bank, a Michigan savings bank, was founded in 1905 as a state chartered
mutual building 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.
Although 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 have increased commercial real
estate and small business loans within its primary market area. Commercial loan
growth was strong during 2003.
Offsetting the commercial loan growth is a reduction in residential mortgage
loans. The historically low interest rates induced many borrowers to refinance
mortgage and consumer debt into new mortgages. The Bank manages interest rate
risk by selling long-term fixed-rate mortgages, so portfolio residential
mortgages decreased during 2003. Consumer loans also decreased during 2003, due
to borrowers who consolidated debt into mortgages.
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 includes all of St. Joseph County
and parts of Cass, Branch, Calhoun, Van Buren, Allegan, Hillsdale and Kalamazoo
counties.
3
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 Bancorp, primarily with respect to future events and the future
financial performance of Bancorp. 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. Bancorp undertakes no obligation to update, amend or clarify
forward-looking statements as a result of new information, future events, or
otherwise.
CRITICAL ACCOUNTING POLICIES
The banking industry is highly regulated. Furthermore, the nature of the
banking industry is such that, other than described below, the use of estimates
and management judgment are not likely to present a material risk to the
financial statements. In cases where estimates or management judgment are
required, internal controls and processes are established to provide assurance
that such estimates and management judgments are materially correct to the best
of management's knowledge.
ALLOWANCE FOR LOAN LOSSES - Accounting for loan classifications, accrual status,
and determination of the allowance for loan losses is based on regulatory
guidance. This guidance includes, but is not limited to, generally accepted
accounting principles, the uniform retail credit classification and account
management policy issued by the Federal Financial Institutions Examination
Council ("FFIEC"), and the joint policy statement on the allowance for loan
losses methodologies issued by the FFIEC. Accordingly, the allowance for loan
losses includes a reserve calculation based on an evaluation of loans determined
to be impaired, risk ratings, historical losses, loans past due, and other
subjective factors. However, there is still a degree of subjectivity when
formulating the level of the allowance for loan losses and historical trends may
not be indicative of future levels provided to the reserve account.
COMMERCIAL LOAN RATING SYSTEM AND IDENTIFICATION OF IMPAIRED LOANS - Bancorp has
a defined risk rating system that is designed to assess the risk of individual
loans and overall risk of the commercial loan portfolio. The system assigns a
risk weighting to factors such as cash flow, collateral, financial condition,
operating performance, repayment history, management, and
4
strength of the customer's industry. An assessment of risk is performed as a
part of the loan approval process as well as periodic updates based on the
circumstances of the individual loan. Bancorp employs both internal and external
loan review services to assess risk ratings.
ORIGINATED MORTGAGE SERVICING RIGHTS ("OMSR") - Bancorp records the original
"OMSR" based on market data. The OMSR is amortized into non-interest income in
proportion to the period of the estimated future net servicing income of the
underlying financial asset. Additionally, an independent third party valuation
is performed to determine potential impairment of the OMSR as a result of
changes in interest rates and expected future loan repayment speeds. Significant
changes in interest rates or repayment speeds could have a significant impact on
the carrying value of mortgage servicing assets.
DEFERRED INCOME TAX ASSETS -Deferred income tax assets and liabilities are
determined using the liability (or balance sheet) method. Under this method, the
net deferred tax asset or liability is determined based on the tax effects of
the various temporary differences between the book and tax bases of the various
balance sheet assets and liabilities and gives current recognition to changes in
tax rates and laws. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized.
GOODWILL AND INTANGIBLE ASSETS - Bancorp had $5.1 million of goodwill at
December 31, 2003 and 2002. Effective January 1, 2002, Bancorp adopted Financial
Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets,
which changes Bancorp's accounting for goodwill and other intangible assets.
Generally intangible assets that meet certain criteria are recognized and
subsequently amortized over their estimated useful lives. Goodwill and
intangible assets with indefinite lives, such as Bancorp's goodwill, are not
amortized. However, such assets are tested for impairment annually after
adoption of SFAS 142.
RESULTS OF OPERATIONS
Bancorp reported net income of $2.6 million, $2.8 million and $2.8
million for the years ended December 31, 2003, 2002 and 2001, respectively.
Basic earnings per share was $0.93, $0.95 and $0.90 for the years ended December
31, 2003, 2002 and 2001, respectively. The decrease in net interest income from
2002 to 2003 was offset by the decrease in the provision for loan losses. The
increase in noninterest income, mostly from mortgage banking activities,
contributed income to offset the increase in noninterest expenses.
INTEREST INCOME
2003 COMPARED TO 2002. Interest income decreased $2.2 million to $15.2
million from $17.4 million. This decrease is primarily due to the decreases in
interest rates and average loans outstanding to $214.5 million in 2003 from
$217.6 million in 2002. Due to the general decline in interest rates, and the
consumers' preference for fixed rate loan products, management consciously
allowed the residential loan portfolio to decrease. Management does not wish to
book long-term, fixed rate loans in the current interest rate environment. This
action resulted in a decrease in residential mortgage loans for 2003. We believe
the consequences to this action will result in greater future returns and less
interest rate risk. During 2003 the decrease in average
5
loans outstanding reduced interest income from loans by $221,526. The remaining
$1.7 million decrease in interest income from loans is due to the change in
rates. The increase in average commercial mortgage loans to $58.8 million in
2003 from $42.9 million in 2002 contributed $947,974 to interest income. The
reduction in average yield earned on average commercial loans to 6.20% in 2003
from 6.89% in 2002 reduced interest income by $254,760. Management also believes
the expansion of commercial lending will lead to an improved interest margin
when rates increase. Most commercial credits are priced on a variable basis and
the expansion of commercial deposit accounts, which are non-interest bearing,
will help to reduce the cost of funding. Loan demand for the company has been
strong despite the apparent decrease in booked loans. This fact is reflected in
the increase in loans serviced for others. Loans serviced for others increased
by $38.5 million, or 21.50%, in 2003, while the residential mortgage portfolio
loans decreased by $9.1 million, or 7.10%. While the residential mortgage loans
booked into the loan portfolio is negative, the Bank has a larger customer base
than in 2002. This base gives us the ability to cross sell other Bank products
and services. The long-term goal of management is to capitalize on the new
relationships acquired by the bank during the last two years of record mortgage
originations. The average yield on interest-earning assets decreased to 5.95% in
2003 from 6.71% in 2002. This is primarily due to changes in the composition of
interest-earning assets and lower yields as interest-earning assets repriced
through 2003. The Bank is positioned to increase interest income when interest
rates increase. The decrease in interest expense was smaller than the decrease
in interest income, due to the Bank's positive interest rate gap. The positive
gap position will continue to have a negative impact on net interest income
until market rates begin to increase. Management believes the current low rate
environment is not the appropriate time to change its interest rate position. If
the interest rate position would be changed and rates go up, the Bank would not
realize the benefit of the positive interest rate gap. The funding costs of
interest-bearing liabilities will continue to decrease in the current low rate
environment, although the decreased cost will likely not match the larger
decrease expected in loan rates in the current rate environment. Management
anticipates interest rate increases, if the U.S. economic recovery accelerates.
2002 COMPARED TO 2001. Interest income decreased $2.5 million to $17.4
million from $19.9 million. This decrease is primarily due to the decreases in
interest rates and average loans outstanding to $217.6 million in 2002 from
$224.6 million in 2001. The average yield on interest-earning assets decreased
to 6.71% in 2002 from 7.87% in 2001. This is primarily due to changes in the
composition of interest-earning assets and lower yields as interest-earning
assets repriced through 2002. The Bank purchased mortgage-backed securities and
interest-bearing deposits as loans refinanced and were subsequently sold. The
Bank also purchased bank-owned life insurance at the end of 2001, which also
contributed to the decrease in interest income from 2001 to 2002. Increases in
the cash value of bank-owned life insurance are recognized as noninterest
income.
INTEREST EXPENSE
2003 COMPARED TO 2002. Interest expense decreased $1.4 million to $7.0
million in 2003 from $8.4 million in 2002. 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 to 2.84% in 2003
from 3.39% in 2002.
6
2002 COMPARED TO 2001. Interest expense decreased $2.0 million to $8.4
million in 2002 from $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 to 3.39% in 2002
from 4.24% in 2001.
NET INTEREST INCOME
2003 COMPARED TO 2002. Net interest income for the year ended December
31, 2003 was $8.2 million compared to $9.0 million for the year ended December
31, 2002, a decrease of $0.8 million or 8.9%. This decrease was caused primarily
by decreases in the Bank's net interest margin to 3.11% in 2003 from 3.47% in
2002. Although market rates remained relatively stable during 2003, loans and
investments continued to reprice lower in accordance with their contractual
repricing frequency to a weighted average yield of 5.95% in 2003, compared to
6.71% in 2002. Rates paid on interest-bearing liabilities decreased to 2.85% for
2003 from 3.39% for 2002. The Bank has positioned itself for net interest income
to increase with rising interest rates. If rates do not rise in 2004, management
expects continued downward pressure on net interest income. Management expects
rates to stay stable through most of 2004, followed by increases, if the U.S.
economic recovery accelerates.
2002 COMPARED TO 2001. Net interest income for the year ended December
31, 2002 was $9.0 million compared to $9.5 million for the year ended December
31, 2001, a decrease of $0.5 million or 5.7%. This decrease was caused primarily
by decreases in the Bank's net interest margin to 3.47% in 2002 from 3.77% in
2001. As market rates decreased during 2002, loans and investments repriced
lower in accordance with their adjustment cycle. Rates paid on interest-bearing
liabilities decreased to 3.39% for 2002 from 4.24% for 2001.
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. The Bank's net interest margin for
2003, 2002 and 2001 was, 3.21%, 3.47% and 3.77% respectively. This decrease over
the last three years demonstrates the effect of the Bank's positive gap position
during these years. A positive gap means that interest-bearing assets are
repricing at a faster pace than interest-bearing liabilities. Management has
anticipated an increase in rates over the last three years and resisted the
temptation of placing long-term, fixed rate, assets on the balance sheet. This
mitigation of interest rate risk has sacrificed short-term earnings under the
current interest rate environment, but has placed the institution in a more
favorable position when rates rise. The most significant risk to this business
strategy is that rates do not ultimately rise. Management does not believe this
scenario is likely in the long-term. Management expects interest rates to remain
stable through most of 2004, followed by increases, if the U.S. economy
recovers.
7
AVERAGE BALANCES AND INTEREST RATES
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2003 2002
------------------------------------ -----------------------------------
AVERAGE INTEREST AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
------------------------------------ -----------------------------------
Interest-Earning Assets:
Loans (1) $214,493,505 $13,820,902 6.44% $217,597,254 $15,729,020 7.23%
Mortgage-backed securities 8,354,243 257,592 3.08% 6,083,847 238,145 3.91%
Investment securities (2) 15,231,418 573,762 3.76% 10,069,556 429,210 4.26%
Interest-bearing deposits 17,991,888 593,342 3.30% 25,879,158 1,014,317 3.92%
------------------------------------ -----------------------------------
Total interest-earning assets $256,071,054 $15,245,598 5.95% $259,629,815 $17,410,692 6.71%
==================================== ===================================
Interest-Bearing Liabilities:
Deposits $189,523,293 $4,134,633 2.18% $184,120,609 $5,042,699 2.74%
FHLB advances 57,041,886 2,882,640 5.05% 64,034,040 3,317,401 5.27%
------------------------------------ -----------------------------------
Total interest-bearing
liabilities $246,565,179 $7,017,273 2.84% $248,154,649 $8,414,100 3.39%
==================================== ===================================
Net interest income $8,228,325 $8,996,592
============= =============
Interest rate spread 3.11% 3.32%
===== =====
Net interest-earning assets $9,505,875 $11,475,166
============ ============
Net interest margin 3.21% 3.47%
===== =====
(1) Interest on loans includes fees. Nonaccrual loans and loans held
for sale have been included in the average balances of loans.
(2) Yield on investment securities is reported on an actual and not
a tax equivalent basis
2001
------------------------------------
AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
------------------------------------
Interest-Earning Assets:
Loans (1) $224,638,896 $18,276,561 8.14%
Mortgage-backed securities 1,143,720 74,936 6.55%
Investment securities (2) 7,768,763 537,388 6.92%
Interest-bearing deposits 19,691,832 1,049,582 5.33%
------------------------------------
Total interest-earning assets $253,243,211 $19,938,467 7.87%
====================================
Interest-Bearing Liabilities:
Deposits $177,212,048 $6,369,577 3.59%
FHLB advances 68,153,648 4,031,835 5.92%
------------------------------------
Total interest-bearing
liabilities $245,365,696 $10,401,412 4.24%
===================================
Net interest income $9,537,055
=============
Interest rate spread 3.63%
=====
Net interest-earning assets $7,877,515
(liabilities) ============
Net interest margin 3.77%
=====
(1) Interest on loans includes fees. Nonaccrual loans and loans held
for sale have been included in the average balances of loans.
(2) Yield on investment securities is reported on an actual and not
a tax equivalent basis
8
The following table presents information regarding the weighted average yields
received on loans and other assets and the weighted average rates paid on
deposits and borrowings on the last day of the years indicated. Non-accruing
loans have been included in the table as loans carrying a zero yield.
AT DECEMBER 31,
2003 2002 2001
WEIGHTED AVERAGE RATE:
Loans 5.92% 6.89% 7.58%
Mortgage-backed securities 4.34% 5.29% 6.61%
Investments(1) 4.58% 5.12% 5.90%
Interest-bearing deposits 2.66% 3.60% 4.26%
All interest-earning assets 5.60% 6.45% 7.33%
WEIGHTED AVERAGE COST:
Deposits (interest-bearing) 1.90% 2.51% 2.77%
FHLB advances 4.62% 4.83% 5.68%
All interest-bearing liabilities 2.52% 3.10% 3.59%
INTEREST RATE SPREAD 3.08% 3.35% 3.74%
(1) Yield on investment securities is reported on an actual and not
a tax equivalent basis.
