<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31,1996 Commission File No. 2-78178
SOUTHERN MICHIGAN BANCORP, INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Michigan 38-2407501
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
51 West Pearl Street, Coldwater. Michigan 49036
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (517) 279-5500
Securities registered pursuant to Section 12(b) or 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. X
---
The aggregate market value of the Registrant's common stock, par value $2.50
per share (based on the average of the bid and asked prices) held by
non-affiliates of the registrant as of March 1, 1997 was $42,640,000.
The number of shares outstanding of the Registrant's common stock as of March 1,
1997 was 952,854 shares (including common stock subject to repurchase
obligation).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended December 31,
1996, are incorporated by reference into Parts II, III, and IV hereof.
<PAGE> 2
PART I
ITEM 1.BUSINESS
OVERVIEW
The Registrant, Southern Michigan Bancorp, Inc. (the "Company"), was organized
as a Michigan Corporation in March 1982 for the purpose of becoming a bank
holding company by acquiring all of the outstanding shares of Southern Michigan
National Bank, which it did in November of 1982. The Company's business
currently consists of wholly owning and operating Southern Michigan Bank &
Trust (the "Bank"), a general commercial bank with its main office located at
51 West Pearl Street, Coldwater, Michigan 49036.
The Bank is a Michigan banking corporation and a successor, by conversion of
charter effective December 15, 1992, to Southern Michigan National Bank. The
Bank operates twelve (12) branch offices in the primarily rural areas of Branch,
Hillsdale, and Calhoun counties in southwestern Michigan.
BANKING SERVICES
The Bank offers a full range of banking services to individuals, businesses,
governmental entities and other institutions. These services include checking,
savings, and NOW accounts, time deposits, safe deposit facilities, and money
transfers. The Bank's lending operations provide secured and unsecured
commercial and personal loans, real estate loans, consumer installment loans,
lines of credit and accounts receivable financing.
The Bank's Trust Department offers a wide variety of fiduciary services to
individuals, businesses, not-for-profit organizations and governmental
entities, including services as trustee for personal, corporate, pension,
profit sharing, and other employee benefit trusts. The Bank also provides
securities custody services as an agent, acts as the personal representative
for estates and as a fiscal, paying and escrow agent for corporate customers
and governmental entities.
The Bank also offers securities brokerage services through an unaffiliated
broker. The Bank maintains correspondent banking relationships with several
other larger banks, which involve check clearing operations, transfer of funds,
loan participations, and the purchase and sale of federal funds and other
similar services.
COMPETITION
The banking business in the Bank's market area is highly competitive. The Bank
competes with other banks, savings and loan associations, credit unions and
finance companies. Banks and other financial institutions from surrounding
areas maintain branches within the Bank's service area and offer additional
competition. The Bank is also faced with increasing competition from
non-depository financial intermediaries, such as large retailers and investment
banking and securities brokerage firms.
<PAGE> 3
SUPERVISION AND REGULATION
GENERAL
Various federal and state banking laws and regulations affect the business of
the Company and the Bank. They are subject to supervision, regulation, and
periodic examination by the Board of Governors of the Federal Reserve System
(the "FRB") and the Financial Institutions Bureau of the State of Michigan (the
"FIB") and the Federal Deposit Insurance Corporation (the "FDIC"),
respectively. The following is a summary of certain statutes and regulations
affecting the Company and the Bank. This summary is qualified in its entirety
by such statutes and regulations, which are subject to change based on pending
and future legislation and action by regulatory agencies. Proposals to change
the laws and regulations governing the operation of banks and companies which
control banks and other financial institutions are frequently raised in
Congress. The likelihood of any major legislation and the impact such
legislation might have on the Company or the Bank are, however, impossible to
predict.
THE BANK HOLDING COMPANY ACT
As a bank holding company, the Company is subject to regulation by the FRB
under the Bank Holding Company Act of 1956, as amended (the "BHCA"). The BHCA
restricts the product range of a bank holding company by circumscribing the
types of businesses it may own or acquire. The BHCA limits a bank holding
company to owning and managing banks or companies engaged in activities
determined by the FRB to be closely related to banking. The BHCA requires a
bank holding company to obtain the prior approval of the FRB before acquiring
substantially all of the assets of a bank or a bank holding company or direct
or indirect ownership or control of more than five percent of the voting shares
of a bank or a bank holding company.
Prior to September 29, 1995, the BHCA also prohibited a bank holding company
from acquiring shares of any bank located outside the state in which the
operations of the bank holding company's banking subsidiaries are primarily
conducted unless the acquisition is specifically authorized by statute of the
state of the bank whose shares are to be acquired. Under the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal
Act"), the restriction on interstate bank acquisitions was repealed effective
September 29, 1995. The Federal Reserve Board is now generally authorized to
approve bank acquisitions by out-of-state bank holding companies whether or not
such acquisition is prohibited by state law.
The Riegle-Neal Act permits States to require that a target bank have been in
operation for a minimum period, up to five years, and to impose
nondiscriminatory limits on the percentage of the total amount of deposits with
insured depository institutions in the State which may be controlled by a
single bank or bank holding company. In addition, the Riegle-Neal Act imposes
Federal deposit concentration limits (10% of nationwide total deposits, and 30%
of total deposits in the host State on applications subsequent to the
applicant's initial entry to the host State), and adds new statutory conditions
to Federal Reserve Board approval, i.e., the applicant meets or exceeds all
applicable Federal regulatory capital standards and is "adequately managed."
Also effective September 29, 1995, any bank subsidiary (and, in certain
circumstances thrift subsidiary) of a bank holding company may receive deposits
to existing accounts, renew time deposits, and close, service and receive
payments on (but not disburse proceeds of) loans, as an agent for its depository
institution affiliates without being considered a branch of the affiliate under
any otherwise applicable law. Such agency activities must be conducted on terms
consistent with safe and sound banking practices.
The Riegle-Neal Act also authorizes, effective June 1, 1997, the responsible
Federal banking agency to approve applications for the interstate acquisition
of branches or mergers of depository institutions across State lines without
regard to whether such activity is contrary to State law. Any State may,
however, by adoption of a nondiscriminatory law after September 29, 1994 and
before June 1, 1997, either elect to have this provision take effect before
June 1, 1997 or opt-out of the provision. The State of Michigan has adopted
currently effective legislation opting into the Riegle-Neal Act's interstate
branching provision. The effect of opting out is to prevent banks chartered by,
or having their main office located in, such State from participating in any
interstate branch acquisition or merger. Each State is permitted to prohibit
interstate branch acquisitions (i.e., acquisition of a branch without
acquisition of the entire target bank), to examine acquired or de novo branches
of out-of-state
<PAGE> 4
banks with respect to compliance with certain host State laws, and to retain a
minimum age requirement of up to five years, a nondiscriminatory deposit cap,
and nondiscriminatory notice or filing requirements. The responsible Federal
agency will apply the same Federal concentration limits and capital and
management adequacy requirements noted above with respect to BHCA applications.
Branches acquired in a host State by a State-chartered bank will be subject to
the activity limits and other laws of the host State to the same extent as a
branch of a bank chartered by the host State. Branches acquired in a host State
by an out-of-state national bank will be subject to community reinvestment,
consumer protection, fair lending and interstate branching laws of the host
State (except to the extent the application of such laws to national banks is
preempted by Federal law or is determined by the Comptroller of the Currency to
be discriminatory), and to other nontax laws of the host State to the same
extent as branches of a national bank having its main office in the host State.
The establishment of de novo branches by an out-of-state bank will continue to
require express statutory authority under the law of the host State and of the
chartering jurisdiction.
Among other things, the Riegle-Neal Act also preserves State taxation
authority, prohibits the operation by out-of-state banks of interstate branches
as deposit production Offices, imposes additional notice requirements upon
interstate banks proposing to close branch offices in a low or moderate-income
area, and creates new Community Reinvestment Act evaluation requirements for
interstate depository institutions. The Act mandates new restrictions on
interstate activities of foreign banks, and requires public notice of, and
opportunity to comment on, proposed ruling by a Federal banking agency which
would preempt certain State laws.
DIVIDEND RESTRICTIONS
The Company's principal source of income is the Bank's payment of dividends on
the stock of the Bank owned by the Company. Michigan law restricts the Bank's
ability to pay these dividends. Under the Michigan Banking Code, no dividend
may be declared by a Michigan state-chartered bank in an amount greater than
net profits then on hand after deducting losses and bad debts. In addition, if
the surplus of the Bank is less than the amount of its capital stock, before a
dividend may be declared, the Bank must transfer to surplus not less than 10%
of the net profits of the Bank for the preceding half year in the case of
quarterly or semiannual dividends or not less than 10% of its net profits for
the preceding two consecutive half year periods in the case of annual
dividends. The term "net profits" means the remainder of all eamings from
current operations plus actual recoveries on loans, investments and other
assets, after deducting from the total thereof all current operating expenses,
actual losses, accrued dividends on preferred stock, if any, and all federal
and state taxes. As of December 31, 1996, the amount of dividends the Bank
could pay to the Company without prior regulatory approval was $3,306,000 in
addition to 1997 net income.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), no insured depository institution may declare any dividend if,
following the payment of such dividend, the institution would be under
capitalized (see "Capital Requirements").
<PAGE> 5
TRANSACTIONS WITH AFFILIATES AND INSIDERS
The Bank and the Company are affiliates of each other and, as such, are subject
to certain federal restrictions on loans and extensions of credit to the
Company, on investments in the Company's and its affiliates' securities, on
acceptance of such securities as collateral for loans to any borrower and on
leases and services and other contracts between the Bank and the Company.
Additionally, regulations allow a bank to extend credit to the bank's and its
affiliates' executive officers, directors and principal shareholders or their
related interests only if the loan is made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with non-insiders, and if credit underwriting standards
are followed that are no less stringent than those applicable to comparable
transactions with non-insiders. Moreover, loans to insiders must not involve
more than the normal risk of repayment or present other unfavorable features
and must, in certain circumstances, be approved in advance by a majority of the
entire board of directors of the Bank. The aggregate amount that can be lent to
all insiders is limited to the Bank's unimpaired capital and surplus.
DEPOSIT INSURANCE
Deposits held by the Bank are insured, to the extent permitted by law, by the
Bank Insurance Fund ("BIF") administered by the FDIC. A minimum designated
reserve ratio of 1.25 percent of insured deposits has been established for the
BIF. However, the FDIC may set a higher designated reserve ratio if
circumstances raise a significant risk of substantial future losses to the BIF.
Assessment rates are established sufficient to maintain reserves at the
designated reserve ratio or, if the ratio is less than the designated ratio, to
increase the ratio to the designated ratio within a reasonable period of time.
The FDIC began collecting FDIC assessments on a quarterly basis in 1995. As
required under FDICIA, the FDIC has established a system of risk-based deposit
insurance premiums. Under this system each insured institution's assessment is
based on the probability that the BIF will incur a loss related to that
institution, the likely amount of the loss, and the revenue needs of the BIF.
Under the risk-based assessment system and effective January 1, 1997, a
depository institution pays an assessment of between 0 cents and 27 cents per
$100 of insured deposits based on its capital level and risk classification. To
arrive at a risk based assessment for an insured institution, the FDIC places
it in one of nine risk categories using a two step analysis based first on
capital ratios and then on other relevant supervisory information. For 1996, a
$2,000 minimum deposit insurance assessment was imposed on the most highly
rated banks. Also in 1996, pursuant to the Deposit Insurance Funds Act, enacted
by Congress in September, the FDIC imposed a special assessment on bank
deposits at a rate not tied to risk classification in order to service debt on
the Financing Corporation (FICO) bonds issued in connection with the federal
government's bail out of the thrift industry. Any future significant changes in
the deposit insurance assessment rate imposed by the FDIC could have a material
effect on the earnings of the Company.
CAPITAL REQUIREMENTS
The FRB has imposed risk-based capital guidelines applicable to the Company.
These guidelines require that bank holding companies maintain capital
commensurate with both on and off balance sheet credit and other risks of their
operations. Under the guidelines, a bank holding company must have a minimum
ratio of total capital to risk-weighted assets of 8.0 percent. In addition, a
bank holding company must maintain a minimum ratio of Tier I capital equal to
4.0 percent of risk-weighted assets. Tier I capital includes common
shareholder's equity, qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries, less goodwill. At
December 31, 1996, the Company's total capital to risk-weighted assets was
12.9 percent, which is above the regulatory minimum requirements.
As a supplement to risk-based capital requirements, the FRB has also imposed
leverage capital ratio requirements. The leverage ratio requirements establish
a minimum required ratio of Tier I capital to total assets less goodwill of 3
percent for the most highly rated bank holding companies. All other bank
holding companies are required to maintain additional Tier I capital yielding a
leverage ratio of 4 percent to 5 percent, depending on the particular
circumstances and risk profile of the institution. The Company's Tier I capital
to total assets ratio at December 31, 1996 was 11.9 percent.
<PAGE> 6
The Bank is also subject to risk-weighted capital standards and leverage
measures which are similar, but in some cases not identical, to the
requirements for bank holding companies which apply to the Company. At December
31, 1996, the Bank met all applicable capital requirements. Under FDICIA, the
Federal bank regulators must take various specified prompt corrective actions
based on levels of an insured depository institution's capital that are below
the adequately capitalized level. These prescribed actions increase
restrictions on the institution as its capital declines.
MONETARY POLICY AND ECONOMIC CONDITIONS
The business of commercial banks, such as the Bank, is affected by monetary and
fiscal policies of various regulatory agencies, including the FRB. Among the
regulatory techniques available to the FRB are open market operations in United
States Government securities, changing the discount rate for member bank
borrowings, and imposing and changing the reserve requirements applicable to
member bank deposits and to certain borrowings by member banks and their
affiliates (including parent companies). These policies influence to a
significant extent the overall growth and distribution of bank loans,
investments and deposits and the interest rates charged on loans, as well as
the interest rates paid on savings and time deposits.
The monetary policies of the FRB have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to do so
in the future. In view of constantly changing conditions in the national
economy and the money market, as well as the effect of acts by the monetary and
fiscal authorities, including the FRB, no definitive predictions can be made by
the Company or the Bank as to future changes in interest rates, credit
availability, deposit levels, or the effect of any such changes on the
Company's or the Bank's operations and financial condition.
EMPLOYEES
As of December 31, 1996, 148 persons were employed by the Bank; 126 were full
time employees and 22 were part time employees.
<PAGE> 7
Selected Statistical Information
The following tables describe certain aspects of the Company's business in
statistical form.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Year Ended December 31 (Dollars in thousands)
-------------------------------------------------------------------------------------
1996 1995 1994
-------------------------- --------------------------- ----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------------------------- --------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
Loans (A) (B) (C) $137,273. $13,739. 10.0% $123,684. $ 11,982. 9.7% $119,637. $ 10,176. 8.5%
Taxable investment securities (D) 36,372. 2,442. 6.7 37,326. 2,634. 7.1 34,358. 1,869. 5.4
Tax-exempt investment securities (A) 14,732. 1,145. 7.8 12,986. 1,121. 8.6 11,057. 947. 8.6
Federal funds sold 1,309. 69. 5.3 2,333. 135. 5.8 625. 28. 4.5
-------- ------- -------- -------- -------- --------
Total interest earning assets 189,686. 17,395. 9.2 176,329. 15,872. 9.0 165,677. 13,020. 7.9
Non-interest earnings assets: 14,358. 9,173.
Cash and due from banks 10,572. 10,120. 8,915.
Other assets 12,106. (1.606.) (1,425.)
Less allowance for loan losses (1.784.)
-------- -------- --------
Total assets $210,580. $199,201. $182,340.
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits $ 62,657. $1,956. 3.1 $ 57,349 $ 1,834. 3.2 $ 53,180. 1,402. 2.6
Savings deposits 37,971. 1,293. 3.4 $ 37,681. 1,243. 3.3 36,969. 1,207. 3.3
Time deposits 60,466. 3,177. 5.3 58,161. 3,039. 5.2 48,837. 1,990. 4.1
Federal funds purchased 592. 33. 5.6 666. 36. 5.4
Subordinated notes 82. 9. 11.0 1,000. 110. 11.0 1,000. 110. 11.0
Other borrowings 1,105. 135. 12.2 994. 154. 15.5 1,670. 197. 11.8
-------- ------ -------- -------- -------- -----
Total interest bearing liabilities 162,873. 6,603. 4.1 155,185. 6,380. 4.1 142,322. 4,942. 3.5
</TABLE>
(continued)
<PAGE> 8
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY - CONTINUED
<TABLE>
<CAPTION>
Year Ended December 31 (Dollars in thousands)
-------------------------------------------------------------------------------------
1996 1995 1994
-------------------------- --------------------------- ----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------------------------- --------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY -
Continued
Non-interest bearing liabilities:
Demand deposits $ 24,557. $ 22,996 $ 21,349
Other 1,248. 1,312 1,022
Common Stock subject to repurchase
obligation 2,894. 1,848 1,326
Shareholders' equity 19,008. 17,860 16,321
-------- -------- --------
Total liabilities and shareholders'
equity $210,580. $199,201 $182,340
======== ======== ========
Net interest earnings $10,792 $9,492 $8,078
======= ====== ======
Net yield on interest earning assets 5.7% 5.4% 4.9%
==== ==== ====
</TABLE>
(A) Includes tax equivalent adjustment of interest (assuming a 34%
tax rate) for securities and loans of $369,000 and $23,000,
respectiveiy, for 1996; $379,000 and $17,000, respectively,
for 1995; and $322,000 and $18,000, respectively, for 1994.
(B) Average balance includes average nonaccrual loan balances of $443,000
in 1996; $284,000 in 1995; and $162,000 in 1994.
(C) Interest income includes loan fees of $884,000 in 1996; $472,000 in
1995, and $527,000 in 1994.
(D) Average balance includes average unrealized gain (loss) of $31,000 in
1996, $69,000 in 1995 and ($36,000) in 1994 on available-for-sale
securities. The yield was calculated without regard to this average
unrealized gain (loss).
<PAGE> 9
<TABLE>
<CAPTION>
The following table sets forth for the periods indicated a summary of changes
in interest income and interest expense, based upon a tax equivalent basis,
resulting from changes in volume and changes in rates:
1996 COMPARED TO 1995 1995 COMPARED TO 1994
---------------------------------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Interest income on: VOLUME RATE(A) NET VOLUME RATE(A) NET
---------------------------------------------------------------
Loans $1,350 $407 $1,757 $ 354 $1,452 $1,806
Taxable investment securities (66) (126) (192) 172 593 765
Tax-exempt investment securities 142 (118) 24 166 8 174
Federal funds sold (55) (11) (66) 97 10 107
=============================================================================================================
Total interest earning assets $1,371 $ 152 $1,523 $ 789 $2,063 $2,852
=============================================================================================================
Interest expense on:
Demand deposits $ 167 $ (45) $ 122 $ 116 $ 316 $ 432
Savings deposits 10 40 50 23 13 36
Time deposits 121 17 138 423 626 1,049
Federal funds purchased 33 0 33 (36) 0 (36)
Subordinated notes (101) 0 (101) 0 0 0
Other borrowings 16 (35) (19) (94) 51 (43)
- -------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities $ 246 $ (23) $ 223 $ 432 $1,006 $1,438
=============================================================================================================
</TABLE>
<PAGE> 10
INVESTMENT PORTFOLIO
<TABLE>
<CAPTION>
The following table sets forth the fair value and carrying value of investment
securities. The carrying value of available-for-sale securities is equal to
fair value.
DECEMBER 31
------------------------------------------------------------------------
1996 1995 1994
------------------------------------------------------------------------
FAIR CARRYING FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE VALUE VALUE
(Dollars in thousands)
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other U.S. $15,320 $15,320 $24,847 $24,847 $24,107 $24,482
Government agencies and
corporations
States and political subdivisions 19,343 19,035 14,934 14,534 13,157 13,064
Corporate securities 19,566 19,588 12,424 12,310 12,950 13,086
Other securities 2,656 2,656 3,667 3,662 650 647
===========================================================================================================
Total investment securities $56,885 $56,599 $55,872 $55,353 $50,864 $51,279
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth the amortized cost of the maturities (or
anticipated call date, if earlier) and weighted average yield for each range of
maturities at December 31, 1996.
<TABLE>
<CAPTION>
MATURING
---------------------------------------------------------------------------------------
WITHIN 1 YEAR 1 TO 5 YEARS 5 10 10 YEARS AFTER 10 YEARS
---------------------------------------------------------------------------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury and $ 9,045 6.46% $ 6,275 5.96%
other U.S.
Government
agencies and
corporations
States and political 3,838 5.41 11,133 5.44 $3,663 5.41% $ 401 5.95%
subdivisions
Corporate securities 4,069 6.46 15,519 6.39
Other securities 77 5.4 1,947 6.14 632 7.7%
===============================================================================================================
Total $17,029 $ 34,874 $3,663 $1,033
===============================================================================================================
</TABLE>
The weighted average interest yields were computed by multiplying the amortized
cost of each security by its interest yield to give an annual dollar yield per
security, adding the dollar yields per category and dividing the sum by the
total amortized cost of securities of that category. Interest yields given
above are not on a tax equivalent basis.
<PAGE> 11
LOAN PORTFOLIO
TYPES OF LOANS
The following table sets forth the classification of loans by major
category:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------------------------
(Dollars in thousands) 1996 1995 1994 1993 1992
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial, financial, $ 72,108 $ 51,940 $ 49,514 $ 47,011 $ 44,823
and agricultural
Real estate mortgage 47,560 41,293 43,054 42,525 45,795
Installment 33,010 30,004 27,771 22,978 24,906
=========================================================================================
Total loans $152,678 $123,237 $120,339 $112,514 $115,524
======== ======== ======== ======== ========
</TABLE>
MATURITIES
The following table sets forth the maturities of the loan portfolio at
December 31, 1996. Also provided are the amounts due after one year
classified according to interest rate sensitivity.
<TABLE>
<CAPTION>
MATURING
----------------------------------------------------------------
Dollars in thousands) WITHIN 1 YEAR (A) 1 TO 5 YEARS AFTER 5 YRS TOTAL
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial,
and agricultural $23,985 $24,016 $24,107 $ 72,108
Real estate mortgage 2,802 4,345 40,413 47,560
Installment 2,596 25,349 5,065 33,010
=================================================================================================
Total $29,383 $53,710 $69,585 $152,678
======= ======= ======= ========
Loans maturing after
one year with:
Fixed interest rates $29,958 $ 5,134
Variable interest rates 23,752 64,451
=================================================================================================
Total $53,710 $69,585
======= =======
</TABLE>
(A) Amounts include demand loans, loans having no stated schedule of
repayments, or no stated maturity and overdrafts.
<PAGE> 12
NON-PERFORMING LOANS
Non-performing loans include impaired loans, nonaccrual loans and accruing
loans past due 90 days or more. The following table sets forth the aggregate
amount of non-performing loans in each of the following categories:
<TABLE>
<CAPTION>
December 31
-------------------------------------
(Dollars in thousands) 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NONACCRUAL LOANS:
Commercial, financial, $ 448 $ 380 $ 142 $ 160 $ 425
and agricultural
Real estate mortgage 0 24 0 71 88
Installment 2 40 10 68 47
=====================================================================
450 444 152 299 560
LOANS CONTRACTUALLY
PAST DUE 90 DAYS OR
MORE
Commercial, financial, 82 353 6 150 151
and agricultural
Real estate mortgage 129 56 0 25 19
Installment 165 4 5 7 30
=====================================================================
376 413 11 182 200
TOTAL $ 826 $ 857 $ 163 $ 481 $ 760
===== ==== ==== ==== ====
Percent of total loans .54% .70% .14% .40% .66%
outstanding ===== ==== ==== ==== ====
</TABLE>
The accrual of interest income generally is discontinued when a loan becomes
over 90 days past due as to principal or interest. When interest accruals are
discontinued, interest credited to income in the current year and accrued
interest from the prior year is reversed. Management may elect to continue the
accrual of interest when: (1) the estimated net realizable value of collateral
is sufficient to cover the principal balance and accrued interest and; (2) the
loan is in the process of collection.
Interest of $27,000 and $19,000 was realized on nonaccrual loans during 1996
and 1995, respectively. Under original terms for these loans, interest income
which would have been recorded approximates $55,000 and $63,000 in 1996 and
1995, respectively. There are no loan commitments outstanding to extend credit
to these customers.
<PAGE> 13
POTENTIAL PROBLEM LOANS
At December 31, 1996 the Company had approximately $2,767,000 in commercial,
financial, and agricultural loans for which payments are presently current,
but the borrowers are experiencing certain financial and/or operational
difficulties. These loans are subject to frequent management review and
their classification is reviewed on a monthly basis.
All loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention have been included in the above disclosures.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table sets forth changes in the allowance for loan losses:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------------
(Dollars in thousands) 1996 1995 1994 1993 1992
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Balance at beginning of $ 1,609 $ 1,498 $ 1,365 $ 1,401 $ 1,307
year
CHARGE OFFS:
Commercial, financial, 13 87 69 193 138
and agricultural
Installment 157 124 93 124 517
Real estate 0 0 0 0 4
170 211 162 317 659
-------- --------- -------- -------- --------
RECOVERIES:
Commercial financial, 43 43 30 138 91
and agricultural
Installment 62 54 82 139 182
Real estate 3 3 3 4
108 100 115 281 273
-------- --------- -------- -------- --------
NET CHARGE-OFFS 62 111 47 36 386
Provision for loan losses 267 222 180 0 480
-------- --------- -------- -------- --------
Balance at end of year $ 1,814 $ 1,609 $ 1,498 $ 1,365 $ 1,401
======== ========= ======== ======== ========
Average loans $137,273 $123,684 $119,637 $115,524 $114,913
outstanding ======== ======== ======== ======== ========
Ratio of net charge-offs .05% .08% .04% .03% .34%
to average ======== ========= ======== ======== ========
outstanding loans
</TABLE>
<PAGE> 14
The allowance for loan losses is maintained at a level which, in management's
opinion, is adequate to absorb possible loan losses in the loan portfolio. In
assessing the adequacy of the allowance, management reviews the characteristics
of the loan portfolio in order to determine overall quality and risk profile.
Some factors considered by management in determining the level at which the
allowance is maintained include a continuing evaluation of those loans
identified as being subject to possible problems in collection, results of
examination by regulatory agencies, current economic conditions, and historical
loan loss experience.
In determining the 1993 provision for loan losses, management considered the
fact that nonaccrual loan and past due loan amounts decreased from prior years.
Also considered in determining the 1993 provision was the low level of
charge-offs and the decline in outstanding loans. The 1996, 1995 and 1994
provisions increased to provide for loan growth.
<PAGE> 15
Allocation of the Allowance for Loan Losses
The Securities and Exchange Commission's guide to the presentation of
statistical information provides for a break down of the allowance for loan
losses into major loan categories. The Company allocates the allowance among the
various categories through an analysis of the loan portfolio composition, prior
loan loss experience, evaluation of those loans identified as being possible
problems in collection, results of examination by regulatory agencies and
current economic conditions. The entire allowance is available to absorb any
future losses without regard to the category or categories in which the
charged-off loans are classified.
Even though such an allocation has inherent limitations, the Company has
compiled the results of its various reviews and has made estimates of the risks
which might be allocated to the respective loan categories.
The following table sets forth the allocation of the allowance for loan losses:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------------------------------------------------------------------------
1996 1995 1994
-------------------------------------------------------------------------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS LOANS LOANS
IN EACH IN EACH IN EACH
CATEGORY CATEGORY CATEGORY
(Dollars in thousands) ALLOWANCE TO TOTAL LOANS ALLOWANCE TO TOTAL LOANS ALLOWANCE TO TOTAL LOANS
--------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Commercial, financial,
and agricultural $ 351 47.2% $ 313 42.1% $ 369 41.1%
- -----------------------------------------------------------------------------------------------------------------------
Real estate mortgage 95 31.2 83 33.5 86 35.8%
- -----------------------------------------------------------------------------------------------------------------------
Installment 177 21.6 157 24.4 147 23.1
- -----------------------------------------------------------------------------------------------------------------------
Unallocated 1,191 1,056 896
=======================================================================================================================
$1,814 100.0% $1,609 100.0% $1,468 100.0%
====== ===== ====== ===== ====== =====
=======================================================================================================================
<CAPTION>
DECEMBER 31
-----------------------------------------------------------
1993 1992
-----------------------------------------------------------
PERCENT OF PERCENT OF
LOANS LOANS
IN EACH IN EACH
CATEGORY CATEGORY
(Dollars in thousands) ALLOWANCE TO TOTAL LOANS ALLOWANCE TO TOTAL LOANS
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Commercial, financial,
and agricultural $ 344 41.8% $ 430 38.8%
- ---------------------------------------------------------------------------------------
Real estate mortgage 85 37.8 92 39.6
- ---------------------------------------------------------------------------------------
Installment 133 20.4 345 21.6
- ---------------------------------------------------------------------------------------
Unallocated 803 534
=======================================================================================
$1,365 100.0% $1,401 100.0%
====== ===== ====== =====
=======================================================================================
</TABLE>
<PAGE> 16
DEPOSITS
- --------
The following table sets forth the average amount of deposits and rates paid
for deposits:
<TABLE>
<CAPTION>
-------------------------------------------------------------------
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------
1996 1995 1994
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
- -----------------------------------------------------------------------------------------------
Non interest bearing $ 24,557 $ 22,996 $ 21,349
demand deposits
- -----------------------------------------------------------------------------------------------
Interest bearing 62,657 3.1% 57,349 3.2% 53,180 2.6%
demand deposits
- -----------------------------------------------------------------------------------------------
Savings deposits 37,971 3.4 37,681 3.3 36,969 3.3
- -----------------------------------------------------------------------------------------------
Time deposits 60,466 5.3 58,161 5.2 48,837 4.1
- -----------------------------------------------------------------------------------------------
$185,651 $176,187 $160,335
======== ======== ========
===================================================================
</TABLE>
The following table sets forth as of December 31, 1996, the aggregate amount of
outstanding deposits (certificates of deposit) of $100,000 or more by maturity
(in thousands of dollars):
Three months or less $ 4,792.