RATE/VOLUME ANALYSIS. The following table sets forth certain information
regarding changes in interest income and interest expense of Bancorp 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,
2003 VS 2002 2002 VS 2001
------------ ------------
INCREASE (DECREASE) DUE TO: INCREASE (DECREASE) DUE TO:
--------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
Interest Income:
Loans ($221,526) ($1,686,592) ($1,908,118) ($488,311) ($2,059,230) ($2,547,541)
Mortgage-backed securities 76,846 (57,399) 19,447 199,755 (36,456) 163,209
Investment securities 199,173 (54,621) 144,552 113,580 (221,758) (108,178)
Interest-bearing deposits (276,889) (144,086) (420,975) 339,450 (374,715) (35,265)
--------------------------------------- ----------------------------------------
Total interest-earning assets (222,396) (1,942,698) (2,165,094) 164,474 (2,692,249) (2,527,775)
--------------------------------------- ----------------------------------------
Interest Expense:
Deposits 144,174 (1,052,240) (908,066) 337,882 (1,664,760) (1,326,878)
FHLB advances (357,328) (131,433) (488,761) (173,773) (486,661) (660,434)
--------------------------------------- ----------------------------------------
Total interest-bearing
liabilities (213,154) (1,183,673) (1,396,827) 164,109 (2,151,421) (1,987,312)
--------------------------------------- ----------------------------------------
Net Interest Income ($9,242) ($759,025) ($768,267) $ 365 ($540,828) ($540,463)
======================================= ========================================
9
YEAR ENDED DECEMBER 31,
2001 VS 2000
------------
INCREASE (DECREASE) DUE TO:
---------------------------
VOLUME RATE TOTAL
------ ---- -----
Interest Income:
Loans $605,544 ($426,458) $179,086
Mortgage-backed securities (15,888) 3,748 (12,140)
Investment securities (390,143) 46,655 (343,488)
Interest-bearing deposits 981,726 (5,641) 976,085
-------------------------------------
Total interest-earning assets 1,181,239 (381,666) 799,543
-------------------------------------
Interest Expense:
Deposits 137,383 (653,811) (516,428)
FHLB advances 645,974 (254,336) 391,638
-------------------------------------
Total interest-bearing
liabilities 783,357 (908,147) (124,790)
-------------------------------------
Net Interest Income $397,882 $526,451 $924,333
=====================================
PROVISION FOR LOAN LOSSES
2003 COMPARED TO 2002. The provision for loan losses was $819,709 for
the year ended December 31, 2003 and $1,494,916 for the year ended December 31,
2002, a decrease of $675,207. 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 economic conditions. Loans charged off during 2003, net of
recoveries, was $445,589, compared to $874,879 during 2002. This reduction in
net loans charged off allowed the Bank to reduce the provision for loan losses
and still maintain an adequate balance in the allowance for loan losses.
Nonperforming loans have increased to $4.2 million at December 31, 2003
from $3.0 million at December 31, 2002. This increase in nonperforming loans is
primarily due to one commercial relationship for $2.4 million. In 2003 the Bank
had a significant commercial credit "out of compliance" with borrowing
covenants. The Bank identified this credit and began corrective action.
Ultimately, the firm discontinued operations and is in the process of
liquidating its assets. The company has been successful at liquidating assets
and reducing its debt to the Bank by approximately $2.0 million to $2.4 million.
Management is confident we have adequately allowed for possible losses on this
credit. A thorough analysis was conducted on the remaining collateral,
consisting primarily of real estate in our local market area and a personal
guarantee. The result of this analysis indicates the allowance for loan losses
has been appropriately funded. This credit is still subject to the liquidation
of the remaining assets and possible litigation related to the personal
guarantee.
2002 COMPARED TO 2001. The provision for loan losses was $1,494,916 for
the year ended December 31, 2002 and $1,056,194 for the year ended December 31,
2001, an increase of $438,722. The increase was due to the depressed economy,
which increased past due and classified loans, and the Bank's gradually changing
portfolio to include more commercial loans. 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 economic conditions.
The provision for loan losses has been a subject of debate over the last
year among
10
business, the accounting industry and regulatory agencies. The correct provision
is difficult to measure. It is influenced by the national, regional and local
economic conditions and management's assessment of risk in the loan portfolio.
There are no exact guidelines and therefore it is left to management to make its
best estimate. Management believes the current level of the allowance for loan
losses is adequate to cover all expected and unexpected credit risk in the
portfolio. However, the mix of the Bank's loan portfolio has been changing over
the last several years. The loan portfolio is becoming more heavily weighted
with commercial credits. Commercial credits are inherently more risky then
one-to-four-family mortgage loans. The collateral is generally more difficult to
liquidate and the average size of the credit is larger. A single commercial
credit defaulting has a larger impact on the provision for loan losses. The Bank
allocates reserves on commercial loans at a higher percentage of the loan
balance. The level of provision impacts current and future earnings of the Bank.
This is why the subject is of interest to our shareholders, accountants and
regulators. It is management's intention to provide an adequate amount to
reserves to reflect the risk profile of the loan portfolio. If this requires
high provisions in one year and less in another year, these adjustments will be
effectuated. Historical levels of provisions should not be used to make
assumptions regarding future required allocations.
The allowance for loan losses as a percentage of total loans has
increased from 2001 to 2003. This increase is due to the increasing exposure of
the Bank to commercial lending, weak economic development in the Bank's primary
market area (Sturgis, Michigan) and one commercial credit that was impaired in
2003. Because of the Bank's continuing growth in commercial loans, the Bank
expects to continue funding the allowance for loan losses due to higher risks
related to commercial lending.
The Bank has implemented processes to accelerate its collections and
foreclosure actions in an effort to reduce the level of nonperforming assets and
net charge-offs. Exclusive of the single commercial credit, nonperforming assets
have decreased along with the decrease in net charge-offs. Management expects
the enhanced processes will continue to suppress the level of nonperforming
assets and net charge-offs.
NONINTEREST INCOME
2003 COMPARED TO 2002. Noninterest income was $5.8 million in 2003
compared to $5.4 million in 2002, an increase of $357,776. The primary component
of this increase was noninterest income from mortgage banking activities. The
increase in mortgage banking activities was due to the increase in loan sales
during 2003 compared to 2002. Management does not believe this level of mortgage
banking activity will be sustainable in 2004 and beyond. The level of activity
for 2002 and 2003 was primarily driven by mortgage refinance activity. This
refinance activity was driven by the historically low levels of interest rates
available on long-term fixed rate mortgages. Most consumers qualifying to
refinance have taken advantage of the low rates and are not likely to refinance
in the next year. Management expects mortgage banking activity will be dominated
primarily by purchases and sales, rather than refinances, during 2004. Proceeds
from sale of loans increased to $126.3 million in 2003 from $108.7 million in
2002. Service charges and other fees decreased to $1.4 million in 2003 from $1.5
million in 2002, primarily due to a decrease in credit life insurance premiums
earned to $19,589 in 2003 from $74,679 in 2002. This decrease in credit life
insurance premiums earned is due to changes in consumer credit laws for
insurance on
11
second mortgages and refinance of consumer loans with credit life insurance
during 2003. Brokerage commission income will continue to be a large proportion
of non-interest income. Brokerage income is influenced by the U.S. economy and
stock market values. This income presently makes up 14.73% of non-interest
income.
2002 COMPARED TO 2001. Noninterest income was $5.4 million in 2002
compared to $4.5 million in 2001, an increase of $909,886. The primary
components of the increase were mortgage banking activities, an increase in cash
surrender value of life insurance and Oakleaf commissions. The increase in
mortgage banking activities was due to the increase in loan sales during 2002
compared to 2001. Proceeds from sale of loans increased to $109.3 million in
2002 from $74.3 million in 2001. Service fees and other charges decreased to
$1.5 million in 2002 from $1.6 million in 2001, primarily due to a decrease in
insufficient funds fees charged to checking account customers ("NSF fees"). NSF
fees decreased to $562,634 in 2002 from $627,847 in 2001. During 2002, the Bank
recognized an increase in cash surrender value of life insurance totaling
$332,470, compared to $2,959 for 2001 related to insurance policies on key
personnel. The life insurance was purchased with a single premium payment in
December 2001. Commission income from Oakleaf increased to $970,737 in 2002 from
$796,688 in 2001. This increase is due to growth in the relationships managed by
Oakleaf.
NONINTEREST EXPENSE
2003 COMPARED TO 2002. Noninterest expense was $9.6 million in 2003,
compared to $9.0 million in 2002, an increase of $591,929. The largest component
of the increase was salaries and employee benefits, which increased $270,191 to
$4.9 million in 2003 from $4.7 million in 2002. These increases are due to
increases in the cost of employer-provided medical insurance and salary
adjustments. Salary adjustments were the result of staffing changes and cost of
living increases which took effect January 2003. To offset the increase in
health insurance premiums for employees, the Bank instituted a premium sharing
program in August 2003. Additional staffing has been added in 2003 to meet the
increasing sophistication of the Bank's operations. The increase in
sophistication relates primarily to commercial lending operations and the Bank's
wholly owned subsidiary, Oakleaf Financial. The expansion into these areas was
undertaken in an effort to diversify operations and reduce the Bank's reliance
on mortgage banking activities for non-interest income. Management believes that
fee income produced by Oakleaf Financial will help to stabilize non-interest
income from operations. The Bank's compensation expense was also impacted by the
payment of overtime to staff involved in the mortgage banking operations. Data
processing expense increased $102,007, due to expenses incurred converting to a
different servicer in the first quarter of 2003. At December 31, 2003, goodwill
was not impaired and Management does not anticipate impairment in 2004.
Management actively minimizes noninterest expense, although certain noninterest
expenses are outside of Management's direct control. Management expects salaries
and employee benefits to increase by 3-5% annually.
2002 COMPARED TO 2001. Noninterest expense was $9.0 million in 2002,
compared to $8.9 million in 2001, an increase of $113,223 or 1.3%. The largest
component of the increase was salaries and employee benefits, which increased
$640,158 to $4.7 million in 2002 from $4.0 million in 2001. These increases were
due to increases in the cost of employer-provided medical insurance and salary
adjustments. Employer-provided medical insurance was $615,320 in 2002
12
and $421,971 in 2001. Salary adjustments were the result of staffing changes and
cost of living increases which took effect January 2002. Offsetting this
increase were decreases in occupancy and equipment expense and amortization of
goodwill. Occupancy and equipment expense decreased $104,074 to $1.3 million in
2002 from $1.4 million in 2001. Depreciation expense was the primary component
of the decrease in occupancy and equipment expense. Depreciation expense
decreased to $605,318 in 2002 from $670,844 in 2001. Amortization expense was
not recognized in 2002, due to adoption of FAS 142. Upon adoption and at
December 31, 2002 there was no impairment of the Bank's goodwill. Amortization
expense for 2001 was $574,864.
The effective federal income tax rate was 27.3% in 2003, 28.6% in 2002
and 31.8% in 2001.
CASH FLOWS
OPERATING. Cash flows from operating activities are most significantly
affected by net income and mortgage banking activities. Net income was
$2,605,089, $2,790,387, and $2,787.937 for the years ended December 31, 2003,
2002 and 2001, respectively. Gain on sale of loans was $2.7 million, $2.0
million and $1.7 million for the years ended December 31, 2003, 2002, and 2001,
respectively. Loans originated for sale and proceeds from the sale of loans also
increased with the historically low mortgage loan rates. Loans originated for
sale were $118.7 million, $111.1 million, and $77.3 million for the years ended
December 31, 2003, 2002, and 2001, respectively. The increases in loans
originated for sale in 2003, 2002 and 2001 are primarily due to the low
residential mortgage rates. Proceeds from sales of loans were $126.3 million,
$108.7 million, and $74.3 million for the years ended December 31, 2003, 2002,
and 2001, 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. Affecting cash flows from operating activities
are the add-backs of non-cash expenses, which include the provision for loan
losses, depreciation and amortization of mortgage servicing rights.
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, 2003 there was a net increase in loans of $5.0 million. For the year ended
December 31, 2002 and 2001 there were decreases in loans of $4.0 million and
$3.0 million, respectively, primarily due to refinanced loans. Investment
purchases and maturities also affect cash flows from investing activities. The
Bank's management maintains investments at levels that balance returns with
various risks. The Bank decreased its holdings of interest-bearing deposits in
banks by $7.7 to $15.3 million at December 31, 2003 from $23.0 million at
December 31, 2002. The Bank increased its holdings of interest-bearing deposits
in banks by $8.0 million to $23.0 million at December 31, 2002 from $15.0
million at December 31, 2001. The Bank purchased $6.0 million of bank-owned life
insurance in 2001. Management seeks to use loans as its primary investment
option. But in the absence of attractive loan opportunities, the Bank may pursue
other investment alternatives. Considerations for investment decisions include
interest rate risk, liquidity needs, liquidity risk and credit risk.
13
FINANCING. Cash flows from financing activities are mostly affected by
changes in deposits and FHLB advances. Deposits decreased $2.6 million for the
year ended December 31, 2003 and increased $23.4 million and $3.8 million for
the years ended December 31, 2002, and 2001, respectively. Certificates of
deposit with balances greater than or equal to $100,000 (commonly referred to as
Jumbo Certificates), which carry greater interest rate sensitivity, decreased by
$5.0 million to $29.4 million at December 31, 2003. The Bank views Jumbo
Certificates of deposit as a source of liquidity. The Bank's reliance on this
funding source decreased in 2003 to 14.73% of deposits at December 31, 2003,
compared to 17.01% of deposits at December 31, 2002. Transaction savings
accounts and checking accounts increased $9.5 million, or 10.4%, from December
31, 2002 to December 31, 2003. Transaction savings accounts and checking
accounts represent 50.59% of deposits at December 31, 2003, compared to 45.23%
of deposits at December 31, 2002. Bank management is actively attempting to
increase these core deposit account relationships. The increase in transaction
savings accounts and checking accounts provides relatively inexpensive funding
for future growth, compared to alternative certificates of deposit and FHLB
advances at higher interest rates. The Bank also used FHLB advances for
financing its operating and investing activities. The FHLB advances decreased
$8.6 million and $5.7 million for the years ended December 31, 2003 and 2002 and
increased $2.7 million for the year ended December 31, 2001. During the year
ended December 31, 2003, the Bank used funds from maturing interest-bearing
deposits in other banks to prepay $402,891 of FHLB advances due in May 2004 with
an interest rate of 7.17%. FHLB advances are secured by Bank assets. The primary
asset used by the FHLB is loans secured by real estate. The Bank may pledge
specific loans or categories of loans for advance purposes. This poses risk to
the Bank and stockholders in the fact these assets may become less liquid or
subject to set-off. The borrowing base of the Bank is calculated, by the FHLB,
based substantially on mortgage loans outstanding. If the Bank's mortgage loan
portfolio shrinks it can impact the Bank's ability to utilize the FHLB as a
source of funding and liquidity. The Bank will continue to use Jumbo
Certificates of Deposit, FHLB advances and core deposits as its primary sources
of funds for operations.
FINANCIAL CONDITION
GENERAL. The Bank's total assets at December 31, 2003 were $287.3
million compared to $296.7 million at December 31, 2002, a decrease of $9.3
million or 3.2%. Management had the opportunity to grow assets by retaining
long-term, fixed rate, mortgage loans. We did not believe this was prudent asset
management, during a time of historically low interest rates. We maintained our
disciplined approach to managing interest rate risk. The decrease in assets was
primarily in interest-bearing deposits in banks and loans held for sale.
Management had invested in these deposits as a short-term strategy to enhance
earning for the shareholder. We believed the funds would be deployed in 2003 in
the form of increased loans held in portfolio. The low market interest rates
prompted a heavy refinancing year for residential mortgages. The funds from the
refinanced residential mortgages were redeployed into commercial loans,
investments, and used to reduce advances at the FHLB.
LOANS. The Bank's net loans increased to $215.5 million at December 31,
2003 from $212.0 million at December 31, 2002. This increase was primarily due
to new commercial loans. Many consumers elected to refinance their
adjustable-rate mortgage loans and consumer debt
14
into fixed rate mortgages to take advantage of historically low interest rates.
In addition to reducing net interest income, the refinance activity resulted in
fewer residential loans in the Bank's portfolio. The Bank sells long-term, fixed
rate, residential mortgages in the secondary market. Historically, the major
buyer of these loans has been the Federal Home Loan Mortgage Corporation
(FHLMC). In 2003 the Bank entered into an arrangement with the Federal Home Loan
Bank of Indianapolis (FHLBI) to sell loans. This relationship provides an
alternative buyer for Bank loans and Management believes this relationship may
provide a higher profit margin on loans sold. The loan sales in 2003 decreased
residential mortgage loans to $118.7 million at December 31, 2003 from $127.8
million at December 31, 2002. Commercial mortgage loans increased to $66.4
million, or 29.6% of gross loans, at December 31, 2003 from $50.4 million, or
23.2% of gross loans at December 31, 2002. The demand for fixed-rate mortgage
loans in 2003 and 2002 was higher due to historically low interest rates during
the period. The proceeds from sales of loans (primarily fixed-rate, residential
mortgages) were $126.3 million and $108.7 million for 2003 and 2002,
respectively. The mortgage loans originated for sale ($118.7 million during 2003
and $111.1 million during 2002) were primarily funded by the secondary mortgage
market sales. 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 term, fixed-rate loans and provides a source of liquidity
to fund loan demand. Bank Management does not view the decrease in loan balances
as a continuing trend. An increase in market interest rates will decelerate the
pace of refinance activity in the residential loan portfolio and the Bank
intends to continue focusing its efforts on growing commercial loans.
At December 31, 2003, outstanding loan commitments were $4.4 million and
$42.1 million on fixed and variable-rate loans, respectively. Of these loan
commitments, Management expects $18.4 million to be disbursed for new loans
during the first half of 2004. The additional loan commitments are unused lines
of credit, which may be drawn at any time by the borrower. These loan
commitments will be funded by interest-bearing deposits, maturing assets, and
additional FHLB borrowings, if needed.
Loans serviced for others increased by $38.5 million to $217.0 million
at December 31, 2003 from $178.5 million at December 31, 2002. This servicing
portfolio consists of loans originated by the Bank and sold in the secondary
mortgage market with servicing retained by the Bank. Management believes this
provides the Bank with a competitive advantage in its market. The retention of
servicing requires the Bank to keep a higher staffing level than if the
servicing is sold. But many consumers have discovered the difficulties
encountered when loan servicing is sold. The retention of servicing also allows
the Bank to cross-sell other banking products and services to these customers.
The value of the right to service is appraised quarterly and any temporary
impairment of the value of servicing rights is recognized quarterly. The
originated mortgage servicing rights asset had a valuation allowance at December
31, 2003 of $22,274. This allowance was established to recognize the measured
impairment of the asset. The Bank will continue to monitor the valuation of the
servicing rights asset. If subsequent analysis shows changes in the appraised
impairment, the valuation allowance will be adjusted to match the impairment.
Management expects the value of servicing will increase as interest rates rise.
Generally, consumers are less inclined to refinance a lower-than-market fixed
rate mortgage when rates increase. If this logic prevails, the value of
servicing should increase due to the expected increase in duration of the
underlying cash flows.
15
Bancorp has no purchased mortgage servicing portfolio.
INTEREST-BEARING DEPOSITS IN BANKS. Interest-bearing deposits in banks
were $15.3 million at December 31, 2003, compared to $23.0 million at December
31, 2002, a decrease of $7.7 million. The decrease of deposits was used to
reduce FHLB advances. During 2002, growth in deposits and refinanced loans
provided funds for investments in $100,000 certificates of deposit in domestic
financial institutions.
SECURITIES - AVAILABLE FOR SALE. Investment securities available for
sale of $4.0 million at December 31, 2003 consisted of a mortgage-backed
security issued by the Federal National Mortgage Association. The Bank's
investment strategy has historically been to carry its mortgage-backed
securities in the held-to-maturity portfolio. Management has changed this
strategic decision, so that a balanced investment portfolio can more directly
contribute to future liquidity needs by being carried as available-for-sale.
SECURITIES - HELD-TO-MATURITY. Investment securities held-to-maturity
consist of U.S agency mortgage-backed securities, municipal obligations, and a
trust preferred security. The investment securities held-to-maturity were $10.9
million at December 31, 2003 compared to $12.6 million at December 31, 2002, a
decrease of $1.7 million. The decrease was primarily due to matured municipal
obligations and principal payments on mortgage-backed securities.
DEPOSITS AND BORROWED FUNDS. Deposits were $199.9 million at December
31, 2003 compared to $202.6 million at December 31, 2002, a decrease of $2.6
million or 1.3%. Although interest-bearing deposits decreased to $187.6 million
at December 31, 2003, compared to $189.8 million at December 31, 2002, the
decrease is due to a decrease of $11.7 million in certificates of deposit.
Certificates of deposit with balances greater than or equal to $100,000
(commonly referred to as Jumbo Certificates), which carry greater interest rate
sensitivity, decreased by $5.0 million to $29.4 million at December 31, 2003.
The Bank views Jumbo Certificates of deposit as a source of liquidity. The
Bank's reliance on this funding source decreased in 2003 to 14.73% of deposits
at December 31, 2003, compared to 17.01% of deposits at December 31, 2002.
Transaction savings accounts and checking accounts increased $9.5 million, or
10.4%, from December 31, 2002 to December 31, 2003. Transaction savings accounts
and checking accounts represent 50.59% of deposits at December 31, 2003,
compared to 45.23% of deposits at December 31, 2002. Bank management is actively
attempting to increase these core deposit account relationships. The increase in
transaction savings accounts and checking accounts provides relatively
inexpensive funding for future growth, compared to alternative certificates of
deposit and FHLB advances at higher interest rates. The Bank offers competitive
rates on its time deposits and uses borrowed funds, when that strategy enhances
net interest income.
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 annually in March. The Bank will renew the line of credit at maturity in
March 2004. All borrowings from FHLB are collateralized by substantially all
mortgage loans.
Long-term advances were $49.9 million at December 31, 2003 compared to
$57.7 million at December 31, 2002 a decrease of $7.8 million. Short-term
advances were $5.9 million at
16
December 31, 2003 compared to $6.7 million at December 31, 2002 a decrease of
$0.8 million. Management does not anticipate a need to increase FHLB advances
until demand for portfolio loans increases.
CAPITAL RESOURCES
The stockholders' equity of the Bancorp was $29.2 million at December
31, 2003 compared to $27.5 million at December 31, 2002, an increase of $1.7
million or 6.21%. The primary component of this increase was net income $2.6
million less dividends paid of $982,987. During January 2002, the Board of
Bancorp approved a program to repurchase up to 10 percent of Bancorp's issued
and outstanding common stock in the open market and in privately negotiated
transactions. Through December 31, 2002, Bancorp redeemed 301,999 shares of its
common stock at a total redemption price of $3.0 million. The repurchase program
expired in January 2003 with no additional stock repurchased. The stockholders'
equity was 10.15% of total assets at December 31, 2003. Management continues to
monitor and evaluate the best capital structure of Bancorp. A structure that
provides sufficient capital to fund future growth, yet maximizes earnings per
share, is deemed optimal. Management does not project a need for capital beyond
what can be provided by retained earnings. If additional capital is needed,
Bancorp will consider, among other options, issuing trust preferred securities
or a secondary offering of common stock.
ASSET/LIABILITY MANAGEMENT
The primary component of Bancorp's earnings is net interest income of
the Bank. 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 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 techniques to reduce the rate
sensitivity of its deposits and borrowed money. Those techniques include
attracting longer-term certificates of deposit when the market will permit,
emphasizing core deposits,
17
which are less sensitive to changes in interest rates, and borrowing through
long-term FHLB advances. The Bank's asset/liability management strategy will
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. These assumptions are
based on national statistics and may not reflect the Bank's own experience. 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, 2003, the following
table illustrates the interest rate sensitivity of the Bancorp's consolidated
equity to changes in market interest rates.
(in Thousands of Dollars)
-----------------------
Book value of stockholders' equity $29,158
4% increase in market rates 45,548
3% increase in market rates 48,063
2% increase in market rates 47,651
1% increase in market rates 47,691
No change (current market value of equity) 46,697
1% decrease in market rates 44,752
2% decrease in market rates 42,160
3% decrease in market rates 39,051
4% decrease in market rates 34,762
As the table shows, Bancorp's book value of equity is less than
estimated market value in all of the scenarios. That indicates that Bancorp is
able to withstand fluctuations in market interest rates without posting a
significant threat to either Bancorp's stockholders' equity or the federal
deposit insurance system, and therefore, Bancorp can be deliberate in its
actions to adjust the asset-liability mix. Bancorp 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
Bancorp'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.
18
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 Bancorp's consolidated interest rate repricing gaps for selected
maturity periods as of December 31, 2003:
(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 $ 8,668 $ 5,910 $ 4,573 $ 1,283 $ 7,671 $ 12,074 $ 2,117 $ 42,296
Loans 83,910 12,090 17,490 17,216 18,192 61,679 4,000 214,517
--------------------------------------------------------------------------------------------
Total interest-earning assets $ 92,578 $ 18,000 $ 22,063 $ 18,499 $ 25,863 $ 73,753 $ 6,117 $256,873
--------------------------------------------------------------------------------------------
Savings accounts $ 1,323 $ 2,646 $ 4,120 $ 4,120 $ 4,120 $ 21,566 $ 5,710 $ 43,605
Checking accounts 1,772 3,556 5,613 5,613 5,613 27.997 7,371 57,535
Certificates & Term IRA's 2,887 6,137 8,886 4,222 6,428 52,840 5,098 86,498
Other IB liabilities (FHLB advances) 5,876 3,026 0 0 00 15,903 31,000 55,805
--------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 11,858 $ 15,365 $ 18,619 $ 13,955 $ 16,161 $118,306 $ 49,179 $243,443
--------------------------------------------------------------------------------------------
Asset (liability) gap $ 80,720 $ 2,635 $ 3,444 $ 4,544 $ 9,702 -$44,553 -$43,062 $ 13,430
Cumulative asset gap 80,720 83,355 86,799 91,343 101,045 55,492 13,430
Cumulative gap as a percentage
of cumulative earning assets 87.2% 75.4% 65.4% 60.4% 57.1% 22.5% 5.2%
Total interest-earning assets exceeded interest-bearing liabilities by
$13.4 million at December 31, 2003. 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 $101.0 million. This indicates the Bancorp's net interest
income would increase with rising interest rates, because more of its assets
than liabilities would reprice at the higher rates in the next year. 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
Bancorp. 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: Bancorp recognizes the limitations of static gap analysis as
a tool for managing its interest rate risk. Bancorp 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, asset and
liability mixes, and prepayment options inherent in financial instruments, as
well as interest rate levels in order to quantify risk. Bancorp'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
19
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.