Over three months through six months 8,837.
Over six months through twelve months 2,117.
Over twelve months 1,692.
--------
$17,438.
========
RETURN ON EQUITY AND ASSETS
- ---------------------------
The following table sets forth consolidated operating and capital ratios:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- --------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
--------------------------
1996 1995 1994
- --------------------------------------------------------------------------
Return on average assets 1.45% 1.31% 1.11%
- --------------------------------------------------------------------------
Return on average equity 16.09 14.64 12.36
- --------------------------------------------------------------------------
Dividend payout ratio 32.74 35.18 33.71
- --------------------------------------------------------------------------
Average equity to average assets ratio 10.40 8.97 8.95
- --------------------------------------------------------------------------
</TABLE>
Average equity used in the above table excludes common stock subject to
repurchase obligation.
<PAGE> 17
ITEM 2. PROPERTIES
The Bank's main office is located at 51 West Pearl Street, Coldwater, Michigan.
This facility, which opened in 1955 and expanded in 1976, consists of a one
story structure comprising 27,945 square feet. Parking is available for
approximately 125 cars and 9 teller windows are available to serve the Bank's
customers. The Bank owns eleven branch offices, two of which are in Coldwater,
two in Union City, Michigan, one in Kinderhook, Michigan, one in Tekonsha,
Michigan, one in Hillsdale, Michigan, one in Camden, Michigan, one in Athens,
Michigan, one in North Adams, Michigan and one in Pennfield Township (Battle
Creek), Michigan. The Bank also leases 1700 square feet from a third party for
use in its Battle Creek loan production office. In addition, the Registrant owns
a 15,000 square foot building in Battle Creek, Michigan and a 14,000 square
foot building in Coldwater, Michigan. 6,000 square feet of the Battle Creek
building is leased to the Bank for use by one of its Battle Creek branches.
3,500 square feet is leased to a local college, 2,300 square feet is leased as
office space to local businesses and the remaining space is presently
unoccupied. 7,446 square feet of the Coldwater building is leased to the Bank
for use as a Consumer Loan center, 3,420 square feet is leased to a local title
once, 762 square feet is leased to a local insurance company and 394 square
feet is leased to community nonprofit organizations. The Bank's branch offices
range in size from 465 square feet to 6,000 square feet, with nine of the
branch offices having drive-in facilities and seven of the branches having
automated teller machines.
All of the Registrant's and the Bank's facilities are maintained in good
condition and are adequately insured. Management of Registrant believes the
present facilities are adequate to meet both current and future needs.
ITEM 3. LEGAL PROCEEDINGS
The Bank is frequently engaged in litigation, both as plaintiff and defendant,
which is incident to its business. In certain proceedings, claims or
counterclaims may be asserted against the Bank. Based on the facts known to it
to date, management of the Registrant does not currently anticipate that the
ultimate liability, if any, arising out of any such litigation will have a
material effect on the consolidated financial statements of the Registrant.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
<PAGE> 18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS
"Common Stock Market Prices and Dividends" on page 2 of the Annual Report to
Shareholders for the year ended December 31, 1996 is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA
"Selected Financial Data" on page 2 of the Annual Report to Shareholders for
the year ended December 31, 1996 is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 5 through 10 of the Annual Report to Shareholders for the
year ended December 31, 1996 is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, the Notes thereto and Report of
Independent Auditors included on pages 13 through 29 in the Annual Report to
Shareholders for the year ended December 31, 1996 are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
None
<PAGE> 19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names of the directors, their ages as of February
28, 1997 principal occupations and year in which each was elected.
<TABLE>
<CAPTION>
<S> <C> <C>
PRINCIPAL OCCUPATION(S) YEAR FIRST BECAME
NAME OF DIRECTOR (1) AGE FOR PAST 5 YEARS (2) DIRECTOR OF REGISTRANT
- -------------------- --- -------------------- ----------------------
Jerry L. Towns (3) 62 President and Chief Executive Officer of 1982
Southern Michigan Bancorp, Inc.
(Chairman of Southern Michigan Bank &
Trust)
James T. Grohalski (3) 56 Executive Vice President and Chief 1982
Financial Officer of Southern Michigan
Bancorp, Inc. (President of Southern
Michigan Bank & Trust)
James Briskey 63 Owner - Briskey Elevator (grain elevator 1982
operator)
William E. Galliers 54 Co-owner and Chief Executive 1993
Officer - G & W Display Fixtures, Inc.
Nolan E. Hooker 45 Owner - Hooker Oil Co. (distributor of 1991
heating oil)
Gregory J. Hull 48 Farmer 1995
Thomas E. Kolassa 49 Owner - The Planning Group (insurance) 1995
James J. Morrison 48 Owner - Morrison & Associates 1991
(insurance)
Jane L. Randall 75 Owner - Dally Tire Co. (tire distributor) 1982
Freeman E. Riddle 64 Owner - Spoor & Parlin Farm Equipment 1982
</TABLE>
NOTES:
(1) Current directors of Registrant are also directors of Southern
Michigan Bank & Trust.
(2) The business experience of each director during the past five years
was that typical of a person engaged in the principal occupation listed for
each.
(3) Messrs. Towns and Grohalski, the Registrant's two executive officers
(who are also directors) have held the same positions since the organization of
Registrant in 1982.
<PAGE> 20
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth compensation paid by the Registrant and the Bank
with respect to the fiscal year ended December 31, 1996 to the Company's Chief
Executive Officer and the only other executive officer whose combined salary and
bonus exceeded $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
ANNUAL COMPENSATION
- ---------------------------------------------------------------------------------------------
NAME AND PRINCIPAL ALL OTHER
POSITION YEAR SALARY ($) (1) COMPENSATION ($) (2)
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jerry L Towns
President and Chief Executive 1996 $149,201 $5,978
Officer of the Registrant and 1995 $134,190 $6,038
Chairman of the Bank 1994 $114,454 $5,287
- ---------------------------------------------------------------------------------------------
James T Grohalski
Executive Vice President 1996 $ 135,225 $ 7,191
and Chief Financial Officer 1995 $ 123,968 $ 7,239
of the Registrant and 1994 $ 103,672 $ 6,744
President of the Bank
- ---------------------------------------------------------------------------------------------
</TABLE>
(1) The amounts shown includes amounts deferred under the 401 (k)
provisions of the Bank's Employee Stock Ownership Plan ("ESOP") and the
Bank's Executives' Deferred Compensation Plan ("Deferred Compensation
Plan").
(2) The amounts shown include the following for 1995: (i) employer
contributions to accounts in the ESOP and the Deferred Compensation
Plan of $2,600 and $3,000, respectively for Mr. Towns; and $3,796 and
$3,000 respectively for Mr. Grohalski; (ii) $378 and $395 constituting
the value of insurance premiums paid by the Bank for term life
insurance for Mr. Towns' and Mr. Grohalski's benefit, respectively.
RETIREMENT BENEFITS
- -------------------
Officers of the Registrant participate in the Southern Michigan Bank & Trust
Retirement Plan (the "Retirement Plan"), which has been adopted by the
Registrant. Under the terms of the Plan, a normal monthly retirement benefit is
provided to covered employees who attain the age of 65. It provides for a
normal retirement benefit after 30 years of credited service equal to 35% of a
participant's actual monthly compensation based on the participant's highest
consecutive five year average compensation (see the column captioned
"Remuneration"). For participants with less than 30 years credited service,
reduced benefits are available in an amount equal to the normal retirement
benefit reduced by 1/30 for each year of service less than 30. Participants are
100% vested after five years of credited service, and are subject to forfeiture
upon termination of employment with credited service less than five years. The
following table represents estimated normal annual benefits payable on a
straight-life annuity basis upon retirement at age 65 and are not subject to
deduction for social security benefits:
<PAGE> 21
PENSION PLAN TABLE
YEARS OF SERVICE
REMUNERATION 25 30 35
110,000 $32,100 $38,500 $38,500
120,000 35,000 42,000 42,000
130,000 37,900 45,500 45,500
140,000 40,800 49,000 49,000
150,000 43,750 52,500 52,500
Jerry L. Towns has 25 years of credited service and $123,000 current covered
remuneration. James T. Grohalski has 30 years of credited service and $111,000
current covered remuneration.
The Bank also has in effect supplemental retirement arrangements in the form of
Executive Employee Salary Continuation Agreements with its executive officers
under which a specified annual benefit, in addition to that provided under the
Retirement Plan, is payable to the officer upon retirement at age 65, subject
to reduction for credited service of less than 30 years on the same basis as
under the Retirement Plan. The specified benefit under the salary continuation
agreements is also payable beginning at the executive officers attaining age
65, if the officer is terminated or has his title, responsibility or
compensation significantly lessened or the situs of his employment is changed
without his consent. The specified annual benefit, when added to the benefit
under the Retirement Plan, is intended to be approximately equal to the benefit
the officer would have received under the Retirement Plan but for a plan
amendment which changed the Plan's benefit formula to comply with changes in
pension laws and which substantially reduced the executive officers' benefits.
For Jerry L. Towns, the specified annual benefits payable upon retirement at
age 65 under the supplemental retirement arrangement is $16,860. For James T.
Grohalski, the specified annual benefit payable upon retirement at age 65 under
the supplemental retirement arrangement is $22,060.
The Bank also has a Deferred Compensation Plan for directors and certain
executive officers. Under the Deferred Compensation Plan, participants elect to
defer a portion of their compensation (in the case of directors, their fees) on
a pretax basis. Upon retirement at or after age 65, the participant or his
designated beneficiary is entitled to a benefit equal to the amount of the
participant's deferrals to the Plan plus earnings on such deferrals at a
specified rate of interest compounded annually, payable in equal monthly
amounts for not less than 180 months. Upon a participant's death before
retirement, other than as a result of suicide, the benefit described above is
paid to the participant's designated beneficiary. Upon the participant's
termination of employment or retirement before age 65, the benefit payable to
the participant at age 65 is determined by multiplying the amount deferred
under the Plan by the ratio of the number of months for which the participant
made deferrals to the number of months from the time the participant began
making deferrals to the participant's reaching age 65. The amounts shown in the
summary compensation table above include amounts deferred as contributions
under the Plan, which amounts are subject to forfeiture pursuant to the formula
described above for determining the applicable benefit in the event the
participant's employment terminates before retirement at age 65.
DIRECTORS' FEES
Currently, each director of the Bank whose principal occupation is not with the
Bank, receives an annual fee of $6,000, in addition, outside directors are
compensated $150 for each Committee meeting attended.
<PAGE> 22
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 28, 1997, the names and
addresses of all beneficial owners of 5% or more of Registrant's common stock
(its only authorized class of stock), showing the amount and nature of such
beneficial ownership:
<TABLE>
<CAPTION>
TITLE OF NAME & ADDRESS OF AMOUNT & NATURE OF PERCENT
CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS
(1)
<S> <C> <C> <C>
Common Stock Southern Michigan Bank & Trust 154,152 (a) 16.178
51 W. Pearl Street
Coldwater, Michigan 49036
Common Stock Southern Michigan Bank & Trust 80,997 (b) 8.50
Employee Stock Ownership Plan
51 W. Pearl Street
Coldwater, Michigan 49036
Common Stock Harvey B. Randall
8391 Old U.S. 27 South 1,208.0626 (c) 6.971
Marshall, Michigan 49068 65,216 (d)
Common Stock Max I. Larsen
410 East Chicago Street 57,238.84 6.007
Coldwater, Michigan 49036
</TABLE>
(1) Based upon information furnished to the Registrant by the individuals
named above. The nature of beneficial ownership for shares shown is
sole voting and investment power, except as set forth below.
(a) Shares are held by Bank's Trust Department in various
fiduciary capacities which include power to vote the shares.
(b) Shares are voted in accordance with instructions from
plan participants.
(c) Sole voting and investment power.
(d) Shared voting and investment power.
<PAGE> 23
The following table sets forth, as of February 28, 1997, the total number of
shares of Registrant's common stock beneficially owned, and the percent of such
shares so owned, by each director and by all directors and executive officers
of the Registrant as a group.
<TABLE>
<CAPTION>
NAME OF INDIVIDUALS OR AMOUNT AND NATURE PERCENT
NUMBER OF PERSONS IN OF OF
GROUP BENEFICIAL OWNERSHIP(1) TOTAL CLASS
--------------------------------------------------------------------------------
<S> <C> <C> <C>
James Briskey 4,840(a)
4,840(b) 9,680 1.016
William E. Galliers 200(b) 200 (2)
James T. Grohalski 1,442.5361 1,442.5361 (2)
Nolan E. Hooker 76(a)
200(b) 276 (2)
Gregory J. Hull 300 300 (2)
Thomas E. Kolassa 359.8588(a) 359.8588 (2)
James J. Morrison 990.9346(b) 990.9346 (2)
Jane L. Randall 2,220.379 2,220.379 (2)
Freeman E. Riddle 1,880.1797(a)
1,112(b) 2,992.1797 (2)
Jerry L. Towns 258(a)
75.0575(b) 333.0575 (2)
All directors and
executive officers as
a group (10 persons) 18,794.9457 18,794.9457 1.972
</TABLE>
(1) Based upon information furnished to the Registrant by the individual
named and the members of the designated group. The nature of beneficial
ownership for shares shown is sole voting and investment power
except as set forth below.
(a) Sole voting and investment power.
(b) Shared voting and investment power.
(2) Less than one percent (1%).
<PAGE> 24
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The second paragraph of Note C to the consolidated financial statements on
pages 20 and 21 of the Annual Report to Shareholders for the year ended
December 31, 1996 is incorporated herein by reference.
<PAGE> 25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report.
(a)(3) Exhibits (Numbered in accordance with Item 601 of
Regulation S-K).
Exhibit 2 - Not applicable.
Exhibit 3 - Articles of Incorporation and By-Laws
incorporated by reference to Exhibit 3 to the Company's
Annual Report on Form 10-K for the year ended December
31, 1991. (file number 2-78178).
Exhibit 4 - Instruments Defining the Rights of
Security Holders of the Registrant are the Articles of
Incorporation and By-Laws (see Exhibit 3, above).
Exhibit 9 - Not applicable.
Exhibit 10- Material Contracts - Executive Compensation
Plans and Arrangements: (1) Master Agreements for
Directors' Deferred Income Plan; (2) Composite form of
Executive Employee Salary Continuation
Agreement, as amended; and; (3) Master Agreements for
Executives' Deferred Compensation Plan, as amended, are
incorporated by reference to Exhibit 10 to the Registrants
Annual Report on Form 10-K for the year ended December 31,
1994. (file number 2-78178).
Exhibit 11- Not applicable.
Exhibit 12- Not applicable.
Exhibit 13- Registrant's 1996 Annual Report to Shareholders.