Bancorp's Board of Directors compares net interest income sensitivity to
established tolerance limits for fluctuation. Throughout 2003, the forecasted
exposure was within the Bancorp's established policy limits, except in falling
rate change scenarios. Management recognizes the "out of policy" condition in
the falling rate environment and has reported this condition to the Board
quarterly. The Bancorp's Board of Directors and Management consider further
significant rate decreases from December 31, 2003 unlikely and have not changed
the Bank policy's tolerance limits to conform to the existing rate environment.
Net Interest Income Sensitivity: Change in Projected Results vs. Constant Rates
Year-End 2003 12 Month Projection
Rate Shock Amount
(2.00%) (1.00%) 0.00% 1.00% 2.00%
-----------------------------------------------
Percent Change in net interest (9.68%) (4.15%) 0.00% 1.27% 2.03%
income vs. constant rates
ALCO Policy Limit (6.00%) (3.00%) 0.00% (4.00%) (8.00%)
EFFECT OF INTEREST RATE FLUCTUATIONS
Bancorp's consolidated results of operations depend to a large extent on
the Bank's level of 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.
Bancorp measures its interest rate risk primarily using simulation
analysis. This analysis is prepared by the Chief Financial Officer and reviewed
by the ALCO. ALCO is comprised of the Chief Executive Officer, Chief Financial
Officer, Executive Vice President and Senior Officers of the Bank. Bancorp's
Board of Directors review quarterly reports that estimate Bancorp's sensitivity
to changes in interest rates. Sensitivity is estimated for net interest income
and market value of portfolio equity.
While Bancorp uses various tools to monitor interest rate risk, it is
unable to predict
20
future fluctuations in interest rates or the specific impact thereof. The market
value of most of Bancorp's financial assets is sensitive to fluctuations in
market interest rates. Fixed-rate investments and mortgage loans decline in
value as interest rates rise. Adjustable-rate investments and loans generally
have less market value volatility than fixed-rate assets.
LIQUIDITY
Bancorp 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.
Bancorp 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,
loan sales, maturing investments, deposit accounts, and FHLB borrowings.
The primary market factor that impacted liquidity throughout 2003 was
low interest rates for residential mortgages. The residential mortgages that
have refinanced into low fixed-rate terms have been sold to the secondary
mortgage market, providing funds for Bancorp to redeploy. Bancorp originated
commercial mortgage and commercial nonmortgage loans to hold in its portfolio,
so the percentage of commercial loans to total loans increased. Excess funds
from refinanced residential mortgages have been invested in securities
available-for-sale and funded the decreases in deposits and borrowings. An
increase in loan rates would probably reduce Bancorp's liquidity position,
because borrowers would be more likely to prefer adjustable-rate mortgages,
which Bancorp holds in its portfolio. Management expects market interest rates
to remain stable through most of 2004, followed by increases as the U.S. economy
recovers.
CONTRACTUAL OBLIGATIONS
The long-term debt obligations consist of certificates of deposit and
advances from the Federal Home Loan Bank. The following schedule represents
principal payments only and does not include interest.
Payments Due by Period
--------------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
Total 1 Year Years Years Years
----- ------ ----- ----- -----
Certificates of deposit $ 86,497,877 $28,560,353 $26,914,006 $25,925,965 $ 5,097,553
FHLB advances 49,929,132 3,025,849 5,903,283 10,000,000 31,000,000
---------------- ---------------- --------------- --------------- ----------------
Total contractual obligations $136,427,009 $31,586,202 $32,817,289 $35,925,965 $36,097,553
21
OFF-BALANCE SHEET ACTIVITIES
OTHER COMMERCIAL CREDITS - The Bank is a party to credit related financial
instruments with off-balance sheet risks in the normal course of business to
meet the financing needs of its customers. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized on the balance sheet of the Bank.
Commitments to extend credit are agreements to lend to a customer as long as
there are no violations of any condition established in the contract.
Commitments for equity lines of credit or overdraft protection may expire
without being drawn. Therefore, total commitments 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. 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, may not contain a specified maturity date and may be drawn to
the total extent of the Bank's commitment.
Commercial and standby letters of credit are a conditional commitment issued by
the Bank to guarantee the performance of a customer to a third party. The
letters of credit are primarily used to support public and private borrowing
arrangements. All letters of credit have expiration dates within one year.
At December 31, 2003, the Bank had total commitments of $4.4 million and $42.4
million on fixed rate and variable rate loans, respectively.
The following table discloses contractual expiration dates for commitments of
the Bank at December 31, 2003.
Amount of Commitment Expiration Per Period
---------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
Total 1 Year Years Years Years
----- ------ ----- ----- -----
Home equity lines of credit $22,399,696 $ 2,476,712 $ - $ 526,885 $19,396,099
Lines of credit 7,194,263 6,551,137 458,615 181,351 3,160
Undisbursed construction loans 3,138,158 3,138,158 - - -
Standby letters of credit 230,000 230,000 - - -
New Loans 12,910,000 12,910,000 - - -
---------------------------------------------------------------------------------
Total commitments with expiration $45,872,117 $25,306,007 $ 458,615 $ 708,236 $19,399,259
Overdraft protection - no expiration 890,968
-------------
Total commitments $46,763,085
=============
All of the commercial credits are underwritten using the commercial loan
underwriting guidelines.
COLLATERAL REQUIREMENTS - To reduce credit risks related to the use of
credit-related financial instruments, the Bank might deem it necessary to obtain
collateral. The amount and nature of the
22
collateral obtained are based on the Bank's credit evaluation of the borrower.
Collateral held varies, but may include cash, securities, accounts receivable,
inventory, property, plant and equipment and real estate. Although these items
are used to secure loans, they are not included on the balance sheet of Bancorp.
LEGAL CONTINGENCIES - Various legal claims also arise from time to time in the
normal course of business which, in the opinion of Management, will have no
material effect on Bancorp's consolidated financial statements.
OTHER OFF-BALANCE SHEET ACTIVITIES - During the year ended December 31, 2003,
Bancorp purchased an investment for $25,000 in a venture capital company.
Bancorp has a minority interest of approximately 1% in the company. The venture
capital company seeks viable projects in various stages of development for
investment. Bancorp has committed to contribute an additional $225,000 as
capital is required to fund projects.
IMPACT OF INFLATION
The majority of assets and liabilities of financial institutions are
monetary in nature. Generally, changes in interest rates have a more significant
impact on earnings of the Bank than inflation. Although influenced by inflation,
changes in rates do not necessarily move in either the same magnitude or
direction as changes in the price of goods and services. Inflation does impact
the growth of total assets, creating a need to increase equity capital at a
higher rate to maintain an adequate equity to assets ratio, which in turn
reduces the amount of earnings available for cash dividends. Inflation for
calendar year 2003 did not have a material impact on the Company.
RECENT ACCOUNTING DEVELOPMENTS
In June 2001, Statement of Financial Accounting Standards ("SFAS") 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, Bancorp will no longer be amortizing goodwill. Goodwill
amortization was $574,864 in 2001. No impairment loss was recorded upon adoption
of FAS 142. For comparison purposes, had FAS 142 been adopted in 2001, adjusted
net income would have been approximately $3,167,347 in 2001, compared to
$2,605,089 and $2,790,387 in 2003 and 2002, respectively. The primary reason for
the decrease in net income since 2001 is the lower net interest margin.
In November, 2002, the Financial Accounting Standards Board ("FASB")
issued Financial Interpretation No. ("FIN") 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 elaborates on the disclosures to be made by a
guarantor about its obligations under certain guarantees issued. It also
clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition
23
and measurement provisions of FIN 45 have been applied on a prospective basis to
guarantees issued or modified after December 31, 2002. However, the value of
such guarantees is immaterial and the adoption of this Standard did not have a
material effect on Bancorp's financial statements.
On March 13, 2002, FASB determined that loan commitments related to the
organization or acquisition of mortgage loans that will be held for sale must be
accounted for as derivative instruments, effective for fiscal quarters beginning
after April 10, 2002. Accordingly, Bancorp adopted such accounting on July 1,
2002. Bancorp enters into commitments to originate loans whereby the interest
rate on the loan is determined prior to funding (rate lock commitments). Rate
lock commitments on mortgage loans that are intended to be sold are considered
to be derivatives. Accordingly, such commitments, along with any related fees
received from potential borrowers, are recorded at fair value in derivative
assets or liabilities, with changes in fair value recorded in the net gain or
loss on sale of mortgage loans. Fair value is based on fees currently charged to
enter into similar agreements, and for fixed-rate commitments also considers the
difference between current levels of interest rates and the committed rates.
Prior to July 1, 2002, such commitments were recorded to the extent of fees
received. Fees received were subsequently included in the net gain or loss on
sale of mortgage loans. The cumulative effect of adopting SFAS No. 133 for rate
lock commitments as of July 1, 2002 was not material.
In December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement 123."
SFAS No. 148 provides alternative methods of transition for a voluntary change
to the fair value method of accounting for stock-based employee compensation. In
addition, this Statement amends disclosure requirements to require more
prominent disclosures about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results in both
annual and interim financial statements. SFAS No. 148 was effective for
financial statements for fiscal years ending after December 15, 2002. As
permitted by SFAS No. 148, Bancorp will continue to apply the provisions of APB
Opinion No. 25, "Accounting for Stock-Based Compensation," for all employee
stock option grants and has elected to disclose pro forma net income and
earnings per share amounts as if the fair-value based method had been applied in
measuring compensation costs. The required disclosures are in Note 1 of
Bancorp's financial statements for 2003.
RECENT LEGISLATION
THE SARBANES-OXLEY ACT OF 2002 On July 30, 2002, President Bush signed
into law the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"). The stated goals
of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide
for enhanced penalties for accounting and auditing improprieties at publicly
traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws.
The Sarbanes-Oxley Act is the most far-reaching U.S. securities
legislation enacted in some time. The Sarbanes-Oxley Act generally applies to
all companies, both U.S. and non-U.S., that file or are required to file
periodic reports with the Securities and Exchange Commission (the "SEC") under
the Securities Act of 1933 or the Securities Exchange Act of
24
1934. Given the extensive SEC role in implementing rules relating to many of the
Sarbanes-Oxley Act's new requirements, the final scope of these requirements
remains to be determined.
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and securities
exchanges to adopt extensive additional disclosure, corporate governance and
other related rules, and mandates further studies of certain issues by the SEC
and the Comptroller General. The Sarbanes-Oxley Act represents significant
federal involvement in matters traditionally left to state regulatory systems,
such as the regulation of the accounting profession, and to state corporate law,
such as the relationship between a board of directors and management and between
a board of directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters:
o audit committees for all reporting companies;
o certification of financial statements by the chief executive
officer and the chief financial officer;
o the forfeiture of bonuses or other incentive-based compensation
and profits from the sale of an issuer's securities by directors
and senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
o a prohibition on insider trading during pension plan black out
periods;
o disclosure of off-balance sheet transactions;
o a prohibition on personal loans to directors and officers;
o expedited filing requirements for Forms 4's for reporting of
securities transactions by directors and executive officers;
o disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
o "real time" filing of periodic reports;
o the formation of a public accounting oversight board;
o auditor independence; and
o various increased criminal penalties for violations of
securities laws.
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002 and provisions which will become effective at various
times thereafter. The SEC has been delegated the task of enacting rules to
implement various provisions with respect to, among other matters, disclosure in
periodic filings pursuant to the Exchange Act. The SEC continues to implement
various components of the Sarbanes-Oxley Act.
Compliance with Section 404 of the Sarbanes-Oxley Act, requiring
enhanced internal controls, testing and disclosures, will likely increase
internal and external audit expenses of the Company. However because the final
regulations have not been fully codified, Management is unable to accurately
estimate the amount of these increases.
USA PATRIOT ACT - Under the USA PATRIOT Act of 2001, adopted by the U.S.
Congress on October 26, 2001 to combat terrorism, FDIC insured banks and
commercial banks will be required to increase their due diligence efforts for
correspondent accounts and private banking customers. The USA PATRIOT Act
requires banks to engage in additional
25
record keeping or reporting, requiring identification of owners of accounts, or
of the customers of foreign banks with accounts, and restricting or prohibiting
certain correspondent accounts.
During 2002, the Federal Crimes Enforcement Network, a bureau of the
Department of Treasury, issued regulations to implement the provisions of the
USA PATRIOT Act. To date, it has not been possible to predict the impact and USA
PATRIOT Act and its implementing regulations may have on Bancorp and the Bank.
26
DIRECTORS OF BANCORP
--------------------
Raymond H. Dresser, Jr. Chairman, Dresser, Dresser, Haas & Caywood, P.C. Retained Counsel
Eric L. Eishen President and Chief Executive Officer, Sturgis Bank & Trust Company
Leonard L, Eishen Retired President and Chief Executive Officer, Sturgis Bank & Trust Company
Lawrence A. Franks Chairman of the Board, President, Burr Oak Tool and Gauge Company, Inc.
Donald A. Frost President, LTI Printing, Inc.