With the exception of the information incorporated by
reference included in Items 3, 5, 6, 7, 8, and 13, the
1996 Annual Report to Shareholders is furnished for the
Commission's information only and is not deemed filed as
part of this report.
Exhibit 16- Not applicable.
Exhibit 18- Not applicable.
Exhibit 19- Not applicable.
Exhibit 21- Subsidiary of Registrant.
Exhibit 22- Not applicable.
Exhibit 23- Consent of Independent Auditors.
Exhibit 24- Not applicable.
Exhibit 27- Financial Data Schedule.
Exhibit 28- Not applicable.
<PAGE> 26
(b) No reports on Form 8-K were filed in the last Quarter of the period
covered by this report.
(c) Exhibits - See Item 14(a)(3) above.
(d) Financial Statement Schedules - Omitted due to inapplicability or
because required information is shown in the Financial Statements and
Notes thereto.
<PAGE> 27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOUTHERN MICHIGAN BANCORP, INC.
Dated: MARCH 31, 1997 By: JAMES T. GROHALSKI
--------------------- -------------------------
James T. Grohalski
Executive Vice President and
Secretary/Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
JAMES BRISKEY JAMES J. MORRISON
----------------------- ---------------------------
James Briskey - Director James J. Morrison - Director
WILLIAM E. GALLIERS JANE L. RANDALL
------------------- ------------------------
Wiliam E. Galliers- Director Jane L. Randall - Director
JAMES T. GROHALSKI FREEMAN E. RIDDLE
----------------------- ---------------------------
James T. Grohalski Freeman E. Riddle - Director
Executive Vice President
and Director
(Principal Financial &
Accounting Officer)
NOLAN E. HOOKER JERRY L. TOWNS
------------------------ -----------------------
Nolan E. Hooker- Director Jerry L. Towns- President
Chief Executive Officer & Director
GREGORY J. HULL
-------------------------
Gregory J. Hull - Director
THOMAS E. KOLASSA MARCH 31, 1997
---------------------------- ---------------------------
Thomas E. Kolassa - Director Date
<PAGE> 28
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1) and (2)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1996
SOUTHERN MICHIGAN BANCORP, INC.
COLDWATER, MICHIGAN
<PAGE> 29
FORM 10-K: ITEM 14(a)(1) AND (2)
SOUTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARY
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements and report of independent
auditors of Southern Michigan Bancorp, Inc. and subsidiary included in the
Annual Report to Shareholders of the Registrant for the year ended December 31,
1996 are incorporated by reference in Item 8:
- Report of Crowe Chizek and Company LLP, independent auditors
- Consolidated balance sheets - December 31, 1996 and 1995
- Consolidated statements of shareholders' equity - Years ended
December 31, 1996, 1995, and 1994
- Consolidated statements of income - Years ended December 31,
1996, 1995, and 1994
- Consolidated statements of cash flows - Years ended December 31,
1996, 1995, and 1994
- Notes to consolidated financial statements - December 31, 1996
Schedules to the consolidated financial statements required by Article 9 of
Regulation S-X are not required under the related instructions or are
inapplicable, and therefore have been omitted.
<PAGE> 1
[SOUTHERN MICHIGAN BANCORP, INC. LOGO]
1996 ANNUAL REPORT
SOUTHERN MICHIGAN BANCORP, INC.
<PAGE> 2
"Increased my loan volume by over 80%." - "Working well together." - "Work area
was rearranged to create more space and easier working conditions." -
"Departments are working more as a Team." - "The Battle Creek Mortgage Center
has opened." - "All of you are wonderful." - "Sold four services to a
customer." - "It's wonderful to work with sharing and caring people." -
"Learning to get a more positive attitude towards my work." - "Team building -
everyone is working harder." - "Loan volume has exceeded our expectations." -
"My department has greatly improved teamwork communications." - "Being a part
of the FOA conversion team and assisting with CSR training have been a very
positive learning experience for me." - "Customers are responding." - "Make
resources available to do your job well." - "Sharing knowledge benefits all." -
"Better teamwork creates a better workplace."
- ------------------------------------------------------------------------------
At Southern Michigan Bank & Trust, our work teams are linked by a common bond -
the pursuit of long-term value for every stakeholder. In 1996, we celebrated
our first year under this team-based management system by creating a sucess
chain, which signifies our commitment to each other and to our common goals.
Each link in the colored paper chain, created by each employee, features a
positive statement about last year's experiences. What better theme for an
annual report that reveals a record year of financial performance!
<PAGE> 3
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31
1996 1995 1994 1993 1992
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total interest income $17,004,000 $15,477,000 $12,680,000 $11,863,000 $13,290,000
Net interest income 10,400,000 9,096,000 7,738,000 6,702,000 7,194,000
Provision for loan losses 267,000 222,000 180,000 0 480,000
Net income 3,058,000 2,615,000 2,018,000 1,590,000 1,466,000
Per share data:
Net income 3.24 2.82 2.21 1.79 1.69
Cash dividends 1.06 .99 .75 .70 .64
Balance sheet data:
Capital note 0 1,000,000 1,000,000 1,000,000 1,000,000
Common stock subject to repurchase 3,555,000 2,232,000 1,464,000 1,187,000 861,000
Equity 19,616,000 18,497,000 16,855,000 15,614,000 14,575,000
Total assets 235,561,000 209,977,000 195,625,000 178,453,000 172,477,000
Return on average assets 1.45% 1.31% 1.11% .90% .85%
Return on average equity 16.09% 14.64% 12.36% 10.56% 10.37%
</TABLE>
COMMON STOCK MARKET PRICES AND DIVIDENDS
The Company's common stock, for which there is no established public trading
market, is traded infrequently in the local over-the-counter market. Market
prices are based on information provided by an established securities dealer.
There were 465 shareholders of record at December 31, 1996.
High and low market prices and dividends for the last two years were:
<TABLE>
<CAPTION>
1996 1995
MARKET PRICE CASH Market Price Cash
------------------------- DIVIDENDS ------------------------- Dividends
HIGH BID LOW BID DECLARED High Bid Low Bid Declared
<S> <C> <C> <C> <C> <C> <C>
Quarter Ended
- -------------------------------------------------------------------------------------------------------------------------------
March 31 $ 34.00 $ 30.00 $ .24 $ 22.00 $ 21.00 $ .20
June 30 35.00 33.00 .24 25.50 22.00 .21
September 30 39.50 35.00 .24 29.00 25.50 .22
December 31 45.00 39.50 .34 30.00 28.00 .36
</TABLE>
There are restrictions that currently limit the Company's ability to pay cash
dividends. Information regarding dividend payment restrictions is described in
Note K to the consolidated financial statements for the year ended December 31,
1996.
All per share amounts have been adjusted for a 2 for 1 stock split in 1995 and
a 10 percent stock dividend declared in 1993.
2 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 4
Five Year Financial Performance
FIVE YEAR FINANCIAL PERFORMANCE
Net income and dividends per share
[Line Graph]
Net income Dividends
---------- ---------
92 1.69 .64
93 1.79 .70
94 2.21 .75
95 2.82 .99
96 3.24 1.06
Per share amounts have been adjusted for 10 percent stock dividend declared in
1993 and a 2 for 1 stock split in 1995.
RETURN ON ASSETS
(net income divided by average assets)
[Line Graph]
92 .85
93 .90
94 1.11
95 1.31
96 1.45
Return on assets is a standard measure of financial performance in the banking
industry.
NET INTEREST MARGIN
(fully taxable equivalent basis)
[Line Graph]
92 4.45
93 4.19
94 4.79
95 5.10
96 5.36
Net interest margin is the difference between the yield on earning assets and
the interest cost of funding those assets.
CAPITAL RATIOS
(at year end)
[Line Graph]
Total Primary
----- -------
92 10.34 8.95
93 10.75 10.19
94 10.64 10.13
95 11.11 10.60
96 10.61 9.84
Capital as a percentage of total assets indicates the Company's ability to
continue growing.
RATIO OF AVERAGE EQUITY TO AVERAGE ASSETS
[Line Graph]
92 8.24
93 9.09
94 9.68
95 9.98
96 10.40
Average equity to average assets measures the extent to which the shareholders'
investment has been leveraged.
1996 Annual Report to Shareholders 3
<PAGE> 5
[PHOTO OF JERRY L. TOWNS AND JAMES T. GROHALSKI]
LETTER TO SHAREHOLDERS
To Our Shareholders:
Last year we had the pleasure of reporting records in terms of deposits, asset
growth, and profits. This year, on the occasion of the One Hundred Twenty-
Fifth Anniversary of Southern Michigan Bank & Trust and its predecessor, we're
extremely pleased to repeat last year's message of setting new records.
As you will note on the following pages, it was a very good year in every
respect and, happily, has been reflected in the value of your stock in our
company.
Several changes occurred during 1996 which helped our efforts. The Loan Center
was opened at 2 West Chicago Street in Coldwater in February, and we were
fortunate to acquire two new branch offices in December from a major regional
competitor. The new offices in Pennfield and North Adams contributed
approximately $18 million in new deposits, and we anticipate loan growth in
those locations during 1997. In addition, we opened a new loan office in Battle
Creek dedicated to increasing our mortgage loan activity in that area.
We're also pleased to note steady, solid, growth in our Investment Center and
cordially invite you to visit our specialist, Bonnie Kubicek, at any time to
discuss non-deposit investment products.
On a slightly more somber note, we regret to announce the retirement from our
Board of Directors of Mr. Harvey Randall. Mr. Randall joined the Board in 1969
following the acquisition of the First State Bank in Tekonsha and has served
your interests as shareholders on a high level ever since. We will sincerely
miss his dedication and wise counsel in the future.
We look forward to seeing you at our annual shareholders meeting which is
scheduled for Monday, April 21st at 4:00 p.m. at Michigan Gas Utilities, 70
Sauk River Drive, in Coldwater.
Your questions and comments are always welcomed at any time.
/s/ JERRY L. TOWNS /s/ JAMES T. GROHALSKI
Jerry L. Towns James T. Grohalski
President & C.E.O. Executive Vice-President
4 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS
The following discussion provides information about the Company's financial
condition which supplements the Consolidated Financial Statements included
elsewhere in this Annual Report. The analysis should be read in conjunction
with such financial statements and Five Year Performance and Selected Financial
Data presented in other sections of this Annual Report.
FINANCIAL CONDITION
The Company functions as a financial intermediary and, as such, its financial
condition should be examined in terms of trends in its sources and uses of
funds.
The Company uses its funds primarily to support its lending activities. Loans
increased by 23.9% in 1996 and 2.4% in 1995. The growth in 1996 occurred in all
loan categories and is the result of continued good economic conditions within
the Company's market area. The good economic conditions caused many businesses
within the market area to expand. This strong loan demand, along with more
competitive pricing techniques caused the Bank's commercial loan portfolio to
grow significantly in 1996. The growth in 1995 occurred in commercial and
installment loans while real estate mortgage loans declined. Increased
commercial and installment loan demand can be attributed to continued good
economic conditions. The real estate mortgage loan decline can be attributed to
an increase in sales of loans in the secondary market, thus reducing the number
of new loans that the Bank retains.
The Bank's real estate mortgage loan sales to the secondary market increased
significantly in 1996. Gains of $236,000 (after the capitalization of mortgage
servicing rights) were recognized in 1996 and gains of $41,000 were recognized
in 1995. There were no loans held for sale at December 31, 1996. The real
estate portfolio largely consists of residential mortgages within the local
area with a low risk of loss.
Despite the significant increase in secondary market loan sales in 1996, the
Bank's mortgage portfolio increased due to the offering of some attractive
adjustable rate mortgage products and the Bank's increased efforts to become a
market leader in the consumer lending area, as displayed through the opening of
two retail loan centers during 1996. The Bank anticipates that the sale of
loans in the secondary market will continue to increase.
Loan commitments, consisting of unused credit card and home equity lines,
available amounts on revolving lines of credit and other approved loans which
have not been funded, were $26,429,000 and $18,779,000 at December 31, 1996 and
1995, respectively. All of these commitments, with the exception of unused
credit card lines ($1,892,000 at December 31, 1996 and $1,481,000 at December
31, 1995), are priced at a variable interest rate thus minimizing the Bank's
risk in a changing environment.
There are no significant concentrations in any loan category as to borrower,
industry or location.
Another significant use of funds is the investment securities portfolio.
Investments increased by 2.3% in 1996 and 7.9% in 1995. The 1996 increase
occurred during the month of December following the significant increase in
deposits associated with the acquisition of two branches from First of
America-Michigan. The increase in 1995 is due to deposit growth, the net
unrealized gain position of the available-for-sale portfolio and the
reclassification of the Bank's U.S. Treasury and other U.S. Government Agencies
portfolios from held to maturity to available for sale. The transfer was made
pursuant to FASB Special Report, A Guide to Implementation of Statement 115,
and the securities transferred had net unrealized gains of $88,000.
The available-for-sale portfolio had net unrealized gains of $31,000 and
$328,000 at December 31, 1996 and 1995, respectively. Net unrealized gains in
the investment portfolio classified as held to maturity totaled $286,000 and
$519,000 at December 31, 1996 and 1995, respectively. It is the Company's
intent to hold these investment securities to maturity with the
available-for-sale securities being available to sell should the Company's
liquidity needs require it. There is no concentration of investments in the
portfolio which would constitute an unusual risk.
Deposits traditionally represent the Company's principal source of funds. Total
deposits increased 12.9% in 1996 and 6.6% during 1995. The 1996 increase
occurred primarily as the result of the acquisition of $18,635,000 in deposits
from First of America-Michigan in December. The two branches acquired are
located in Calhoun and Hillsdale counties and will increase the Company's
penetration within those markets. As of January 31, 1997, the Calhoun County
branch's deposits have declined by $1,200,000 since the acquisition date. This
branch is located in a very competitive market, and other First of America
locations are accessible to the depositors.
The 1995 increase occurred primarily in interest bearing checking accounts and
time deposits. The Bank historically experiences an increase in checking
accounts in December and a decline in these balances in January. The increase
in time deposits was the result of $5,000,000 in short term deposits made by
local municipalities which matured in February 1996, and were withdrawn upon
maturity.
1996 Annual Report to Shareholders 5
<PAGE> 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS (CONTINUED)
Premises and equipment increased by 31.9% in 1996 and 20.5% in 1995. The 1996
increase was due to the completion of renovations for the two new retail loan
centers opened in 1996, and associated furniture and equipment purchases. The
1995 increase was due to the start of renovations on the retail loan center
buildings.
The Company had no material commitments for capital expenditures at December
31, 1996.
CAPITAL RESOURCES
The Company maintains a strong capital base to take advantage of business
opportunities while ensuring that it has resources to absorb the risks inherent
in the business.
The Federal Reserve Board (FRB) has imposed risk-based capital
guidelines applicable to the Company. These guidelines require that bank
holding companies maintain capital commensurate with both on and off balance
sheet credit risks of their operations. Under the guidelines, a bank holding
company must have a minimum ratio of total capital to risk-weighted assets of 8
percent. In addition, a bank holding company must maintain a minimum ratio of
Tier 1 capital equal to 4 percent of risk-weighted assets. Tier 1 capital
includes common shareholders' equity, qualifying perpetual preferred stock and
minority interests in equity accounts of consolidated subsidiaries less
goodwill.