James A. Goethals Vice Chairman of the Board, Retired President, Sturgis Foundry Corporation
Philip G. Ward President Emeritus, Glen Oaks Community College
OFFICERS OF BANCORP
-------------------
Eric L. Eishen President, Chief Executive Officer
Ronald W. Scheske Vice President
Brian P. Hoggatt Chief Financial Officer, Secretary/Treasurer
27
DIRECTORS OF THE BANK
---------------------
Raymond H. Dresser, Jr. Chairman, Dresser, Dresser, Haas & Caywood, P.C. Retained Counsel
Eric L. Eishen President and Chief Executive Officer
Leonard L. Eishen Retired President and Chief Executive Officer
Lawrence A. Franks Vice Chairman of the Board, 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
Philip G. Ward President Emeritus, Glen Oaks Community College
OFFICERS OF THE BANK
--------------------
Eric L. Eishen President, Chief Executive Officer
Steven G. Gage Senior Vice President, Commercial Lending
Brian P. Hoggatt Senior Vice President, Chief Financial Officer, Treasurer, Corporate Secretary
Tracey L. Parker Senior Vice President, Retail Lending
Ronald W. Scheske Executive Vice President
David E. Watters Vice President, Senior Trust Officer
Jose D. Albarran Vice President
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, Loss Mitigation
Jason J. Hyska Vice President
Gary E. Metz Vice President
Larry W. Miller Vice President
Christine M. Moline Vice President, Private Banking
Janet M. Stahl Vice President (hired January 2004)
Jason A. Wagner Vice President
Sandra J. Cagle Assistant Vice President
Trudy R. Gloy Assistant Vice President
Regina L. Schinker Assistant Vice President (resigned January 2004)
Camille M. Wilson Assistant Vice President
28
BANK CORPORATE INFORMATION
Location Address City, St Zip Telephone Fax
-------- ------- ------------ --------- ---
Sturgis (Main Office) 113-125 East Chicago Road Sturgis, MI 49091 (269) 651-9345 (269) 651-5512
(269) 651-8263
(269) 865-5902
BRANCH OFFICES
Bronson 863 West Chicago Road Bronson, MI 49028 (517) 369-7322 (517) 369-2347
Centreville 158 West Main Centreville, MI 49032 (269) 467-8525 (269) 467-4180
Climax 125 North Main Climax, MI 49034 (269) 746-4256 (269) 746-4108
Coldwater 290 East Chicago Road Coldwater, MI 49036 (517) 278-5634 (517) 278-5613
Colon 110 South Blackstone Street Colon, MI 49040 (269) 432-3229 (269) 432-2971
South Haven 1121 LaGrange Street South Haven, MI 49090 (269) 637-8444 (269) 637-5560
Sturgis 1001 South Centerville Road Sturgis, MI 49091 (269) 651-9379 (269) 651-1514
Sturgis 1501 East Chicago Road Sturgis, MI 49091 (269) 651-9345 (269) 651-5609
Three Rivers 115 North Main Street Three Rivers, MI 49093 (269) 273-8481 (269) 273-1732
White Pigeon 122 West Chicago Road White Pigeon, MI 49099 (269) 483-9668 (269) 483-2725
29
MARKET INFORMATION
------------------
Shares of common stock of Bancorp were held by 391 shareholders of record as of
December 31, 2003 according to Bancorp's transfer agent. Bancorp's shares are
traded on the NASDAQ Small Cap Market under the symbol of "STBI". Trading
activity has been infrequent, and previous price information had not been
regularly published.
The range of high and low trade prices for each quarterly period during the past
two years is presented below:
Year Ended December 31,
-----------------------
2003 2002
------------------- -------------------
High Low High Low
---- --- ---- ---
First quarter $10.60 $9.16 $10.00 $7.57
Second quarter 11.50 10.00 11.00 9.07
Third quarter 12.45 10.50 11.00 10.16
Fourth quarter 15.36 11.50 11.00 10.19
The trade prices listed above are based on actual transactions obtained from
public Internet sources obtained by Bancorp.
The following table summarizes cash dividends paid per share of common stock for
each quarterly period during 2003 and 2002.
2003 2002
------------------
First quarter $.08 $.07
Second quarter .09 .07
Third quarter .09 .07
Fourth quarter .09 .07
------------------
$.35 $.28
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 "Bancorp"). This
reorganization was approved at a special meeting of the shareholders of the Bank
on December 11, 2001. Bancorp received all of the various federal and state
regulatory approvals for this reorganization.
This reorganization became effective as of the opening of business on January 1,
2002. Bancorp is a legal entity separate and distinct from its subsidiaries.
Substantially all of Bancorp's revenues 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 to Bancorp, as
well as by Bancorp to its shareholders.
30
Under the Michigan Savings Bank Act, Bancorp 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, Bancorp 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 Bancorp 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.
INDEPENDENT ACCOUNTANTS
-----------------------
Bancorp has employed the accounting firm of Plante & Moran, PLLC as Independent
Accountants for the years ended December 31, 2003, 2002, and 2001. There have
been no disagreements on accounting or financial disclosure matters within this
time period.
FORM 10-K REPORT
----------------
A copy of Bancorp's Annual Report on Form 10-K, as filed with the Securities
Exchange Commission, for the year ended December 31, 2003, as well as other
filings of Bancorp may be obtained by contacting Eric L. Eishen at Sturgis Bank
& Trust Company, 113-125 East Chicago Road, Sturgis, Michigan 49091, telephone
number (269) 651-9345 or through the Securities and Exchange Commission Edgar
System at WWW.SEC.GOV. Copies of the Bank's filings with the
31
FDIC under the Securities Exchange Act of 1934 can be obtained from Sturgis Bank
& Trust Company by contacting Eric L. Eishen at Sturgis Bank & Trust Company,
113-125 E Chicago Road, Sturgis, Michigan 49091, telephone number (269) 651-9345
or, for a nominal fee from the FDIC at telephone number (202) 898-8913 or fax
number (202) 898-3909.
The Bank maintains a website at WWW.STURGISBANK.COM. On this site, a
link is provided to the SEC's website that provides all filings of the Company.
In this way, the Company makes available reports, including the annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
securities transaction reports on Form 3, Form 4, and Form 5, and certain other
reports filed or furnished pursuant to the Exchange Act as soon as reasonably
practicable after it electronically files such material with, or furnishes it
to, the Securities and Exchange Commission.
32
STURGIS BANCORP, INC. AND SUBSIDIARIES
--------------------------------------
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2003
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONTENTS
REPORT LETTER 1
CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheet 2-3
Statement of Income 4
Statement of Changes in Stockholders' Equity 5
Statement of Cash Flows 6-7
Notes to Consolidated Financial Statements 8-42
Independent Auditor's Report
To the Board of Directors and Stockholders
Sturgis Bancorp, Inc. and Subsidiaries
Sturgis, Michigan
We have audited the accompanying consolidated balance sheet of Sturgis Bancorp,
Inc. and Subsidiaries as of December 31, 2003 and 2002 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, 2003. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the 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
Bancorp, Inc. and Subsidiaries as of December 31, 2003 and 2002 and the
consolidated results of their operations and their cash flows for each year in
the three-year period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the financial statements, the Corporation changed its
method of accounting for goodwill in 2002.
/s/ Plante & Moran, PLLC
Plante & Moran, PLLC
Kalamazoo, Michigan
March 2, 2004
STURGIS BANCORP, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31
------------------------------
2003 2002
-------------- --------------
ASSETS
Cash and due from banks $ 10,184,272 $ 13,064,101
Federal funds sold 283,905 -
Other short-term investments 27,124 7,183
-------------- --------------
Total cash and cash equivalents 10,495,301 13,071,284
Interest-bearing deposits in banks 15,339,462 23,018,375
Securities - Held-to-maturity (Note 2) 10,938,761 12,590,709
Securities - Available for sale (Note 2) 4,026,250 -
Federal Home Loan Bank stock, at cost 4,274,700 4,115,400
Loans held for sale 1,321,674 7,437,506
Loans, net (Note 3) 215,527,565 212,043,350
Real estate owned 749,899 1,358,759
Bank owned life insurance (Note 10) 6,628,534 6,335,429
Accrued interest receivable 1,591,414 1,731,948
Investment in limited partnerships (Note 5) 1,192,077 161,080
Premises and equipment, net (Note 6) 6,488,123 6,641,980
Goodwill, net of accumulated amortization (Note 1) 5,109,419 5,109,419
Originated mortgage servicing rights (Note 4) 1,974,988 1,501,922
Other assets 1,679,426 1,567,296
-------------- --------------
Total assets $ 287,337,593 $ 296,684,457
============== ==============
See Notes to Consolidated
Financial Statements. 2
STURGIS BANCORP, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET (CONTINUED)
December 31
------------------------------
2003 2002
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Noninterest-bearing $ 12,282,992 $ 12,747,121
Interest bearing (Note 7) 187,637,221 189,816,675
-------------- --------------
Total deposits 199,920,213 202,563,796
Federal Home Loan Bank advances (Note 8) 55,804,670 64,381,396
Deferred federal income taxes (Note 9) 483,865 306,667
Accrued interest payable 678,547 935,954
Other liabilities 1,291,947 1,044,116
-------------- --------------
Total liabilities 258,179,242 269,231,929
STOCKHOLDERS' EQUITY (Notes 1, 11, and 12)
Preferred stock - $1 par value:
Authorized - 1,000,000 shares
Issued and outstanding - 0 shares
Common stock - $1 par value:
Authorized - 9,000,000 shares
Issued and outstanding - 2,808,535 shares and 2,799,535
shares at December 31, 2003 and 2002, respectively 2,808,535 2,799,535
Additional paid-in capital 17,805,688 17,732,617
Accumulated other comprehensive income 1,650 -
Retained earnings 8,542,478 6,920,376
-------------- --------------
Total stockholders' equity 29,158,351 27,452,528
-------------- --------------
Total liabilities and stockholders' equity $ 287,337,593 $ 296,684,457
============== ==============
See Notes to Consolidated
Financial Statements. 3
STURGIS BANCORP, INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31
-----------------------------------------------
2003 2002 2001
------------- ------------- -------------
INTEREST INCOME
Loans $ 13,820,902 $ 15,729,020 $ 18,276,561
Investment securities :
Taxable 870,309 1,209,703 996,892
Tax-exempt 137,235 142,034 93,422
Dividends 417,152 329,935 571,592
------------- ------------- -------------
Total interest income 15,245,598 17,410,692 19,938,467
INTEREST EXPENSE
Deposits 4,134,633 5,042,699 6,369,577
Federal Home Loan Bank advances 2,882,640 3,371,401 4,031,835
------------- ------------- -------------
Total interest expense 7,017,273 8,414,100 10,401,412
------------- ------------- -------------
NET INTEREST INCOME 8,228,325 8,996,592 9,537,055
PROVISION FOR LOAN LOSSES (Note 3) 819,709 1,494,916 1,056,194
------------- ------------- -------------
NET INTEREST INCOME - After provision for loan losses 7,408,616 7,501,676 8,480,861
NONINTEREST INCOME
Service charges and other fees 1,438,125 1,536,181 1,634,957
Investment brokerage commission income 846,902 970,737 796,688
Mortgage banking activities 2,662,112 2,028,497 1,508,451
Trust fee income 485,327 478,653 492,803
Increase in value of bank owned life insurance 293,105 332,470 2,959
Other income 24,871 46,128 46,922
------------- ------------- -------------
Total noninterest income 5,750,442 5,392,666 4,482,780
NONINTEREST EXPENSES
Salaries and employee benefits (Note 10) 4,921,978 4,651,787 4,011,629
Occupancy and equipment 1,385,120 1,304,802 1,408,876
Data processing 753,998 651,991 592,805
Professional services 376,751 353,039 367,586
Amortization of goodwill - - 574,864
Real estate owned expense 225,063 201,698 139,762
Advertising expense 220,850 176,265 180,177
Other 1,694,195 1,646,444 1,597,104
------------- ------------- -------------
Total noninterest expenses 9,577,955 8,986,026 8,872,803
------------- ------------- -------------
INCOME - Before income tax expense 3,581,103 3,908,316 4,090,838
INCOME TAXES (Note 9) 976,014 1,117,929 1,302,901
------------- ------------- -------------
NET INCOME $ 2,605,089 $ 2,790,387 $ 2,787,937
============= ============= =============
BASIC EARNINGS PER SHARE $ 0.93 $ 0.95 $ 0.90
------------- ------------- -------------
DILUTED EARNINGS PER SHARE $ 0.93 $ 0.95 $ 0.90
------------- ------------- -------------
See Notes to Consolidated
Financial Statements. 4
STURGIS BANCORP, INC. AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Additional Other Total
Paid-in Comprehensive Retained Stockholders'
Common Stock Capital Income Earnings Equity
-------------- --------------- -------------- ------------- -----------------
BALANCE - January 1, 2001 $ 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 - - - 2,787,937 2,787,937
Cash dividends ($.26 per share) - - - (806,399) (806,399)
-------------- --------------- -------------- ------------- -----------------
BALANCE - December 31, 2001 3,101,534 20,435,912 - 4,959,488 28,496,934
Stock redemption (301,999) (2,703,295) - - (3,005,294)
Net income - - - 2,790,387 2,790,387
Cash dividends ($.28 per share) - - - (829,499) (829,499)
-------------- --------------- -------------- ------------- -----------------
BALANCE - December 31, 2002 2,799,535 17,732,617 - 6,920,376 27,452,528
Net income - - - 2,605,089 2,605,089
Change in unrealized gain on securities
available for sale, net of tax effect of $850 - - 1,650 - 1,650
-----------------
Total comprehensive income 2,606,739
Stock options exercised 9,000 73,071 - - 82,071
Cash dividends ($.35 per share) - - - (982,987) (982,987)
-------------- --------------- -------------- ------------- -----------------
BALANCE - December 31, 2003 $ 2,808,535 $ 17,805,688 $ 1,650 $ 8,542,478 $ 29,158,351
-------------- --------------- -------------- ------------- -----------------
See Notes to Consolidated
Financial Statements. 5
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31
-----------------------------------------------
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,605,089 $ 2,790,387 $ 2,787,937
Adjustments to reconcile net income to net cash
from operating activities
Depreciation 624,228 605,318 670,844
Amortization of mortgage servicing rights 826,420 1,155,206 1,100,901
Provision for loan losses 819,709 1,494,916 1,056,194
Deferred income taxes 176,348 58,334 (1,667)
Accretion and amortization of securities 95,270 61,319 3,040
Gain on sale of loans (2,743,952) (2,032,156) (1,749,768)
Proceeds from the sale of loans held for sale 126,277,169 108,718,408 74,319,076
Loans originated for sale (118,716,871) (111,084,772) (77,333,342)
Gain on real estate owned (17,275) (37,685) (35,329)
Loss on disposal of premises and equipment 48,467 - 74,110
Loss of equity in limited partnership 19,003 63,000 18,000
Loss on sale of available for sale securities 36,342 - -
Loss on impairment of investment 75,000 - -
Increase in cash value of bank owned life insurance (293,105) (332,470) (2,959)
Stock dividend from Federal Home Loan Bank stock (159,300) - -
Net change in:
(Increase) decrease in accrued interest and
other assets 28,404 (429,008) (544,155)
Increase (decrease) in accrued interest and
other liabilities (8,505) 142,755 230,202
------------- ------------- -------------
Net cash provided by operating activities 9,692,441 1,173,552 593,084
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits in banks 7,678,913 (12,176,995) (3,673,612)
Proceeds from maturities of securities held-to-maturity 360,000 1,105,000 4,630,000
Purchases of securities held-to-maturity - (10,213,700) (1,425,000)
Principal reductions of mortgage-backed securities 1,121,678 361,147 223,490