As a supplement to the risk-based capital requirements, the FRB has also
adopted leverage capital ratio requirements. The leverage ratio requirements
are intended to insure that adequate capital is maintained against risks other
than credit risk. The leverage ratio requirements establish a minimum ratio of
Tier 1 capital to total assets of 3 percent for the most highly rated bank
holding companies and banks that do not anticipate and are not experiencing
significant growth. All other bank holding companies are required to maintain a
ratio of Tier 1 capital to assets of 4 to 5 percent, depending on the
particular circumstances and risk profile of the institution.
Regulatory agencies have determined that the capital component created by the
adoption of Financial Accounting Standards Board (FASB) Statement No. 115
should not be included in Tier 1 capital. As such, the net unrealized
appreciation or depreciation on available-for-sale securities is not included
in the ratios listed below. The ratios include the common stock subject to
repurchase obligation in the Company's employee stock ownership plan (ESOP).
The following table summarizes the Company's capital ratios as of December 31:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Tier 1 risk-based capital ratio 11.9% 14.3%
Total risk-based capital ratio 12.9% 15.6%
Leverage ratio 9.9% 9.3%
</TABLE>
The table above indicates that the Company's capital ratios are above the
regulatory minimum requirements. The risk-based capital ratios declined in 1996
as a result of the branch acquisitions and the significant increase in loans.
In addition to these regulatory requirements, a certain level of capital growth
must be achieved to maintain appropriate levels of equity to total assets.
During 1996 and 1995, total average assets grew 5.7% and 9.2%, respectively. At
the same time, average equity (including common stock held by the ESOP)
increased 11.1% in 1996 and 11.7% in 1995. This indicates that the Company has
retained adequate capital to support its asset growth and has the ability to
continue growing. Future growth opportunities will focus on maintaining the
existing customer base and growing within the Calhoun and Hillsdale County
markets.
LIQUIDITY AND INTEREST RATE SENSITIVITY
The primary functions of asset/liability management are to assure adequate
liquidity and maintain an appropriate balance between interest-earning assets
and interest-bearing liabilities. Liquidity management involves the ability to
meet the cash flow requirements of customers who may be either depositors
wanting to withdraw funds or borrowers needing assurance that sufficient funds
will be available to meet their credit needs. Interest rate sensitivity
management seeks to avoid fluctuating net interest margins and enhance
consistent growth of net interest income through periods of changing interest
rates.
Maturing loans and investment securities are the principal sources of asset
liquidity. Securities maturing or callable within 1 year were $16,218,000 at
December 31, 1996 representing 28.7% of the amortized cost of the investment
securities portfolio, a decrease
6 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS (CONTINUED)
from the 38.8% level of 1995. Loans maturing within 1 year were $30,499,000 at
December 31, 1996 representing 20.0% of the loan portfolio, an increase from
the 15.3% level of 1995.
Interest rate sensitivity varies with different types of interest-earning
assets and interest-bearing liabilities. Overnight federal funds and mutual
funds on which rates change daily and loans which are tied to the prime rate or
a comparable index differ considerably from long-term investment securities and
fixed-rate loans. Similarly, certificates of deposit and money market
investment accounts are much more interest sensitive than passbook savings
accounts and long-term capital notes. The shorter term interest rate
sensitivities are key to measuring the interest sensitivity gap, or excess
interest-earning assets over interest-bearing liabilities.
The following table shows the interest sensitivity gaps for five different time
intervals as of December 31, 1996:
<TABLE>
<CAPTION>
0-30 31-90 91-365 1-5 Over 5
Days Days Days Years Years
----------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets $47,942 $( 8,462) $60,059 $78,660 $14,801
Interest-bearing liabilities 44,440 76,779 33,100 19,834 300
----------------------------------------------------
Interest sensitivity gap $ 3,502 $(68,317) $26,959 $58,826 $14,501
====================================================
</TABLE>
The primary interest sensitive assets in the one year repricing range are
commercial loans and adjustable rate mortgage loans. The primary interest
sensitive liabilities in the one year repricing range are money market
investment accounts, certificates of deposit and interest bearing checking
accounts. This analysis indicates that growth in rate sensitive liabilities has
outpaced the growth in rate sensitive assets in the one year range. This has
occurred primarily as a result of the inclusion of interest bearing checking
accounts and savings account balances in a repricing period of one year or less
as these accounts have become rate sensitive as interest rates have fluctuated.
The long-term interest sensitivity gap indicates that the Company's net
interest margin would improve with an increase in interest rates and decline
with further declines in interest rates. Trying to minimize the interest
sensitivity gap is a continual challenge in a changing rate environment and one
of the objectives of the Company's asset/liability strategy.
Federal law places restrictions on extensions of credit from banks to their
parent holding company and, with certain exceptions, to other affiliates, on
investments in stock or other securities thereof, and on the taking of such
securities as collateral for loans. Note K to the Consolidated Financial
Statements discusses these limitations between the Company and its banking
subsidiary.
During the year ended December 31, 1996, there was a net decrease in cash and
cash equivalents of $3,660,000. The major source of cash in 1996 was the
increase in deposits resulting from growth in the existing deposit base and the
acquisition of two branches. The major use of cash in 1996 was the increase in
loans.
During the year ended December 31, 1995, there was a net increase in cash and
cash equivalents of $2,751,000. The major source of cash in 1995 was the growth
in the existing deposit base. The major uses of cash in 1995 were the growth in
loans, the investment of funds in the investment securities portfolio and the
increase in federal funds sold.
During the year ended December 31, 1994, there was a net increase in cash and
cash equivalents of $6,049,000. The major source of cash in 1994 was the
increase in deposits resulting from growth in the existing deposit base and the
acquisition of a branch. The major use of cash in 1994 was the growth in loans.
RESULTS OF OPERATIONS
Net interest income is an effective measurement of how well management has
balanced the Company's interest rate sensitive assets and liabilities. Net
interest income increased by 14.3% in 1996, 17.6% in 1995 and 15.4% in 1994.
The increases in all three years are due to improvements in the net interest
margin. The 1996 net interest margin increased as a result of the reinvestment
of funds received from maturing investment securities into the higher yielding
loan portfolio, along with the stability of the Company's cost of funds. The
primary reason for the 1995 increase was the Company's ability to maintain or
decrease the interest rates paid on deposits, while loan interest rates
remained fairly steady. During 1994, loan interest rates increased while the
Company was able to raise deposit rates at a much slower pace, thus causing the
net interest margin to rise.
1996 Annual Report to Shareholders 7
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS (CONTINUED)
The uncertain economic environment and potential fluctuations in interest rates
are expected to continue to impact the Company and the industry in 1997.
Depending on these interest rate fluctuations, there may be market pressure to
raise deposit rates in 1997. The Company monitors deposit rates on a weekly
basis and adjusts deposit rates as the market dictates. An increase in deposit
rates without loan rate increases would cause the Company's net interest margin
to decline.
The provision for loan losses is based on an analysis of the required additions
to the allowance for loan losses. The allowance for loan losses is maintained
at a level believed adequate by management to absorb potential losses in the
loan portfolio. Some factors considered by management in determining the level
at which the allowance is maintained include specific credit reviews, past loan
loss experience, current economic conditions and trends, results of
examinations by regulatory agencies and the volume, growth and composition of
the loan portfolio.
Effective January 1, 1995, the Company adopted FASB Statement 114 as amended by
Statement 118. The Statement requires that impaired loans, as defined, be
reduced to the present value of expected cash flows discounted at the loan's
effective interest rate or to the fair value of collateral if the loan is
collateral dependent, by allocating a portion of the allowance for loan losses
to such loans. If these allocations cause the allowance for loan losses to
increase, such increase is included in the provision for loan losses. The
effect of adopting Statements 114 and 118 was included in the provision for
loan losses and was not material for 1995.
The provision for loan losses was $267,000 in 1996, $222,000 in 1995, $180,000
in 1994. The provisions in all three years were increased to provide for loan
growth. Net charge-offs were $62,000 in 1996, $110,000 in 1995 and $47,000 in
1994. The provision for loan losses will be increased in 1997 to provide for a
possible increase in losses as a result of the Bank's significant loan growth
and will be adjusted quarterly, if necessary, to reflect actual charge-off
experience and any known future losses.
Non-interest income, excluding security gains and losses, increased by 15.8% in
1996, 5.8% in 1995 and 3.7% in 1994. The increase in 1996 was due to an
increase in trust income, as a result of increased trust assets, increased
secondary market gains due to an increase in activity and the capitalization of
mortgage servicing rights, increased earnings on Bank owned life insurance
policies and increased rental income. These increases were partially offset by
a $61,000 unrealized loss on $1,200,000 in real estate mortgage loans
previously classified as held for sale and transferred to the Bank's loan
portfolio. This loss will be amortized through the maturity dates of the loans.
The increase in 1995 was due to an increase in trust income, as a result of
increased trust assets, $41,000 in gains on the sale of real estate mortgages
to the secondary market, and the receipt of life insurance proceeds. The
increase in 1994 was due to increases in service charges and trust income and
the receipt of life insurance proceeds in 1994, partially offset by $93,000 in
gains recognized on the sale of adjustable rate mortgage loans to a third party
in 1993. The increase in service charges was due to the overall increase in
deposits, particularly demand deposits which generate more service fees. The
increase in trust income is the result of an increase in trust assets and
several estate settlements in 1994.
Security gains of $10,000 and $17,000 were recognized in 1996 and 1995,
respectively. No gains were recognized in 1994.
Non-interest expense increased by 10.6% in 1996, 9.1% in 1995 and 3.4% in 1994.
The 1996 increase was due to increased salary and benefit costs associated with
an increase in the number of employees, increased occupancy and equipment costs
associated with the new retail loan centers and technology improvements made
throughout the Bank, increased training expenditures and increased marketing
and advertising expenditures to promote the new retail loan centers and the
branches acquired from First of America. These increases were partially offset
by a decline in legal fees and FDIC premiums.
The 1995 increase was due to increased salary and benefit costs associated with
an increase in the number of employees, increased legal fees, increased
marketing expenditures, increased postage costs and increased office supply
costs due to recent paper price increases. These increases were partially
offset by a refund received on the Company's FDIC insurance premium when the
rate was lowered to 4 cents per $100 of deposits from 23 cents per $100 in
deposits. The 1994 increase was primarily due to increased salary and benefit
costs, increased legal fees and nonrecurring costs associated with the
acquisition of the Athens branch. These increases were partially offset by
lower equipment maintenance costs, lower telephone service costs and lower
audit and examination costs.
Income tax expense was $1,150,000 in 1996, $835,000 in 1995 and $600,000 in
1994. Tax-exempt income continues to have a major impact on the Company's tax
expense. The benefit offsetting lower coupon rates on municipal instruments is
the nontaxable feature of the income earned on such instruments. This resulted
in a lower effective tax rate and reduced federal income tax expense by
approximately $227,000, $231,000 and $201,000, in 1996, 1995 and 1994,
respectively.
8 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS (CONTINUED)
Results of operations can be measured by various ratio analyses. Two widely
recognized performance indicators are the return on equity and the return on
assets. The Company's return on average equity was 16.09% in 1996, 14.64% in
1995 and 12.36% in 1994. The return on average assets was 1.45% in 1996, 1.31%
in 1995 and 1.11% in 1994.
The majority of assets and liabilities of a financial institution are monetary
in nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories.
However, inflation does have an important impact on the growth of total assets
in the banking industry and the resulting need to increase equity capital at
higher than normal rates in order to maintain an appropriate equity-to-assets
ratio. Another significant effect of inflation is on other expenses, which tend
to rise during periods of general inflation.
Management believes the most significant impact on financial results is the
Company's ability to react to changes in interest rates. As discussed
previously, management is attempting to maintain an essentially balanced
position between interest sensitive assets and liabilities in order to protect
against wide interest rate fluctuations.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, accruing loans past due 90 days
or more, and other real estate which includes foreclosures and deeds in lieu of
foreclosure.
A loan generally is classified as nonaccrual when full collectibility of
principal or interest is doubtful or a loan becomes 90 days past due as to
principal or interest, unless management determines that the estimated net
realizable value of the collateral is sufficient to cover the principal balance
and accrued interest. When interest accruals are discontinued, unpaid interest
credited to income in the current year is reversed, and unpaid interest accrued
in prior years is charged to the allowance for loan losses. Nonperforming loans
are returned to performing status when the loan is brought current and has
performed in accordance with contract terms for a period of time.
The following table sets forth the aggregate amount of nonperforming loans in
each of the following categories:
<TABLE>
<CAPTION>
December 31
1996 1995 1994
--------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual loans:
Commercial, financial and agricultural $448 $380 $ 142
Real estate mortgage 0 24 0
Installment 2 40 10
450 444 152
--------------------------
Loans contractually past due 90 days or more:
Commercial, financial and agricultural 82 353 6
Real estate mortgage 129 56 0
Installment 165 4 5
--------------------------
376 413 11
--------------------------
Total Nonperforming Loans $826 $857 $163
Other real estate owned 76 76 108
--------------------------
Total Nonperforming Assets $902 $ 933 $ 271
==========================
Nonperforming loans to year-end loans .54% .70% .14%
Nonperforming assets to year-end loans
and other real estate owned .59% .76% .23%
</TABLE>
The increase in nonperforming loans in 1996 and 1995 were to be expected with
the increase in loan volume. These loans are subject to continuous monitoring
by management and are specifically reserved for in the allowance for loan
losses where appropriate.
1996 Annual Report to Shareholders 9
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULT OF OPERATIONS (CONTINUED)
At December 31, 1996, the Company had approximately $2,767,000 in commercial,
financial and agricultural loans for which payments are presently current, but
the borrowers are experiencing certain financial and/or operational
difficulties. These loans are subject to frequent management review and their
classification is reviewed on a monthly basis.
In management's evaluation of the loan portfolio risks, any significant future
increases in nonperforming loans is dependent to a large extent on the economic
environment. In a deteriorating or uncertain economy, management applies more
conservative assumptions when assessing the future prospects of borrowers and
when estimating collateral values. This may result in a higher number of loans
being classified as nonperforming.
REGULATORY MATTERS
Representatives of the Financial Institutions Bureau, a division of the
Department of Commerce of the State of Michigan, completed an examination at
the Company's subsidiary bank using financial information as of December 31,
1996. The purpose of the examination was to determine the safety and soundness
of the bank.
Examination procedures require individual judgments about a borrower's ability
to repay loans, sufficiency of collateral values and the effects of changing
economic circumstances. These procedures are similar to those employed by the
Company in determining the adequacy of the allowance for loan losses and in
classifying loans. Judgments made by regulatory examiners may differ from those
made by management. The Company's level and classification of identified
potential problem loans was not revised significantly as a result of this
regulatory examination process.
Management and the Board of Directors evaluate existing practices and
procedures on an ongoing basis. In addition, regulators often make
recommendations during the course of their examination that relate to the
operations of the Company and the Bank. As a matter of practice, management and
the Board of Directors consider such recommendations promptly.
10 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 12
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL INFORMATION
Management of Southern Michigan Bancorp, Inc. has prepared and is responsible
for the accompanying financial statements and for their integrity and
objectivity. In the opinion of management, the financial statements, which
necessarily include amounts based on management's estimates and judgments, have
been prepared in conformity with generally accepted accounting principles on a
consistent basis. Management also prepared the other information in the Annual
Report and is responsible for its accuracy and consistency with the financial
statements.
The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that transactions
are executed in accordance with the Company's authorizations and policies.
Further, such a system provides reasonable assurances as to the integrity and
reliability of the financial statements which fairly present financial position
and results of operations in conformity with generally accepted accounting
principles. Internal accounting controls are augmented by written policies
covering standards of personal and business conduct and an organizational
structure providing for division of responsibility and authority.
Management monitors the effectiveness of and compliance with established
control systems through a continuous program of internal audit and credit
examinations and recommends possible improvements thereto. In addition, as part
of their audit of the Company's financial statements, Crowe, Chizek and Company
LLP, independent auditors, completed a study and evaluation of selected
internal accounting controls to establish a basis for reliance thereon in
determining the nature, timing, and extent of audit tests to be applied.
Management has considered the recommendations from the examination of controls
concerning the Company's system of internal controls and has taken actions that
we believe are cost-effective in the circumstances to respond appropriately to
these recommendations. Management believes that, as of December 31, 1996, the
Company's system of internal controls is adequate to accomplish the objectives
discussed herein. Further, management believes the system of controls has
prevented or detected on a timely basis any occurrences that could be material
to the financial statements and that timely corrective actions have been
initiated when appropriate.
The Board of Directors exercises its responsibility for the financial
statements and related information through the Audit Committee, which is
composed entirely of outside directors. The Audit Committee meets regularly
with management and Crowe, Chizek and Company LLP, to assess the scope of the
annual audit plan and to review the status and results of audits, including
major changes in accounting policies and reporting practices. Crowe, Chizek
and Company LLP has direct and confidential access to the Audit Committee at
all times to discuss the results of their audits.
/s/ JERRY L. TOWNS /s/ JAMES T. GROHALSKI
Jerry L. Towns James T. Grohalski
President and Executive Vice-President
Chief Executive Officer and Chief Financial Officer
1996 Annual Report to Shareholders 11
<PAGE> 13
[PHOTO]
COMMUNITY REINVESTMENT - MORTGAGES
Home buyers in our communities got an unprecedented boost in 1996 from Southern
Michigan Bank & Trust, as the bank greatly increased its commitment to
residential mortgage lending.
We have offered mortgages for many years. But, with the opening of The Loan
Center in Coldwater and The Mortgage Center in Battle Creek, our consumer
lending programs were greatly amplified. Not only did we create facilities that
make it much more convenient to apply for a loan, we staffed the offices with
trained mortgage specialists to increase customer service, and we developed new
products around customer needs.
As a result, Southern Michigan Bank & Trust has become a leader in mortgage
lending in a field that had been dominated by our competitors. This increase in
market share will give us many new opportunities to deepen relationships with
customers in 1997, increasing the value we are able to deliver to shareholders,
and strengthening our reinvestment in the communities we serve.
Our lending initiatives also have given us an unexpected benefit - community
appreciation! In late 1996, Southern Michigan Bank & Trust was honored by the
Branch County Association of Realtors as "Affiliate of the Year." In the photo
above, Mortgage Loan Specialists Diana Butler and Matt Dwyer accept the award
from Valerie Proctor, President, Branch County Association of Realtors.
12 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 14
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
1996 1995
-----------------------------------
<S> <C> <C>
ASSETS
Cash $ 3,319,256 $ 3,253,889
Due from banks 10,200,629 13,926,329
-----------------------------------
Cash and cash equivalents 13,519,885 17,180,218
Federal funds sold 4,500,000
Investment securities available-for-sale - Note B 24,098,821 31,343,270
Investment securities held to maturity
(fair value of $32,786,000 in 1996 and $24,529,000 in 1995) - Note B 32,500,052 24,009,586
Loans - Note C 152,678,249 123,236,727
Less allowance for loan losses - Note D (1,814,205) (1,609,422)
-----------------------------------
150,864,044 121,627,305
Premises and equipment - Note E 5,227,387 3,962,179
Other assets - Notes H and I 9,351,090 7,354,518
-----------------------------------
TOTAL ASSETS $235,561,279 $209,977,076
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits - Note F:
Non-interest bearing $ 35,013,894 $ 24,571,152
Interest bearing 174,453,530 160,952,963
-----------------------------------
Total deposits 209,467,424 185,524,115
Accounts payable and other liabilities 2,922,996 2,723,691
Capital note - Note G 1,000,000
-----------------------------------
TOTAL LIABILITIES 212,390,420 189,247,806
Common stock subject to repurchase obligation in ESOP - Note I 3,555,068 2,232,177
Shareholders' equity:
Common stock, $2.50 par value:
Authorized - 2,000,000 shares
Outstanding - 869,550 shares (1995 - 857,984) 2,173,875 2,144,960
Capital surplus 2,734,568 3,511,336
Retained earnings 14,686,712 12,629,739
Net unrealized appreciation on available-for-sale
securities, net of tax of $11,000 in 1996 and $117,000 in 1995 20,636 211,058
-----------------------------------
TOTAL SHAREHOLDERS' EQUITY 19,615,791 18,497,093
-----------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $235,561,279 $209,977,076
===================================
</TABLE>
See accompanying notes to consolidated financial statements.
1996 Annual Report to Shareholders 13
<PAGE> 15
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net Unrealized
Appreciation
(Depreciation)
On Available
Common Capital Retained For-Sale
Stock Surplus Earnings Securities TOTAL
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1994 $2,093,430 $3,878,200 $ 9,596,907 $ 45,350 $15,613,887
Net income for 1994 2,018,038 2,018,038
Cash dividends declared - $.75 per share (680,301) (680,301)
Common stock issued under dividend
reinvestment plan (12,504 shares) 31,260 219,356 250,616
Change in common stock subject to repurchase (1,535) (181,180) (182,715)
Net change in unrealized appreciation
(depreciation) on available-for-sale
securities, net of tax (164,283) (164,283)
--------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 2,123,155 3,916,376 10,934,644 (118,933) 16,855,242
Net income for 1995 2,614,953 2,614,953
Cash dividends declared - $.99 per share (919,858) (919,858)
Common stock issued under dividend
reinvestment plan (12,493 shares) 31,233 272,461 303,694
Change in common stock subject to repurchase (9,428) (677,501) (686,929)
Net change in unrealized appreciation
(depreciation) on available-for-sale
securities, net of tax 329,991 329,991
--------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 2,144,960 3,511,336 12,629,739 211,058 18,497,093
Net income for 1996 3,058,105 3,058,105
Cash dividends declared - $1.06 per share (1,001,132) (1,001,132)
Common stock issued under
dividend reinvestment plan (14,146 shares) 35,365 439,585 474,950
Change in common stock subject to repurchase (6,450) (1,216,353) (1,222,803)
Net change in unrealized appreciation (depreciation)
on available-for-sale securities, net of tax (190,422) (190,422)
--------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 $2,173,875 $2,734,568 $14,686,712 $ 20,636 $19,615,791
==========================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
14 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 16
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
---------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans including fees $13,716,918 $11,965,350 $10,157,799
Investment securities:
Taxable 2,442,528 2,634,262 1,869,130
Tax-exempt 775,517 741,747 625,492
---------------------------------------------------------
3,218,045 3,376,009 2,494,622
Other 68,956 135,324 27,886
---------------------------------------------------------
Total interest income 17,003,919 15,476,683 12,680,307
Interest expense:
Deposits 6,426,580 6,116,148 4,599,281
Capital notes 9,242 109,900 110,100
Other 168,377 154,288 233,402
---------------------------------------------------------
Total interest expense 6,604,199 6,380,336 4,942,783
---------------------------------------------------------
NET INTEREST INCOME 10,399,720 9,096,347 7,737,524
Provision for loan losses - Note D 267,000 222,000 180,000
---------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,132,720 8,874,347 7,557,524
Non-interest income:
Service charge on deposit accounts 727,193 731,813 738,401
Trust fees 544,961 479,242 440,865
Securities gains - Note B 10,194 17,425
Gain (loss) on sale of loans 235,810 41,149 (1,591)
Earnings on life insurance policies 203,258 141,911 135,373
Other 203,082 259,188 249,488
---------------------------------------------------------
1,924,498 1,670,728 1,562,536
---------------------------------------------------------
12,057,218 10,545,075 9,120,060
Non-interest expenses:
Salaries and employee benefits - Note I 4,047,457 3,552,382 3,298,120
Occupancy 604,941 512,060 517,943
Equipment 712,078 484,960 472,889
Deposit insurance premium 2,000 193,067 355,208
Legal fees 91,200 185,947 169,724
Other 2,391,437 2,166,706 1,688,138
---------------------------------------------------------
7,849,113 7,095,122 6,502,022
---------------------------------------------------------
Income before income taxes 4,208,105 3,449,953 2,618,038
Federal income taxes - Note H 1,150,000 835,000 600,000
---------------------------------------------------------
NET INCOME $ 3,058,105 $ 2,614,953 $ 2,018,038
=========================================================
NET INCOME PER SHARE $ 3.24 $ 2.82 $ 2.21
=========================================================
</TABLE>
See accompanying notes to consolidated financial statements.
1996 Annual Report to Shareholders 15
<PAGE> 17
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
----------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,058,105 $ 2,614,953 $ 2,018,038
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 267,000 222,000 180,000
Provision for depreciation 410,053 275,109 313,137
Amortization of investment security premiums
and accretion of discounts 165,385 220,150 484,417
Amortization of deposit base intangible and goodwill 49,703 38,898 6,483
Deferred income taxes (31,000) (118,711) (127,532)
Loans originated for sale (11,073,129) (4,807,406) (354,989)
Proceeds on loans sold 11,162,105 4,848,555 353,398
Realized (gain) loss on sale of loans originated for sale (235,810) (41,149) 1,591
Unrealized loss on loans held for sale 61,261
Realized investment security gains (10,194) (17,425)
Unrealized investment security loss 20,000
(Increase) decrease in interest receivable 18,338 (489,402) (58,059)
Increase in interest payable 66,236 53,693 27,458
Increase in other assets
(1,780,806) (674,362) (537,512)
Increase in accounts payable and other liabilities 146,066 278,552 489,551
----------------------------------------------------------
Net cash provided by operating activities 2,273,313 2,403,455 2,815,981
INVESTING ACTIVITIES
Proceeds from maturities of investment securities available-for-sale 15,652,481 19,218,190 13,370,308
Proceeds from maturities of investment securities held to maturity 6,718,853 23,451,626 10,975,174
Proceeds from sales of investment securities 508,554 517,425
Purchases of investment securities available-for-sale (9,735,816) (25,969,808) (9,764,506)
Purchases of investment securities held to maturity
(14,841,578) (20,986,498) (16,206,929)
Net (increase) decrease in federal funds sold 4,500,000 (3,000,000) (1,500,000)
Net increase in loans prior to charge-offs (29,564,999) (3,008,495) (7,871,035)
Net purchases of premises and equipment (1,675,261) (949,954) (570,877)
----------------------------------------------------------
Net cash used in investing activities (28,437,766) (10,727,514) (11,567,865)
FINANCING ACTIVITIES
Acquisition of deposits 18,635,521 9,724,438
Net increase in deposits 5,307,788 11,452,721 5,390,854
Payment of capital note (1,000,000)
Common stock issued 575,038 384,878 344,807
Cash dividends (1,014,227) (762,527) (658,890)
----------------------------------------------------------
Net cash provided by financing activities 22,504,120 11,075,072 14,801,209
----------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,660,333) 2,751,013 6,049,325
Cash and cash equivalents at beginning of year 17,180,218 14,429,205 8,379,880
----------------------------------------------------------
CASH AND CASH EQUIVALENTS AT THE END OF YEAR $ 13,519,885 $ 17,180,218 $ 14,429,205
==========================================================
</TABLE>
See accompanying notes to consolidated financial statements.
16 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Southern Michigan Bancorp, Inc. (the Company) and its wholly owned
subsidiary, Southern Michigan Bank & Trust (the Bank), after elimination of
significant intercompany balances and transactions. The Company and the Bank
provide banking services within the counties of Branch, Hillsdale and Calhoun
in Southwestern Michigan.
USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS: The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that effect
the reported amounts of assets, liabilities and disclosure of contingent
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Estimates that are more susceptible to change in the near
term include the allowance for loan losses and deferred income tax provisions.
INVESTMENT SECURITIES (including mortgage-backed securities): Management
determines the appropriate classification of securities at the time of
purchase. If management has the intent and the Company has the ability at the
time of purchase to hold securities until maturity, they are classified as held
to maturity and carried at amortized historical cost. Securities to be held for
indefinite periods of time and not intended to be held to maturity are
classified as available-for-sale and carried at fair value. Securities
classified as available-for-sale include securities that management intends to
use as part of its asset/liability management strategy and that may be sold in
response to changes in interest rates, resultant prepayment risk, and other
factors. The Company is not currently involved in trading activities.
Premiums and discounts on securities are recognized in interest income using
the level yield method over the estimated life of the security. Gains and
losses on the sale of available-for-sale securities are determined using the
specific identification method.
LOANS: Interest on loans is credited to income based upon principal amount
outstanding. The accrual of interest income generally is discontinued when a
loan becomes over 90 days past due as to principal or interest. When interest
accruals are discontinued, interest credited to income in the current year is
reversed, and accrued interest from the prior year is charged to the allowance
for loan losses. Management may elect to continue the accrual of interest when
the estimated net realized value of collateral is sufficient to cover the
principal balance and accrued interest. Under Financial Accounting Standards
Board (FASB) Statement 114, as amended by Statement 118, the carrying values of
impaired loans are periodically adjusted to reflect cash payments, revised
estimates of future cash flows and increases in the present value of expected
cash flows due to the passage of time. Cash payments representing interest
income are reported as such. Other cash payments are reported as reductions in
carrying value, while increases or decreases due to changes in estimates of
future payments and due to the passage of time are included in the provision
for loan losses.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
level believed adequate to absorb potential losses in the portfolio. Management
determines the adequacy of the allowance for loan losses based on a continuing
evaluation of the loan portfolio, past loan loss experience, current economic
conditions, composition of the loan portfolio and other relevant factors. The
allowance is increased by provisions charged against income.
Effective January 1, 1995, the Company adopted FASB Statement 114 as amended by
Statement 118. The Statement requires that impaired loans, as defined, be
reduced to the present value of expected cash flows discounted at the loan's
effective interest rate or to the fair value of collateral if the loan is
collateral dependent, by allocating a portion of the allowance for loan losses
to such loans. If these allocations cause the allowance for loan losses to
increase, such increase is included in the provision for loan losses. The
effect of adopting Statements 114 and 118 is included in the provision for loan
losses and is not material for 1995.