Purchase of securities available for sale (13,099,117) (9,235,451) -
Proceeds from sales of securities available for sale 9,039,025 9,235,451 -
Purchase of Federal Home Loan Bank stock - - (617,900)
Net (increase) decrease in loans (5,001,089) 4,022,934 2,994,155
Proceeds from sale of real estate owned 1,323,300 682,839 445,113
Purchase of investment in limited partnership (1,050,000) - -
Additions to premises and equipment (541,881) (877,138) (381,990)
Proceeds from the sale of premises and equipment 23,043 - 355,190
Purchase of bank owned life insurance - - (6,000,000)
------------- ------------- -------------
Net cash used in investing activities (146,128) (17,095,913) (3,450,554)
See Notes to Consolidated
Financial Statements. 6
STURGIS BANCORP, INC. AND SUBSIDIARIES
- ----------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
Year Ended December 31
-----------------------------------------------
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand and savings account deposits 9,060,424 6,016,796 8,657,724
Net increase (decrease) in certificates of deposit (11,704,007) 17,417,173 (4,861,501)
Repayment of FHLB advances (14,452,264) (28,367,374) (36,433,513)
Proceeds from FHLB advances 5,875,538 22,671,907 39,100,000
Cash dividends paid on common stock (982,987) (829,499) (806,399)
Stock options exercised 81,000 - -
Stock redemption - (3,005,294) -
------------- ------------- -------------
Net cash provided by (used in)
financing activities (12,122,296) 13,903,709 5,656,311
------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (2,575,983) (2,018,652) 2,798,841
CASH AND CASH EQUIVALENTS - Beginning of year 13,071,284 15,089,936 12,291,095
------------- ------------- -------------
CASH AND CASH EQUIVALENTS - End of year $ 10,495,301 $ 13,071,284 $ 15,089,936
------------- ------------- -------------
SUPPLEMENTAL INFORMATION
Cash paid (received) for:
Interest $ 7,274,680 $ 8,471,931 $ 10,436,770
Income taxes 1,288,033 1,374,118 1,730,136
NONCASH INVESTING AND FINANCING ACTIVITIES:
Loans transferred to real estate owned $ 697,165 $ 1,552,740 $ 847,550
See Notes to Consolidated
Financial Statements. 7
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND CONSOLIDATION - The consolidated financial
statements include the accounts of Sturgis Bancorp, Inc. (the
Corporation) and its wholly owned subsidiary, Sturgis Bank & Trust
Company (the Bank), which includes the Bank's wholly owned
subsidiaries, Oakleaf Financial Services, Inc., 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 via an equal exchange of shares of Sturgis Bank & Trust Co. common
stock for Sturgis Bancorp, Inc. common stock. For comparative financial
statement purposes, the 2001 financial statements of Sturgis Bank &
Trust Co. and Subsidiaries are titled Sturgis Bancorp, Inc. and
Subsidiaries as the formation of the holding company had no impact on
the capital structure of the consolidated entity.
USE OF ESTIMATES - In preparing consolidated financial statements in
conformity with generally accepted accounting principles in the United
States of America, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities
as of the date of the balance sheet and reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from these estimates and assumptions. Material estimates that are
particularly susceptible to significant change in the near term relate
to the determination of the allowance for loan losses, and the
valuation of real estate owned, deferred tax assets, mortgage servicing
rights, and the impairment of goodwill.
NATURE OF OPERATIONS - The Corporation operates predominately in the
south-western portion of Michigan's lower peninsula. Its primary
services include accepting deposits, making commercial and mortgage
loans, engaging in mortgage banking activities, and providing
investment brokerage advisory services.
SEGMENT REPORTING - While management monitors the revenue streams of
various products and services offered, operations are managed and
financial performance is evaluated on a company-wide basis.
Accordingly, all of the Corporation's operations are considered by
management to be aggregated in one reportable operating segment.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK - Most of the
Corporation's activities are with customers located within Michigan.
Note 2 discusses the types of securities in which the Corporation
invests. Note 3 discusses the types of lending in which the Corporation
engages. The Corporation's loan portfolio is concentrated in
residential first-mortgage loans. The Corporation does not have any
significant concentrations to any one industry or customer.
8
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS - For the purpose of the consolidated
statements of cash flows, cash and cash equivalents include cash and
balances due from banks, federal funds sold and other short-term
investments, all of which mature within ninety days.
INTEREST-BEARING DEPOSITS IN BANKS - Interest-bearing deposits in banks
mature within ten years and are carried at cost.
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. Securities not classified as held to
maturity are classified as "available for sale" and recorded at fair
value, with unrealized gains and losses excluded from earnings and
reported in other comprehensive income.
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 and available for sale securities below
their cost, that are deemed to be other than temporary, are reflected
in earnings as realized losses. Gains and losses on the sale of
securities are recorded on the trade date and are determined using the
specific identification method.
FEDERAL HOME LOAN BANK STOCK - The Corporation'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 Corporation'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 Corporation 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.
9
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loans that management has the intent and ability to hold for the
forseeable future or until maturity or pay-off 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
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 status 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.
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.
10
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The allowance consists of specific, general and unallocated components.
The specific components relate to loans that are classified as either
doubtful, substandard or special mention. For such loans that are also
classified as impaired, an allowance is established when the discounted
cash flows (or collateral value or observable market price) of the
impaired loan is lower than the carrying value of that loan. The
general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. An
unallocated component is maintained to cover uncertainties that could
affect management's estimate of probable losses. The unallocated
component of the allowance reflects the margin of imprecision inherent
in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect
the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status, collateral
value, and the probability of collecting scheduled principal and
interest payments when due. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all of
the 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
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 Corporation does not separately identify
individual consumer and residential loans for impairment disclosures.
11
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SERVICING - Servicing assets are recognized as separate assets when
rights are acquired through purchase or through sale of financial
assets. Capitalized servicing rights 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.
OFF-BALANCE SHEET INSTRUMENTS - In the ordinary course of business, the
Corporation 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.
In November, 2002, the FASB issued Interpretation No. 45, (FIN 45)
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others," which
elaborates on the disclosures to be made by a guarantor about its
obligations under certain guarantees issued. It also clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing
the guarantee. The initial recognition and measurement provisions of
this Interpretation have been applied on a prospective basis to
guarantees issued or modified after December 31, 2002. However, the
value of such guarantees is immaterial and the adoption of this
Standard did not have a material effect on the Corporation's financial
statements.
RATE LOCK COMMITMENTS - On March 13, 2002, the Financial Accounting
Standards Board determined that loan commitments related to the
organization or acquisition of mortgage loans that will be held for
sale must be accounted for as derivative instruments, effective for
fiscal quarters beginning after April 10, 2002. Accordingly, the
Corporation adopted such accounting on July 1, 2002.
12
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Corporation enters into commitments to originate loans whereby the
interest rate on the loan is determined prior to funding (rate lock
commitments). Rate lock commitments on mortgage loans that are intended
to be sold are considered to be derivatives. Accordingly, such
commitments, along with any related fees received from potential
borrowers, are recorded at fair value in derivative assets or
liabilities, with changes in fair value recorded in the net gain or
loss on sale of mortgage loans. Fair value is based on fees currently
charged to enter into similar agreements, and for fixed-rate
commitments also considers the difference between current levels of
interest rates and the committed rates. Prior to July 1, 2002, such
commitments were recorded to the extent of fees received. Fees received
were subsequently included in the net gain or loss on sale of mortgage
loans.
The cumulative effect of adopting SFAS No. 133 for rate lock
commitments as of July 1, 2002 was not material.
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.
INVESTMENT IN LIMITED PARTNERSHIPS - The Corporation has investments in
limited partnerships that are 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. The Corporation
accounts for these investments under the equity method, whereby the
Corporation annually records its proportionate share of partnership
profits and losses as an adjustment to the carrying value of the
investment.
13
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL AND INTANGIBLE ASSETS - Effective January 1, 2002, the
Corporation adopted Statement of Financial Accounting Standards (SFAS)
No. 142. Goodwill and Other Intangible Assets, which changes the
Company's accounting for goodwill and other intangible assets acquired
in a business combination. Generally, intangible assets that meet
certain criteria are recognized and subsequently amortized over their
estimated useful lives. Goodwill and intangible assets with indefinite
lives are not amortized. However, such assets are tested for impairment
at adoption of SFAS 142 and at least annually thereafter. No impairment
loss was recognized upon the adoption of SFAS 142.
The following table adjusts net income as reported by excluding
goodwill amortization:
2003 2002 2001
-------------- -------------- --------------
Reported net income $ 2,605,089 $ 2,790,387 $ 2,787,937
add back:Goodwill amortization, net
of tax effects - - 379,410
-------------- -------------- --------------
Adjusted net income $ 2,605,089 $ 2,790,387 $ 3,167,347
-------------- -------------- --------------
BASIC EARNINGS PER SHARE:
Reported net income $ 0.93 $ 0.95 $ 0.90
add back:Goodwill amortization, net
of tax effects - - 0.12
-------------- -------------- --------------
Adjusted net income $ 0.93 $ 0.95 $ 1.02
-------------- -------------- --------------
DILUTED EARNINGS PER SHARE:
Reported net income $ 0.93 $ 0.95 $ 0.90
add back:Goodwill amortization, net
of tax effects - - 0.12
-------------- -------------- --------------
Adjusted net income $ 0.93 $ 0.95 $ 1.02
-------------- -------------- --------------
14
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
INCOME TAXES - Deferred income tax assets and liabilities are
determined using the liability (or balance sheet) method. Under this
method, the net deferred tax asset or liability is determined based on
the tax effects of the various temporary differences between the book
and the tax bases of the various balance sheet assets and liabilities
and gives current recognition to changes in tax rates and laws.
Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized.
The Corporation is qualified under provisions of the Internal Revenue
Code that 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,
2003 and 2002 include approximately $918,000 for which no provision for
federal income taxes has been made. Unrecognized deferred taxes on this
amount are 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.
STOCK COMPENSATION PLANS - In December 2002, the FASB issued SFAS No.
148, "Accounting for Stock-Based Compensation-Transition and Disclosure
- an Amendment of FASB Statement No. 123." This Statement amends SFAS
No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No.
123 to require more prominent disclosures about the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results in both annual and interim financial
statements. This Statement was effective for financial statements for
fiscal years ending after December 15, 2002. As permitted by SFAS No.
148, the Company will continue to apply the provisions of APB Opinion
No. 25, "Accounting for Stock-Based Compensation," for all employee
stock option grants and has elected to disclose pro forma net income
and earnings per share amounts as if the fair-value based method had
been applied in measuring compensation costs.
15
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Bancorp's as reported and the pro forma information for the years
ended December 31, follows:
Year Ended December 31
----------------------------------------
2003 2002 2001
------------ ------------ ------------
As reported net income available to
common shareholders $ 2,605,089 $ 2,790,387 $ 2,787,937
Less: stock-based compensation expense
determined under fair value method, net of tax 26,865 93,887 217,081
------------ ------------ ------------
Pro forma net income $ 2,578,224 $ 2,696,500 $ 2,570,856
As reported earnings per share $ 0.93 $ 0.95 $ 0.90
Pro forma earnings per share $ 0.92 $ 0.92 $ 0.83
As reported earnings per diluted share $ 0.93 $ 0.95 $ 0.90
Pro forma earnings per diluted share $ 0.92 $ 0.92 $ 0.83
Compensation expense in the pro forma disclosures is not indicative of
future amounts, as options vest over several years and additional
grants may be made.
EARNINGS PER COMMON 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 Corporation
relate solely to outstanding stock options, and are determined using
the treasury stock method.
Earnings per common share have been computed based on the following:
2003 2002 2001
------------ ------------ ------------
Net income $ 2,605,089 $ 2,790,387 $ 2,787,937
============ ============ ============
Weighted average number of common
shares outstanding 2,808,461 2,949,874 3,101,534
Effect of dilutive options 3,007 2,365 -
------------ ------------ -------------
Weighted average number of common
shares outstanding used to calculate
diluted earnings per common share 2,811,468 2,952,239 3,101,534
============ ============ ============
16
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME - Accounting principles generally require that
recognized revenue, expenses, gains and losses be included in net
income. Although certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, are
reported as a separate component of the equity section of the balance
sheet, such items, along with net income, are components of
comprehensive income.
RECLASSIFICATION - Certain amounts appearing in the prior year's
financial statements have been reclassified to conform to the current
year's financial statements.
NOTE 2 - SECURITIES
The amortized cost and estimated fair value of securities with gross
unrealized gains and losses, follows:
2003
-------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated Fair
Amortized Cost Gains Losses Value
-------------- ------------ ----------- --------------
Available-for-sale securities:
Mortgage-backed $ 4,023,750 $ 2,500 $ - $ 4,026,250
============== ============ =========== ==============
Held-to-maturity securities:
Obligations of states and
political subdivisions $ 2,817,060 $ 75,961 $ (5,803) $ 2,887,218
Mortgage-backed 7,696,701 32,474 (20,987) 7,708,188
Other securities 425,000 - - 425,000
-------------- ------------ ----------- --------------
Total held-to-maturity securities $ 10,938,761 $ 108,435 $ (26,790) $ 11,020,406
-------------- ------------ ----------- --------------
2002
-------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated Fair
Amortized Cost Gains Losses Value
-------------- ------------ ----------- --------------
Held-to-maturity securities:
Other securities $ 500,000 $ - $ - $ 500,000
Obligations of states and
political subdivisions 3,177,986 71,118 - 3,249,104
Mortgage-backed 8,912,723 136,491 (5,618) 9,043,596
-------------- ------------ ----------- --------------
Total held-to-maturity securities $ 12,590,709 $ 207,609 $ (5,618) $ 12,792,700
============== ============ =========== ==============
17
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 2 - SECURITIES (CONTINUED)
Securities with a carrying value of $1,413,296 (market value of
$1,434,580) were pledged at December 31, 2003 to secure uninvested
trust funds. Securities with a carrying value of $215,000 (market value
of $209,208) were pledged at December 31, 2003 to secure U.S. Treasury
Tax & Loan payments.
The amortized cost and fair value of securities of debt securities by
contractual maturity, at December 31, 2003, 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.
Held to Maturity Available for Sale
-----------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ----------- -----------
Due in one year or less $ 415,133 $ 419,111 $ - $ -
Due in one through five years 584,500 610,493 - -
Due after five years through ten years 404,131 423,034 - -
Due after ten years 1,838,296 1,859,580 - -
------------ ------------ ----------- -----------
Total 3,242,060 3,312,218 - -
Mortgage-backed securities 7,696,701 7,708,188 4,023,750 4,026,250
------------ ------------ ----------- -----------
Total $ 10,938,761 $ 11,020,406 $ 4,023,750 $ 4,026,250
------------ ------------ ----------- -----------
For the years ended December 31, 2003, 2002 and 2001, proceeds from
sales of securities available for sale amounted to $9,039,025,
$9,235,451 and $0, respectively. Gross realized losses amounted to
$36,342, $0 and $0 for the years ended December 31, 2003, 2002, and
2001, respectively. The tax benefit applicable to these net realized
losses amounted to $12,356, $0 and $0, respectively.
18
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 3 - LOANS
A summary of the balances of loans follows:
2003 2002
--------------- ---------------
Mortgage loans on real estate:
Residential 1-4 family $ 118,704,063 $ 127,770,040
Commercial 66,409,463 50,440,340
Construction - Residential 10,174,106 8,038,367
Construction - Commercial 4,891,400 3,806,000
--------------- ---------------
200,179,032 190,054,747
Commercial loans 14,784,475 15,072,501
Consumer installment loans:
Consumer and installment 8,324,967 11,354,651
Other 1,129,623 569,566
--------------- ---------------
9,454,590 11,924,217
--------------- ---------------
Subtotal 224,418,097 217,051,465
Less:
Allowance for loan losses 2,294,157 1,920,037
Unearned interest 18,262 16,925
Undisbursed portion of loans in process - Residential 3,757,494 2,885,243
Undisbursed portion of loans in process - Commercial 3,138,158 282,126
--------------- ---------------
Subtotal 215,210,026 211,947,134
Add:
Deferred loan origination and other fees 317,539 96,216
--------------- ---------------
Loans, net $ 215,527,565 $ 212,043,350
--------------- ---------------
19
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 3 - LOANS (CONTINUED)
An analysis of the allowance for loan losses follows:
2003 2002 2001
----------- ------------ ------------
BALANCE - Beginning of year $ 1,920,037 $ 1,300,000 $ 803,744
Provision for loan losses 819,709 1,494,916 1,056,194
Loans charged off (516,174) (950,106) (607,217)
Recoveries of loans previously
charged off 70,585 75,227 47,279
----------- ------------ ------------
BALANCE - End of year $ 2,294,157 $ 1,920,037 $ 1,300,000
=========== ============ ============
The following is a summary of information pertaining to impaired loans:
2003 2002 2001
----------- ------------ ------------
Impaired loans with a valuation
allowance $ 3,049,619 $ 971,607 $ 1,071,876
Impaired loans without a valuation
allowance - - -
Total impaired loans $ 3,049,619 $ 971,607 $ 1,071,876
----------- ------------ ------------
Valuation allowance related to
impaired loans $ 466,595 $ 265,663 $ 91,881
=========== ============ ============
2003 2002 2001
----------- ------------ ------------
Average investment in
impaired loans $ 3,027,784 $ 1,257,324 $ 965,274
=========== ============ ============
Interest income recognized
on impaired loans $ 134,029 $ 49,937 $ 24,115
----------- ------------ ------------
Interest income recognized on a
cash basis on impaired loans $ 144,003 $ 47,394 $ 24,115
----------- ------------ ------------
No additional funds are committed to be advanced in connection with
impaired loans.
20
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
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 approximated $217,000,000 and
$178,500,000 at December 31, 2003 and 2002, respectively.
The fair values of these rights were $2,346,913 and $1,567,794 at
December 31, 2003 and 2002, respectively. The fair value of servicing
rights was determined using the discount rate of 8.0 percent and
prepayment speeds ranging from 6.0 percent to 9.0 percent, depending
upon the stratification of the specific right.
The following summarizes mortgage servicing rights capitalized and
amortized, along with the aggregate activity in related valuation
allowances:
2003 2002 2001
------------- ------------- ------------
Mortgage servicing rights capitalized $ 1,299,486 $ 1,375,920 $ 966,128
------------- ------------- ------------
Mortgage servicing rights amortized $ (1,077,998) $ (881,354) $ (526,036)
------------- ------------- ------------
Valuation allowances:
Balance at beginning of year $ (273,852) $ - $ -
Additions (37,387) (273,852) -
Reductions 288,965 - -
Write-downs - - -
------------- ------------- ------------
Balance at end of year $ (22,274) $ (273,852) $ -
------------- ------------- ------------
21
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 5 - REAL ESTATE INVESTMENT - LIMITED PARTNERSHIP
In February of 2003, the Corporation acquired a 24.75 percent interest
in an Indiana limited partnership formed to construct and operate
multi-family housing units. All income, expenses and tax credits will
be allocated to the Corporation based upon ownership percentage. The
Corporation as an investor is able to exercise influence over operating
and financial policies of the management through provisions of the
partnership agreement that require a majority approval of the limited
partners. At such time as the project is sold, the limited partners
will receive a share of the net proceeds proportionate to the limited
partners' outstanding capital balance. Under the terms of the limited
partnership agreement, the Corporation contributed $1,050,000 in cash,
and is allocated tax losses and affordable housing federal income tax
credits.
Condensed financial information for the investee partnership is
summarized as follows.
December 31,
2003
--------------
Balance Sheet:
Cash $ 28,545
Bond fund 3,687,763
Accounts receivable 51,254
Loans to affiliates, net 62,000
Development costs 10,727,142
Other assets 13,597
--------------
Total assets $ 14,570,301
==============
Accounts payable $ 11,134
Accrued interest 35,127
Bridge loan 2,100,000
Note payable - mortgage 8,900,000
Note payable - developer 1,280,190
Partners' equity 2,243,850
--------------
Total liabilities and partners' equity $ 14,570,301
--------------
Operation - Net income $ -
==============
22
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 6 - PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and
equipment follows:
2003 2002
----------- -----------
Land $ 701,677 $ 666,993
Land improvements 46,807 40,489
Office buildings 6,178,087 5,652,030
Furniture, fixtures and equipment 3,459,929 4,607,664
Construction in progress - 485,569
----------- -----------
Total bank premises and equipment 10,386,500 11,452,745
Less accumulated depreciation (3,898,377) (4,810,765)
----------- -----------
Net carrying amount $ 6,488,123 $ 6,641,980
=========== ===========
Depreciation expense for the years ended December 31, 2003, 2002 and
2001 amounted to $624,228, $605,318, and $670,844, respectively.
23
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 7 - DEPOSITS
Interest bearing deposit balances at December 31 are summarized as
follows:
2003 2002
------------- -------------
Savings deposits $ 43,604,746 $ 40,890,720
NOW accounts 57,534,598 50,724,071
Time:
$100,000 and over 29,440,282 34,452,825
Under $100,000 57,057,595 63,749,059
------------- -------------
Total interest-bearing $ 187,637,221 $ 189,816,675
============= =============
At December 31, 2003, the scheduled maturities of time deposits are as
follows:
2004 $ 28,560,353
2005 22,152,150
2006 4,761,856
2007 14,096,818
2008 11,829,147
Thereafter 5,097,553
------------
Total $ 86,497,877
============
24
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 8 - FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis ("FHLB") are
collateralized by FHLB stock and residential and commercial
non-employee mortgage loans. The unpaid principal balance of pledged
loans was approximately $140,000,000 and $99,000,000 at December 31,
2003 and December 31, 2002, respectively. Total short-term advances,
including advances under a separate line of credit with the FHLB,
consisted of $5,875,538 at December 31, 2003 at an interest rate of
1.11% with an average balance for the year of approximately $1,930,000
and an average interest rate of 1.27%. Total short-term advances,
including advances under a separate line of credit with the FHLB,
consisted of $6,671,907 at December 31, 2002 at an interest rate of
1.33% with an average balance for the year of approximately $3,400,000
and an average interest rate of 1.85%. Maximum amounts outstanding on
the short-term advances for the years 2003 and 2002 were approximately
$12,500,000 and $13,700,000, respectively.
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, 2003 and expires in March, 2004. Advances
outstanding under the line of credit bear interest at a rate of
approximately 42 basis points over the rate paid by the FHLB on their
time deposits (an effective rate of 1.11% and 1.33 % at December 31,
2003 and 2002, respectively). Included in the above total short-term
advances is an outstanding balance on the line of credit of $1,875,538
and $1,671,907 at December 31, 2003 and 2002, respectively.
The Bank had approximately $49,929,132 and $57,709,489 in long-term
advances from FHLB at December 31, 2003 and 2002, respectively.
Interest rates range from 1.11% to 7.34% with maturities ranging from
January, 2003 to February, 2012.
Annual payments of FHLB long-term advances are as follows:
2004 $ 3,025,849
2005 2,557,211
2006 3,346,072
2007 -
2008 10,000,000
2009 and thereafter 31,000,000
------------
Total $ 49,929,132
============
The advances are subject to prepayment penalties subject to the
provisions and conditions of the credit policy of FHLB.
25
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 9 - FEDERAL INCOME TAXES
Sturgis Bancorp, Inc. 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:
2003 2002 2001
----------- ----------- -----------
Current expense $ 799,666 $ 1,059,595 $ 1,304,568
Deferred (benefit) expense 176,348 58,334 (1,667)
----------- ----------- -----------
Total income tax expense $ 976,014 $ 1,117,929 $ 1,302,901
=========== =========== ===========
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:
2003 2002 2001
----------- ----------- -----------
Amount computed at statutory rates $ 1,217,575 $ 1,328,827 $ 1,390,885
Dividends received deduction (10,054) (4,256) (9,351)
Tax-exempt income from Bank owned
life insurance (99,655) (113,040) -
Tax-exempt interest income (51,603) (58,866) (37,903)
Low income housing tax credits (76,367) (75,000) (75,000)
Other, net (3,882) 40,264 34,270
----------- ----------- -----------
Total $ 976,014 $ 1,117,929 $ 1,302,901
=========== =========== ===========
26
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 9 - FEDERAL INCOME TAXES (CONTINUED)
The components of the net deferred tax asset (liability) are as
follows:
2003 2002
------------- ------------
Deferred tax assets:
Investment impairment $ 25,500 $ -
Allowance for loan losses 600,611 504,928
Other 10,895 11,156
------------- ------------
Total deferred tax assets 637,006 516,084
Deferred tax liabilities:
Deferred loan fees (232,089) (259,953)
Mortgage servicing rights (540,746) (299,981)
Amortization (190,940) (33,466)
Depreciation (149,949) (121,476)
Other (7,147) (107,875)
------------- ------------
Total deferred tax liabilities (1,120,871) (822,751)
Valuation allowance - -
------------- ------------
Net deferred tax liability $ (483,865) $ (306,667)
============= ============
27
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 10 - RETIREMENT BENEFITS
The Corporation 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
Corporation'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, 2003, 2002 and 2001 amounted to $239,353,
$194,273 and $177,753, respectively.
Effective January 1, 2002, the Corporation began sponsoring a
non-qualified defined benefit plan to provide supplemental retirement
benefits for certain executives. The following table sets forth the
plan activity and other information as of and for the years ended
December 31, 2003 and 2002.