Real estate mortgage and installment loans are smaller balance homogeneous
loans and are collectively evaluated for impairment. Commercial loans are
evaluated individually for impairment. When credit analysis of borrower
operating results and financial condition indicates the underlying ability of
the borrower's business activity is not sufficient to generate cash flow to
service the business' cash needs, including the Bank's loans to the borrower,
the loan is evaluated for impairment. This may be a delay or shortfall in
payments of 90 days or less. Loans to be
1996 Annual Report to Shareholders 17
<PAGE> 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
evaluated for impairment are included on the Bank's commercial loans watch list
and assigned a liquidation probability. Loans with a liquidation probability of
greater than 50% are generally considered impaired. The expected unrecoverable
portion of impaired loans are charged-off when foreclosure proceedings are
underway and the actual loss can be determined. Loans are generally moved to
nonaccrual status when 90 days or more past due. These loans may not be
impaired. Management has also set minimum loan balance thresholds before
consideration of a loan for impaired status will occur.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
accumulated depreciation. Depreciation is computed principally using
accelerated methods over their estimated useful lives.
LOAN SERVICING RIGHTS: The Company originates mortgage loans for sale to the
secondary market, and sells the loans with servicing retained. Effective
January 1, 1996, the Company adopted FASB Statement 122 on accounting for
mortgage servicing rights. For servicing retained, this Statement requires
capitalizing the cost of mortgage servicing rights, regardless of whether those
rights were acquired through purchase or origination activities. Prior to
adoption of Statement 122, only purchased loan servicing rights were
capitalized, and the Company had no such activity.
Beginning in 1996, the total cost of mortgage loans originated with the intent
to sell is allocated between the loan servicing right and the mortgage loan
without servicing based on their relative fair values at the date of sale. The
capitalized cost of loan servicing rights is amortized in proportion to, and
over the period of, estimated net servicing revenue. For this purpose,
estimated servicing revenues include late charges and other ancillary income.
Estimated servicing costs include direct costs associated with performing the
servicing function and appropriate allocations of other costs. Mortgage
servicing rights are included in other assets.
Mortgage servicing rights are periodically evaluated for impairment by
stratifying them based on predominant risk characteristics of the underlying
serviced loans. These risk characteristics include loan type (fixed or
adjustable rate), term (15 year or 30 year), and note rate. Impairment
represents the excess of cost of an individual mortgage servicing rights
stratum over its fair value, and is recognized through a valuation allowance.
Fair values for individual stratum are based on the present value of estimated
future cash flows using a discount rate commensurate with the risks involved.
Estimates of fair value include assumptions about prepayment, default and
interest rates, and other factors which are subject to change over time.
Changes in these underlying assumptions could cause the fair value of loan
servicing rights, and the related valuation allowance, to change significantly
in the future.
GOODWILL AND CORE DEPOSIT INTANGIBLES: Goodwill is the excess of purchase price
over identified net assets in business acquisitions. Goodwill is amortized on
the straight-line method over 15 years. Core deposit intangibles represent the
value of depositor relationships purchased and is amortized on accelerated
methods over 10 years. Goodwill was $932,000 and $0 and core deposit
intangibles were $664,000 and $149,000 at December 31, 1996 and 1995,
respectively and these balances are included in other assets.
OTHER REAL ESTATE: Other real estate ($76,000 at December 31, 1996 and 1995),
which is included in other assets, comprises properties acquired through a
foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These
properties are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management and real estate is carried at the lower of fair value
minus estimated cost of disposal or cost.
INCOME TAXES: Deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
NET INCOME PER SHARE: Net income per share is based on the weighted average
number of shares outstanding (943,162 in 1996 and 926,991 in 1995). The
weighted average shares and all per share amounts have been adjusted for a 2
for 1 stock split issued in 1995 and includes the common stock subject to
repurchase obligation in ESOP.
CASH FLOW INFORMATION: For purposes of the consolidated statements of cash
flows, the Company considers cash and due from banks as cash and cash
equivalents.
18 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS: Certain amounts in prior years' financial statements have
been reclassified to conform with the 1996 presentation.
PENDING ACCOUNTING CHANGES: The FASB has issued Statement 125, Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities. The Statement
is effective for some transactions in 1997 and others in 1998. It revises the
accounting for transfers of financial assets, such as loans and securities, and
for distinguishing between sales and secured borrowings. The effect on the
financial statements has not yet been determined.
NOTE B - INVESTMENT SECURITIES
Year end investment securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE, 1996 COST GAINS LOSSES VALUE
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury and other U.S.
Government agencies $15,304,858 $64,872 $49,985 $15,319,745
States and political
subdivisions thereof 2,578,948 12,856 5,755 2,586,049
Corporate securities 4,143,992 21,823 4,165,815
Mortgage-backed securities 1,958,890 12,544 1,946,346
---------------------------------------------------------------------------------
Total debt securities 23,986,688 99,551 68,284 24,017,955
Equity securities 80,866 80,866
---------------------------------------------------------------------------------
TOTAL $24,067,554 $99,551 $68,284 $24,098,821
=================================================================================
Available-for-sale, 1995
U.S. Treasury and other U.S.
Government agencies $24,585,728 $275,261 $14,107 $ 24,846,882
States and political
subdivisions thereof 985,000 1,132 986,132
Corporate securities 2,387,171 65,376 2,452,547
---------------------------------------------------------------------------------
Total debt securities 27,957,899 341,769 14,107 28,285,561
Equity securities 3,057,709 3,057,709
---------------------------------------------------------------------------------
TOTAL $31,015,608 $341,769 $14,107 $ 31,343,270
=================================================================================
HELD TO MATURITY, 1996
States and political
subdivisions thereof $16,449,368 $316,307 $9,054 $ 16,756,621
Corporate securities 15,422,317 41,782 63,674 15,400,425
Mortgage-backed securities 6,467 1,078 7,545
---------------------------------------------------------------------------------
Total debt securities 31,878,152 359,167 72,728 32,164,591
Equity securities 621,900 621,900
---------------------------------------------------------------------------------
TOTAL $32,500,052 $359,167 $72,728 $32,786,491
=================================================================================
Held to maturity, 1995
States and political
subdivisions thereof $13,548,332 $405,583 $5,798 $13,948,117
Corporate securities 9,857,195 117,391 2,710 9,971,876
Mortgage-backed securities 23,959 71 24,030
---------------------------------------------------------------------------------
Total debt securities 23,429,486 523,045 8,508 23,944,023
Equity securities 580,100 4,584 584,684
---------------------------------------------------------------------------------
TOTAL $24,009,586 $527,629 $8,508 $24,528,707
=================================================================================
</TABLE>
1996 Annual Report to Shareholders 19
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - INVESTMENT SECURITIES (CONTINUED)
Sales of available-for-sale securities were:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------------------------
<S> <C> <C> <C>
Proceeds $509,000 $517,000 $ 0
Gross gains 10,000 17,000 0
Gross losses 0 0 0
</TABLE>
Contractual maturities of debt securities at year-end 1996 were as follows.
Securities not due at a single maturity date, primarily mortgage-backed
securities, are shown separately. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
HELD-TO-MATURITY SECURITIES AVAILABLE-FOR-SALE SECURITIES
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 3,101,413 $ 3,115,107 $ 9,596,965 $ 19,661,874
Due from one to five years 22,629,950 22,779,683 9,915,052 9,909,338
Due from five to ten years 5,805,322 5,912,823 2,253,889 2,241,254
Due after ten years 335,000 349,433 261,892 259,143
Mortgage-backed securities 6,467 7,545 1,958,890 1,946,346
---------------------------------------------------------------------------------
$31,878,152 $32,164,591 $23,986,688 $ 24,017,955
=================================================================================
</TABLE>
Investment securities with an amortized cost of $2,675,000 and $2,780,000 were
pledged as collateral for public deposits and for other purposes in 1996 and
1995. During 1995, investment securities with an amortized cost of $13,516,000,
a fair value of $13,604,000, unrealized gains of $102,000 and unrealized losses
of $14,000 were reclassified from held-to-maturity to available-for-sale, based
on new interpretations issued for FASB Statement No. 115.
NOTE C - LOANS
A summary of the carrying amount of loans outstanding at December 31 follows:
<TABLE>
<CAPTION>
1996 1995
-----------------------------------
<S> <C> <C>
Commercial, financial and agricultural $ 72,108,263 $ 51,939,675
Real estate mortgage 47,560,430 41,293,102
Installments 33,009,556 30,003,950
-----------------------------------
TOTALS $152,678,249 $123,236,727
===================================
</TABLE>
Certain directors and executive officers of the Company and the Bank, including
their associates and companies in which they are principal owners, were loan
customers of the Bank. Loans to these customers are made in the ordinary course
of business at normal credit terms, including interest rates and collateral,
and generally do not involve more than normal risk of collectibility. The
following is a summary of loans exceeding $60,000 in the aggregate to these
individuals and their associates.
<TABLE>
<S> <C>
Balance at January 1, 1996 $1,874,000
New loans 4,545,000
Repayments 3,820,000
----------
Balance at December 31, 1996 $2,599,000
==========
</TABLE>
20 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - LOANS (CONTINUED)
The unpaid principal balance of mortgage loans serviced for others, which are
not included on the consolidated balance sheet, was $16,836,000 at December 31,
1996. The balance of loans serviced for others related to servicing rights that
have been capitalized was $11,073,000. The remaining balance of loans serviced
for others also have servicing rights associated with them; however, these
servicing rights arose prior to the adoption of FASB Statement 122, and
accordingly, have not been capitalized on the balance sheet.
Activity in 1996 for capitalized mortgage servicing rights was as follows:
<TABLE>
<S> <C>
Beginning of year $ 0
Additions 152,000
Amortized to expense (10,000)
-----------
END OF YEAR $ 142,000
===========
</TABLE>
No valuation allowance was necessary at December 31, 1996.
NOTE D - ALLOWANCES FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31 were
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $1,609,422 $1,497,742 $1,364,452
Provision for loan losses 267,000 222,000 180,000
Loans charged off (169,793) (210,709) (161,969)
Recoveries 107,576 100,389 115,259
----------------------------------------------------
Net charge-offs (62,217) (110,320) (46,710)
----------------------------------------------------
Balance at December 31 $1,814,205 $1,609,422 $1,497,742
====================================================
</TABLE>
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Information regarding impaired loans follows:
Average investment in impaired loans during the year $218,000 $249,000
Interest income recognized on impaired loans on a cash basis
during the year 9,200 4,900
Total impaired loans at year end $209,000 $176,000
Less loans for which no allowance for loan losses is allocated 12,000 17,000
-------- --------
Impaired loans for which an allowance for loan losses is allocated $197,000 $159,000
======== ========
Portion of allowance allocated to these loans $233,000 $ 90,000
======== ========
</TABLE>
1996 Annual Report to Shareholders 21
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E - PREMISES AND EQUIPMENT
Major classes of premises and equipment at December 31 follow:
<TABLE>
<CAPTION>
1996 1995
-------------------------------------
<S> <C> <C>
Land $ 540,452 $ 499,100
Buildings and improvements 6,031,854 5,035,783
Equipment 2,179,413 1,693,101
-------------------------------------
8,751,719 7,227,984
Less accumulated depreciation 3,524,332 3,265,805
-------------------------------------
TOTALS $5,227,387 $3,962,179
=====================================
</TABLE>
NOTE F - Deposits
The carrying amount of domestic deposits at December 31 follows:
<TABLE>
<CAPTION>
1996 1995
-------------------------------------
<S> <C> <C>
Non-interest bearing checking $ 35,013,894 $ 24,571,152
Interest bearing checking 28,614,752 31,406,984
Passbook savings 28,916,838 23,362,565
Money market accounts 34,128,531 31,373,767
Time deposits 66,550,816 58,284,421
Individual retirement accounts and other deposits 16,242,593 16,525,226
-------------------------------------
TOTALS $209,467,424 $185,524,115
=====================================
</TABLE>
The carrying amount of time deposits over $100,000 was $17,438,000 and
$14,733,000 at December 31, 1996 and 1995, respectively. Interest expense on
time deposits over $100,000 was $837,000, $956,000, and $567,000 at December 31,
1996, 1995 and 1994, respectively.
At December 31, 1996, scheduled maturities of time deposits were as follows:
<TABLE>
<S> <C>
1997 $54,153,355
1998 7,013,504
1999 4,225,331
2000 634,307
2001 224,314
Thereafter 300,005
-----------
$66,550,816
===========
</TABLE>
The amount of deposits accepted from certain officers and directors was
$1,527,000 and $1,498,000 at December 31, 1996 and 1995, respectively.
NOTE G - CAPITAL NOTE
The capital note is an obligation of the Bank and is subordinated to the claims
of depositors and certain other creditors. The note bears interest at 11% and
matured January 30, 1996.
Interest paid on the capital note, deposits and other borrowings was $6,538,000
in 1996, $6,327,000 in 1995 and $4,915,000 in 1994.
NOTE H - INCOME TAXES
The components of federal income taxes for the years ended December 31 were as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------------------
<S> <C> <C> <C>
Currently payable $1,181,000 $953,000 $728,000
Deferred credit (31,000) (118,000) (128,000)
-------------------------------------------------------------
$1,150,000 $835,000 $600,000
=============================================================
</TABLE>
A reconciliation of federal income taxes with amounts computed by applying the
statutory federal income tax rate is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------------------
<S> <C> <C> <C>
Statutory tax on pretax income, including tax on security
gains ($3,000 in 1996 and $6,000 in 1995) $1,431,000 $1,173,000 $890,000
Effect of tax-exempt interest income (227,000) (231,000) (201,000)
Effect of life insurance policy cash surrender value increase (75,000) (60,000) (63,000)
Other items-net 21,000 (47,000) (26,000)
-------------------------------------------------------------
$1,150,000 $835,000 $600,000
=============================================================
</TABLE>
22 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H - INCOME TAXES (CONTINUED)
The components of deferred tax assets and liabilities are comprised of the
following at December 31:
<TABLE>
<CAPTION>
1996 1995
---------------------------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $389,000 $ 319,000
Deferred compensation liability 392,000 365,000
Pension liability 91,000 86,000
Other 120,000 149,000
---------------------------------
992,000 919,000
Deferred tax liabilities:
Net unrealized appreciation on available-for-sale securities 11,000 117,000
Mortgage servicing rights 48,000
Other 10,000 16,000
---------------------------------
69,000 133,000
---------------------------------
Net deferred tax asset $923,000 $ 786,000
=================================
</TABLE>
The Company made income tax payments of $1,245,000 in 1996, $910,000 in 1995
and $613,000 in 1994. An allowance against the deferred tax asset was not
considered necessary at December 31, 1996, 1995, or 1994.
NOTE I - RETIREMENT PLANS
The Bank has a noncontributory defined benefit pension plan covering
substantially all full-time employees. The benefits are based on years of
service and the employee's average highest compensation during five consecutive
years of employment. The funding policy is to contribute annually an amount
sufficient to meet the minimum funding requirements set forth in the Employee
Retirement Income Security Act of 1974, plus additional amounts as the Bank may
determine to be appropriate from time to time. Assets of the plan are held in
trust by the Bank. Contributions are intended to provide not only for benefits
attributed to service to date but also for those expected to be earned in the
future.