2003
--------------
Plan assets at fair value $ -
Benefit obligation 177,280
--------------
Underfunded status $ (177,280)
==============
Pension liability $ 177,280
==============
Intangible assets $ 116,240
-------------
Net periodic pension cost $ 36,995
-------------
Change in minimum liability $ 116,240
-------------
Actuarial assumptions:
Weighted average discount rate 6.00%
Increase in future compensation levels 4.00%
To fund the supplemental retirement benefit obligation, the Corporation
has purchased insurance policies on the lives of the participants with
the Corporation as the owner and beneficiary of the policies. At
December 31, 2003 and 2002, the cash value of all corporate owned life
insurance policies on the participants and other officers available to
fund future benefit obligations, amounted to $6,628,534 and $6,335,429,
respectively. There were no supplemental retirement benefits paid by
the plan during 2003 or 2002.
28
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 11 - COMMON STOCK AND OPTIONS
Effective May, 1998, two of the Bank's three stock option 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 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 ten 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.
29
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 11 - COMMON STOCK AND OPTIONS (CONTINUED)
The following is a summary of the activity with respect to the
Corporation's stock option plans for the years ended December 31,
2003, 2002, and 2001:
Weighted-
Average
Number of Exercise Price
Shares Per Share
-------------- ---------------
Outstanding - January 1, 2001 126,402 $ 13.28
Granted - -
Cancelled (2,551) 13.56
Exercised - -
-------------- ---------------
Outstanding - December 31, 2001 123,851 13.28
Granted - -
Cancelled - -
Exercised - -
-------------- ---------------
Outstanding - December 31, 2002 123,851 13.28
Granted - -
Cancelled (3,275) 13.66
Exercised (9,000) 9.00
-------------- ---------------
Outstanding - December 31, 2003 111,576 $ 13.62
============== ===============
For options outstanding at December 31, 2003, the exercise price per
share ranged from $9.00 to $15.88 and the weighted-average remaining
contractual life of the options was approximately 51 months.
30
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 12 - MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Corporation (on a consolidated basis) and the Bank are subject to
various regulatory capital requirements administered by federal
banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's and Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Corporation and 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.
Prompt corrective action provisions are not applicable to bank holding
companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Corporation and the Bank to maintain minimum
amounts and ratios (set forth in the following table) of total and
Tier I capital (as defined in the regulations) to risk-weighted assets
(as defined) and of Tier I capital (as defined) to average assets (as
defined). Management believes, as of December 31, 2003 and 2002, that
the Corporation met all capital adequacy requirements to which it is
subject.
31
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 12 - MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
As of December 31, 2003, the most recent notification from the Federal
Deposit Insurance Corporation, categorized the Corporation as
well-capitalized under the regulatory framework for prompt corrective
action. To be categorized as well-capitalized, an institution must
maintain minimum total risk-based, Tier 1 risked-based and Tier 1
leverage ratios as set forth in the following tables. There are no
conditions or events since the notification that management believes
have changed the Bank's category. The Corporation's and Bank's actual
capital amounts and ratios as of December 31, 2003 and 2002 are also
presented in the table.
For Capital
Actual Adequacy Purposes To be Well-capitalized
-------------------- ------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- ------ --------- ---------
AS OF DECEMBER 31, 2003:
Total capital (to risk-
weighted assets)
Consolidated $ 26,028 12.5% $ 16,705 > 8.0% $ 20,881 > 10.0%
- -
Bank $ 25,522 12.3% $ 16,643 > 8.0% $ 20,804 > 10.0%
- -
Tier 1 capital (to risk-
weighted assets)
Consolidated $ 23,734 11.4% $ 8,352 > 4.0% $ 12,529 > 6.0%
- -
Bank $ 23,228 11.2% $ 8,321 > 4.0% $ 12,482 > 6.0%
- -
Tier 1 capital (to adjusted
assets)
Consolidated $ 23,734 8.4% $ 11,248 > 4.0% $ 14,060 > 5.0%
- -
Bank $ 23,228 8.3% $ 11,229 > 4.0% $ 14,036 > 5.0%
- -
AS OF DECEMBER 31, 2002:
Total capital (to risk-
weighted assets)
Consolidated $ 24,007 12.0% $ 15,952 > 8.0% $ 19,940 > 10.0%
- -
Bank $ 24,985 12.5% $ 16,006 > 8.0% $ 20,007 > 10.0%
Tier 1 capital (to risk-
weighted assets)
Consolidated $ 22,087 11.1% $ 7,976 > 4.0% $ 11,964 > 6.0%
- -
Bank $ 23,065 11.5% $ 8,003 > 4.0% $ 12,004 > 6.0%
Tier 1 capital (to adjusted
assets)
Consolidated $ 22,087 7.5% $ 11,848 > 4.0% $ 14,810 > 5.0%
- -
Bank $ 23,065 7.8% $ 11,848 > 4.0% $ 14,810 > 5.0%
32
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 13 - OFF-BALANCE SHEET ACTIVITIES
Credit Related Financial Instruments - The Corporation 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 Corporation's exposure to credit loss is represented by the
contractual amount of these commitments. The Corporation follows the
same credit policies in making commitments as it does for on-balance
sheet instruments.
At December 31, 2003 and 2002, the following financial instruments
were outstanding whose contract amounts represent credit risk:
Contract Amount
----------------------------
2003 2002
-------------- -------------
Commitments to grant loans $ 12,910,000 $ 4,700,000
Unfunded commitments under lines of credit 33,662,000 23,000,000
Commercial and standby letters of credit 230,000 300,000
Commitments to extend credit are agreements to lend to a customer as
long as there are no violations 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 Corporation, is based on management's credit
evaluation of the customer.
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, may not contain a specified
maturity date and may be drawn upon to the total extent to which the
Corporation is committed.
Commercial and standby letters of credit are conditional commitments
issued by the Corporation 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. All letters of
credit issued have expiration dates within one year.
33
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 13 - OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
COLLATERAL REQUIREMENTS - To reduce credit risk related to the use of
credit-related financial instruments, the Corporation might deem it
necessary to obtain collateral. The amount and nature of the
collateral obtained are based on the Corporation'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 Corporation is permitted to sell or repledge the
collateral on short notice, the Corporation records the collateral in
its balance sheet at fair value with a corresponding obligation to
return it.
LEGAL CONTINGENCIES - Various legal claims also arise from time to
time in the normal course of business which, in the opinion of
management, will have no material effect on the Corporation's
consolidated financial statements.
NOTE 14 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Corporation has granted loans
to principal officers, directors and affiliates. A summary of the
related party loan transactions for the years ended December 31, 2003
and 2002 is as follows:
2003 2002
------------ ------------
Related party loans outstanding at the beginning
of the year $ 1,379,152 $ 1,170,943
Advances 1,153,570 834,538
Principal repayments (806,201) (626,329)
------------ ------------
Related party loans outstanding at the end
of the year $ 1,726,521 $ 1,379,152
============ ============
Deposits from related parties held by the Bank at December 31, 2003
and 2002 approximated $6,000,000 and $7,000,000, respectively.
34
STURGIS BANCORP, INC. AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 15 - 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 Corporation'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 Corporation.
The following methods and assumptions were used by the Corporation in
estimating fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS - The carrying amounts 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 and other securities approximate fair
value based on the 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 commitments on hand from investors or prevailing
market prices.
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.
35
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
DEPOSIT LIABILITIES - The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, 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.
OFF-BALANCE SHEET INSTRUMENTS - Fair values for off-balance-sheet,
credit related financial instruments are based on fees currently
charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties credit
standing.
36
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values and related carrying or notional amounts of
the Corporation's financial instruments, are as follows (000s
omitted):
2003 2002
---------------------------- ----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------- ----------- --------------
Financial assets:
Cash and cash equivalents $ 10,495 $ 10,495 $ 13,071 $ 13,071
Interest-bearing deposits in banks 15,339 15,560 23,018 23,342
Held-to-maturity investment securities 10,939 11,020 12,591 12,792
Available-for-sale investment securities 4,026 4,026
FHLB stock 4,274 4,274 4,115 4,115
Loans held for sale 1,322 1,323 7,437 7,522
Loans in portfolio, net 215,528 218,153 212,043 221,003
Accrued interest receivable 1,591 1,591 1,732 1,732
Financial liabilities:
Deposits 199,920 202,203 202,564 198,121
Accrued interest payable 679 679 936 936
FHLB advances 55,805 57,932 64,381 63,254
37
STURGIS BANCORP, INC. AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 16 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Sturgis Bancorp, Inc., the parent company, was formed January 1, 2002
(Note 1). The financial statements of the parent company as of
December 31, 2003 and 2002 are presented below:
BALANCE SHEET December 31,
--------------------------------
2003 2002
-------------- -------------
Assets:
Cash and due from banks $ 194,547 $ -
Investment in limited partnership 25,000 -
Advances to Sturgis Bank & Trust Company 21,133 -
Other assets 748,425 270,474
Investment in Sturgis Bank & Trust Company 28,653,111 28,430,605
-------------- -------------
Total assets $ 29,642,216 $ 28,701,079
-------------- -------------
Liabilities and stockholders' equity:
Deferred federal income taxes $ 483,865 $ 306,667
Advances from Sturgis Bank & Trust Company - 941,884
-------------- -------------
Total liabilities 483,865 1,248,551
Stockholders' equity 29,158,351 27,452,528
-------------- -------------
Total liabilities and stockholders' equity $ 29,642,216 $ 28,701,079
============== =============
38
STURGIS BANCORP, INC. AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 16 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (CONTINUED)
STATEMENT OF INCOME Year Ended December 31,
--------------------------------
2003 2002
-------------- -------------
Revenue
Dividend from Sturgis Bank & Trust Company $ 2,500,000 $ 3,000,000
Interest income on federal tax refund 761 -
-------------- -------------
Total revenue 2,500,761 3,000,000
Operating expenses 177,787 217,097
-------------- -------------
Income before income taxes and equity in
undistributed net income of
Sturgis Bank & Trust Company 2,322,974 2,782,903
Applicable income tax provision (benefit) (61,260) (73,813)
-------------- -------------
2,384,234 2,856,716
Undistributed net income of Sturgis
Bank & Trust Company 220,855 (66,329)
-------------- -------------
Net income $ 2,605,089 $ 2,790,387
============== =============
39
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 16 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (CONTINUED)
STATEMENT OF CASH FLOWS Year Ended December 31,
--------------------------------
2003 2002
-------------- -------------
Cash flows from operating activities:
Net income $ 2,605,089 $ 2,790,387
Adjustments to reconcile net income to
net cash from operating activities:
Equity in undistributed net income
of Sturgis Bank & Trust Company (220,855) 66,329
Increase in other assets (477,951) (270,474)
Tax benefit of stock options exercised 1,071 -
-------------- -------------
Net cash provided by operating activities 1,907,354 2,586,242
Cash flows from investing activities:
Purchase of investment in limited partnership (25,000) -
Cash flows from financing activities:
Stock redeemed - (3,005,294)
Stock options exercised 81,000 -
Proceeds from advance from
Sturgis Bank & Trust Company - 1,248,551
Payments on advance from
Sturgis Bank & Trust Company (785,820) -
Cash dividends paid on common stock (982,987) (829,499)
-------------- -------------
Net cash used in financing activities (1,687,807) (2,586,242)
-------------- -------------
Net increase in cash and cash equivalents 194,547 -
Cash and cash equivalents at beginning of year - -
-------------- -------------
Cash and cash equivalents at end of year $ 194,547 $ -
============== =============
40
STURGIS BANCORP, INC. AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 17 - RESTRICTION ON DIVIDENDS
Banking regulations place certain restrictions on dividends paid and
loans or advances made by the Bank to the Corporation. The total
amount of dividends that may be paid at any date is generally limited
to the retained earnings of the Bank. However, dividends paid by the
Bank would be prohibited if the effect thereof would cause the Bank's
capital to be reduced below applicable minimum standards. At December
31, 2003, the Bank's retained earnings available for the payment of
dividends totaled $5,234,000. Accordingly, approximately $23,500,000
of the Corporation's investment in the Bank was restricted at December
31, 2003.
Loans or advances made by the Bank to the Corporation are generally
limited to 10 percent of the Bank's capital stock and surplus. Funds
available for loans or advances by the Bank to the Corporation,
amounted to approximately $2,350,000.
NOTE 18 - COMMITMENTS
During the current year, the Corporation purchased an investment for
$25,000 in a venture capital company. The Corporation accounts for
this investment under the equity method and owns approximately 1.23%
of the total. The Corporation has committed to contribute an
additional $225,000 in the future as capital is required.
41
STURGIS BANCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002
NOTE 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
2003
-----------------------------------------------------------
1Q 2Q 3Q 4Q
------------ ------------ ------------ ------------
Interest income $ 4,089,947 $ 3,922,503 $ 3,648,691 $ 3,584,457
Interest expense 1,905,733 1,792,753 1,688,769 1,630,018
Net interest income 2,184,214 2,129,750 1,959,922 1,954,439
Provision for loan losses 318,688 710,787 53,600 (263,366)
Securities gain (loss) - - - (36,632)
Net income 764,976 558,059 716,801 565,253
Earnings per share:
Basic 0.27 0.20 0.26 0.20
Diluted 0.27 0.20 0.25 0.20
2002
-----------------------------------------------------------
1Q 2Q 3Q 4Q
------------ ------------ ------------ ------------
Interest income $ 4,406,049 $ 4,293,422 $ 4,416,668 $ 4,294,553
Interest expense 2,134,948 2,038,575 2,155,328 2,085,249
Net interest income 2,271,101 2,254,847 2,261,340 2,209,304
Provision for loan losses 580,132 235,125 248,635 430,624
Securities gain (loss) - - - -
Net income 671,999 606,285 717,688 794,415
Earnings per share:
Basic 0.22 0.20 0.24 0.28
Diluted 0.22 0.20 0.24 0.28
42