The following table sets forth the plan's funded status and amounts recognized
in the Company's balance sheets at December 31:
<TABLE>
<CAPTION>
1996 1995
------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligation:
Accumulated benefit obligation, including vested benefits
of $1,070,000 in 1996 and $901,000 in 1995. $ 1,101,000 $ 921,000
Projected benefit obligation for service rendered to date (1,853,000) (1,598,000)
Plan assets at fair value, primarily certificates of deposit and equity securities 1,574,000 1,296,000
------------------------------------
Projected benefit obligation in excess of plan assets (279,000) (302,000)
Unrecognized net (gain) loss (71,000) (56,000)
Unrecognized transition obligation 25,000 29,000
Unrecognized prior service cost 73,000 85,000
------------------------------------
Accrued pension cost included in other liabilities $ (252,000) $ (244,000)
====================================
</TABLE>
Net pension cost included the following components:
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned during the period $139,000 $125,000 $129,000
Interest cost on projected benefit obligation 112,000 97,000 101,000
Actual return on plan assets (195,000) (256,000) (58,000)
Net amortization and deferral 98,000 183,000 (11,000)
-----------------------------------------------------------
Net periodic pension cost $154,000 $149,000 $161,000
===========================================================
</TABLE>
The weighted-average discount rate and rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation were 7% for each of the periods and 5% in 1996 and 1995 and 4 1/2%
in 1994. The expected long term rate of return on plan assets was 8%.
1996 Annual Report to Shareholders 23
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - RETIREMENT PLANS (CONTINUED)
The Company has an employee stock ownership plan (ESOP) for substantially all
full-time employees. The Board of Directors determines the Company's
contribution level annually. Assets of the plan are held in trust by the Bank
and administrative costs of the plan are borne by the plan sponsor. Costs
charged to operations for contributions to the plan totaled $71,000 in 1996,
$61,000 in 1995 and $59,000 in 1994.
As of December 31, 1996 and 1995, the ESOP held 80,797 and 75,667 shares of the
Company's stock all of which is allocated to employees. The fair value of the
shares held by the ESOP approximated $3,555,000 and $2,232,000 at December 31,
1996 and 1995, respectively. Upon distribution of shares to a participant, the
participant has the right to require the Company to purchase shares at their
fair value in accordance with terms and conditions of the plan. As such these
shares are not classified in shareholders' equity as permanent equity.
As an incentive to retain key members of management and directors, the Bank has
a deferred compensation plan whereby participants defer a portion of current
compensation. Benefits are based on salary and length of service and are vested
as service is provided from the date of participation through age 65. A
liability is recorded on a present value basis and discounted at current
interest rates. This liability may change depending upon changes in long-term
interest rates. Deferred compensation expense was $176,000 in 1996, $195,000 in
1995 and $221,000 in 1994. The liability for vested benefits was $1,154,000 at
December 31, 1996 and $1,073,000 at December 31, 1995. The Bank holds life
insurance contracts on the plan's participants. The cash surrender value of
these policies was $3,458,000 at December 31, 1996 and $3,266,000 at December
31, 1995 and is included in other assets in the accompanying consolidated
financial statements.
NOTE J - COMMITMENTS
There are various commitments which arise in the normal course of business,
such as commitments under commercial letters of credit, standby letters of
credit and commitments to extend credit. Generally accepted accounting
principles recognize these transactions as contingent liabilities and
accordingly, they are not reflected in the accompanying financial statements.
These arrangements have credit risk essentially the same as that involved in
extending loans to customers and are subject to the Bank's normal credit
policies. Collateral generally consists of receivables, inventory and equipment
and is obtained based on management's credit assessment of the customer.
At December 31, 1996, the Bank had commitments under commercial letters of
credit, used to facilitate customers' trade transactions, of $808,000 (1995 -
$238,000).
Under standby letter of credit agreements, the Bank agrees to honor certain
commitments in the event that its customers are unable to do so. At December
31, 1996 commitments under outstanding standby letters of credit were $203,000
(1995 - $244,000).
Loan commitments outstanding to extend credit at December 31 are detailed
below:
<TABLE>
<CAPTION>
1996 1995
---------------------------------
<S> <C> <C>
Fixed rate $ 1,892,000 $ 1,481,000
Variable rate 24,537,000 17,298,000
---------------------------------
$26,429,000 $18,779,000
=================================
</TABLE>
The fixed rate commitments have stated interest rates ranging from 6.9% to
18.0%. The terms of the above commitments range from 1 to 60 months.
Management does not anticipate any losses as a result of the above related
transactions; however, the above amount represents the maximum exposure to
credit loss for loan commitments and commercial and standby letters of credit.
NOTE K - RESTRICTIONS ON TRANSFERS FROM SUBSIDIARY
Banking laws and regulations restrict the amount the Bank may transfer to the
Company in the form of cash dividends, loans and advances. In 1997, the Bank is
permitted to pay the Company approximately $3,306,000 in addition to 1997 net
income as dividends without prior regulatory approval. Substantially all of the
remaining net assets of the Bank are restricted from transfer to the Company
under Federal Reserve regulations.
24 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION
Condensed financial statements of Southern Michigan Bancorp, Inc. follow:
Balance Sheets
<TABLE>
<CAPTION>
December 31
1996 1995
------------------------------------
<S> <C> <C>
ASSETS
Cash $ 20,447 $ 25,040
Investment securities available-for-sale 2,571,050 1,082,001
Investment securities held-to-maturity 785,116
Investment in subsidiary 19,373,083 17,702,618
Premises and equipment 1,164,186 1,076,976
Other 365,211 393,633
------------------------------------
TOTAL ASSETS $23,493,977 $21,065,384
====================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 323,118 $ 336,114
Common stock subject to repurchase obligation in ESOP 3,555,068 2,232,177
Shareholders' equity 19,615,791 18,497,093
------------------------------------
TOTAL LIABILITY AND SHAREHOLDERS' EQUITY $23,493,977 $21,065,384
====================================
</TABLE>
Statements of Income
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
------------------------------------------------
<S> <C> <C> <C>
Dividends from Bank $1,001,231 $ 919,757 $ 680,301
Interest income 113,428 93,930 57,228
Other income 205,017 104,172 90,277
Other expenses (31,438) (39,554) (51,051)
------------------------------------------------
1,288,238 1,078,305 776,755
Federal income tax expense (98,000) (54,000) (33,000)
------------------------------------------------
1,190,238 1,024,305 743,755
Equity in undistributed net income of subsidiary 1,867,867 1,590,648 1,274,283
------------------------------------------------
NET INCOME $3,058,105 $2,614,953 $2,018,038
================================================
</TABLE>
Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,058,105 $ 2,614,953 $ 2,018,038
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of subsidiary (1,867,867) (1,590,648) (1,274,283)
Amortization of investment security premiums and
accretion of discounts 13,725 3,984 (19,637)
Unrealized investment security loss 20,000
Provision for depreciation 28,660 26,438 22,486
Other 34,442 (125,178) 18,721
-------------------------------------------------
Net cash provided by operating activities 1,267,065 929,549 785,325
</TABLE>
1996 Annual Report to Shareholders 25
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY)
FINANCIAL INFORMATION (CONTINUED)
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
Year ended December 31
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
INVESTING ACTIVITIES
Proceeds from maturities of investment securities available-for-sale $ 2,613,869 $ 2,442,659 $4,213,546
Proceeds from maturities of investment securities held to maturity 780,000 513,439 866,008
Purchases of investment securities available-for-sale (4,110,468) (2,223,763) (5,175,314)
Purchases of investment securities held to maturity (1,298,555)
Purchases of premises and equipment (115,870) (21,679) (320,410)
-------------------------------------------------
Net cash used in investing activities (832,469) (587,899) (416,170)
FINANCING ACTIVITIES
Cash dividends (1,014,227) (762,527) (658,890)
Common stock issued 575,038 384,878 344,807
-------------------------------------------------
Net cash used in financing activities (439,189) (377,649) (314,083)
-------------------------------------------------
INCREASE (DECREASE) IN CASH (4,593) (35,999) 55,072
Cash at beginning of year 25,040 61,039 5,967
-------------------------------------------------
CASH AT END OF YEAR $ 20,447 $ 25,040 $ 61,039
=================================================
</TABLE>
26 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - FAIR VALUE INFORMATION
FASB Statement 107. "Disclosures about Fair Value of Financial Instruments,
" requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. 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. Statement 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value
of the Company and represent point-in-time estimates of value that might not
be particularly relevant in predicting the Company's future earnings or cash
flows.
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance
sheet for cash and due from banks approximate those assets' fair values.
INVESTMENT SECURITIES (INCLUDING MORTGAGE-BACKED SECURITIES): Fair
values for investment securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based
on quoted market prices of comparable instruments. The fair value of
restricted equity securities approximates amortized cost.
LOANS: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying
values. The fair values for other loans are estimated using discounted
cash flows analyses, using interest rates currently being offered for loans
with similar terms to borrowers of similar credit quality.
OFF-BALANCE-SHEET INSTRUMENTS: Fair values for the Bank's letters of
credit 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. It is not practicable to estimate the fair
value of lending commitments because of the wide variety of the instruments.
DEPOSIT LIABILITIES: The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, passbook savings, and certain
types of money market accounts) are, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying amounts).
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 expected monthly maturities on time
deposits.
CAPITAL NOTES: The fair value of the Bank's capital note is estimated
using discounted cash flows analysis based on the Bank's current incremental
borrowing rate for similar types of borrowing arrangements.
The estimated fair values of the Company's financial instruments at December 31
are as follows:
<TABLE>
<CAPTION>
1996 1995
------------------------------- -------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 13,519,885 $ 13,519,885 $ 17,180,218 $ 17,180,218
Investment securities available-for-sale 24,098,821 24,098,821 31,343,270 31,343,270
Investment securities held to maturity 32,500,052 32,786,491 24,009,568 24,528,707
Loans 152,678,249 152,631,506 123,236,727 122,884,129
</TABLE>
1996 Annual Report to Shareholders 27
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - FAIR VALUE INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
1996 1995
---------------------------------- -----------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
---------------------------------- -----------------------------------
<S> <C> <C> <C> <C>
Financial liabilities:
Deposits $(209,467,424) $(209,817,246) $(185,524,115) $(184,302,539)
Capital notes (1,000,000) (1,000,000)
Unrecognized financial instruments:
Commercial letters of credit $(16,000) $(5,000)
Standby letters of credit (4,000) (5,000)
</TABLE>
NOTE N - REGULATORY MATTERS
The Company and Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and
prompt corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain cases.
Failure to meet various capital requirements can initiate regulatory action
that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, under-capitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
The minimum requirements are:
<TABLE>
<CAPTION>
Capital to risk-
weighted assets
------------------------- Tier 1 capital
Total Tier 1 to average assets
------------------------- -----------------
<S> <C> <C> <C>
Well capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
</TABLE>
At year end, actual capital levels (in thousands) and minimum required levels
were:
<TABLE>
<CAPTION>
Minimum Required
To Be
Minimum Required Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
------------------ ------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------ ------------------- ------------------------
<S> <C> <C> <C> <C> <C> <C>
1996
Total capital (to risk weighted assets)
Consolidated $22,731 12.9% $14,067 8.0% $17,584 10.0%
Bank 18,921 10.9% 13,909 8.0 17,386 10.0
Tier 1 capital (to risk weighted assets)
Consolidated $20,917 11.9% $ 7,034 4.0% $10,550 6.0%
Bank 17,107 9.8% 6,954 4.0 10,431 6.0
Tier 1 capital (to average assets)
Consolidated $20,917 9.9% $ 8,423 4.0% $10,529 5.0%
Bank $17,107 8.2% 8,304 4.0 10,379 5.0
</TABLE>
The Company and Bank at year-end 1996 were categorized as well capitalized.
28 Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 30
REPORT OF INDEPENDENT AUDITORS
[Crowe Chizek Logo]
Shareholders and Board of Directors
Southern Michigan Bancorp, Inc.
Coldwater, Michigan
We have audited the accompanying consolidated balance sheets of Southern
Michigan Bancorp, Inc. as of December 31, 1996 and 1995 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 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 financial position of Southern Michigan
Bancorp, Inc. as of December 31, l996 and 1995 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
As discussed in Note A to the financial statements, the Company changed its
method of accounting for impaired loans in 1995 to conform to new accounting
guidance.
CROWE, CHIZEK AND COMPANY LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
January 31, 1997
1996 Annual Report to Shareholders 29
<PAGE> 31
[BACK COVER]
51 W. Pearl St.
Coldwater, MI 49036
(517) 279-5500
<PAGE> 1
EXHIBIT (21)
SUBSIDIARY OF REGISTRANT
STATE OR COUNTY OF
NAME OF SUBSIDIARY INCORPORATION
- ------------------ ------------------
Southern Michigan Bank & Trust Michigan
Southern Michigan Bancorp, Inc. is the immediate parent and owns 100% of the
outstanding shares of Southern Michgan Bank & Trust.
<PAGE> 1
EXHIBIT (23)
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement of
Southern Michigan Bancorp, Inc. on Form S-3 (Registration No. 33-24977), of our
report dated January 31, 1997 on the 1996 consolidated financial statements of
Southern Michigan Bancorp, Inc., which report is included in the 1996 Annual
Report on Form 10-K of Southern Michigan Bancorp, Inc.
Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME FILED AS PART OF
THE ANNUAL REPORT ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH ANNUAL REPORT ON FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 13,520
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 24,089
<INVESTMENTS-CARRYING> 32,510
<INVESTMENTS-MARKET> 32,796
<LOANS> 152,678
<ALLOWANCE> 1,814
<TOTAL-ASSETS> 235,562
<DEPOSITS> 209,468
<SHORT-TERM> 0
<LIABILITIES-OTHER> 6,478
<LONG-TERM> 0
0
0
<COMMON> 2,174
<OTHER-SE> 17,442
<TOTAL-LIABILITIES-AND-EQUITY> 235,562
<INTEREST-LOAN> 13,716
<INTEREST-INVEST> 3,218
<INTEREST-OTHER> 69
<INTEREST-TOTAL> 17,003
<INTEREST-DEPOSIT> 6,426
<INTEREST-EXPENSE> 6,603
<INTEREST-INCOME-NET> 10,400
<LOAN-LOSSES> 267
<SECURITIES-GAINS> 10
<EXPENSE-OTHER> 7,646
<INCOME-PRETAX> 4,208
<INCOME-PRE-EXTRAORDINARY> 4,208
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,058
<EPS-PRIMARY> 3.24
<EPS-DILUTED> 3.24
<YIELD-ACTUAL> 5.7
<LOANS-NON> 450
<LOANS-PAST> 376
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,767
<ALLOWANCE-OPEN> 1,609
<CHARGE-OFFS> 170
<RECOVERIES> 108
<ALLOWANCE-CLOSE> 1,814
<ALLOWANCE-DOMESTIC> 623
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,191
</TABLE>
