<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, 1998 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 disclosures 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-affliliates
of the registrant as of March 1, 1999 was $63,142,000.
The number of shares outstanding of the Registrant's common stock as of March 1,
1999 was 1,857,130 shares (including common stock subject to repurchase
obligation).
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended December 31,
1998, are incorporated by reference into Part II 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 security custodial
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, investment
banks and securities brokerage firms.
2
<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/Reigle-Neal 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 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 were primarily conducted
unless the acquisition was specifically authorized by statute of the state of
the bank whose shares were 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 that are adequately
capitalized and managed whether or not such acquisition is prohibited by law of
the host state.
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, may elect to "opt-in" or "opt-out" of the provision. The State of Michigan
has "opted-in" to 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
3
<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 consists of dividends paid by the Bank
on its Common Stock (all of which is owned by the Company). Michigan law
restricts the Bank's ability to pay these dividends. Under the Michigan Banking
Code of 1969, as amended, no dividend may be declared by the Bank in an amount
greater than net profits then on hand after deducting losses and bad debts.
After payment of a dividend, the Bank must have a Surplus amounting to not less
than 20% of its capital. In addition, if the surplus of the Bank is less than
the amount of its capital, 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 earnings 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, 1998, the amount of
dividends the Bank could pay to the Company without prior regulatory approval
was $1,410,000.
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").
These regulations and restrictions may limit the Company's ability to obtain
funds from its subsidiary for its cash needs, including funds for acquisitions,
payments of dividends and interest and the payment of operating expenses.
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, and other affiliates on investments in the Company's and its
affiliates' securities, on acceptance of such securities as collateral for loans
to any borrowers 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 interest 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.
4
<PAGE> 5
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.
Pursuant to the Deposit Insurance Funds Act, enacted by Congress in September
1996, 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 significant changes in the deposit insurance
assessment rate or FICO bond servicing 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 ("Total Capital") of 8.0 percent.
At least half of Total Capital must be composed of common shareholder's equity,
qualifying perpetual preferred stock and minority interest in equity accounts of
consolidated subsidiaries, less goodwill and certain other intangible assets
("Tier I Capital"). At December 31, 1998, the Company's Total Capital to
risk-weighted assets was 13.7 percent, which is above the regulatory minimum
requirements.
In addition 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 bank holding companies having the highest regulatory rating. All
other bank holding companies are required to maintain a minimum 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
leverage ratio at December 31, 1998 was 9.4 percent.
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, 1998, 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.
5
<PAGE> 6
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 requirement 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, 1998, 139 persons were employed by the Bank; 118 were full
time employees and 21 were part time employees.
6
<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)
------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------
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) $160,666. $15,816. 9.8% $158,193. $15,593. 9.9% $137,273. $13,523. 9.9%
Taxable investment securities (D) 32,449. 2,305. 7.1 33,538. 2,189. 6.5 36,372. 2,443. 6.7
Tax-exempt investment securities (A) 22,342. 1,657. 7.4 16,864. 1,253. 7.4 14,732. 1,144. 7.8
Federal funds sold 4,782. 266. 5.6 1,357. 74. 5.5 1,309. 69. 5.3
-------- ------- -------- ------- -------- -------
Total interest earning assets 220,239. 20,044. 9.1 209,952. 19,109. 9.1 189,686. 17,179. 9.1
Non-interest earnings assets:
Cash and due from banks 15,591. 10,442. 10,572.
Other Assets 16,415. 14,871. 12,106.
Less allowance for loan loss (1,955.) (1,866.) (1,784.)
-------- -------- --------
Total assets $250,290. $233,399. $210,580.
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits 74,154. $ 2,440. 3.3 $63,856$ 2,163. 3.4 $62,657. $ 1,956. 3.1
Savings deposits 44,356. 1,509. 3.4 43,505. 1,485. 3.4 37,971. 1,293. 3.4
Time Deposits 68,177. 3,673. 5.4 67,993. 3,612. 5.3 60,466. 3,178. 5.3
Federal funds purchased 784. 42. 5.4 592. 33. 5.6
Subordinated notes 82. 9. 11.0
Other borrowings 6,146. 410. 6.7 1,404. 141. 10.0 1,105. 135. 12.2
------- ----- ------- ----- ------- ------
Total interest bearing liabilities 192,833. 8,032. 4.2 177,542. 7,443. 4.2 162,873. 6,604. 4.1
</TABLE>
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<PAGE> 8
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY- CONTINUED
<TABLE>
<CAPTION>
Year Ended December 31 (Dollars in thousands)
---------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY-
continued
Non-interest bearing liabilities:
Demand Deposits $ 30,570. $ 30,004. $ 24,557.
Other 1,124. 1,355. 1,248.
Common Stock subject to repurchase
obligation 5,464. 4,227. 2,894.
Shareholders' equity 20,299. 20,271. 19,008.
-------- -------- --------
Total liabilities and shareholders' $250,290. $233,399. $210,580.
equity ======== ======== ========
Net interest earnings $ 12,012. $ 11,666. $ 10,575.
======== ======== ========
Net yield on interest earning assets 5.5% 5.6% 5.6%
=== === ===
</TABLE>
(A) Includes tax equivalent adjustment of interest (assuming a 34% tax rate)
for securities and loans of $563,000 and $35,000, respectively for 1998;
$392,000 and $48,000 respectively for 1997 and $369,000 and $23,000,
respectively, for 1996.
(B) Average balance includes average nonaccrual loan balances of $815,000
in 1998; $500,000 in 1997; and $443,000 in 1996.
(C) Interest income includes loan fees of $563,000 in 1998; $617,000 in
1997; and $668,000 in 1996.
(D) Average balance includes average unrealized gain (loss) of $128,000 in
1998; ($13,000) in 1997; and $31,000 in 1996 on available for sale
securities. The yield was calculated without regard to this average
unrealized gain (loss).
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<PAGE> 9
The following table sets forth 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:
<TABLE>
<CAPTION>
1998 COMPARED TO 1997 1997 COMPARED TO 1996
(Dollars in thousands) Increase (Decrease) Due To Increase (Decrease) Due To
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income on: Volume Rate Net Volume Rate Net
<S> <C> <C> <C> <C> <C> <C>
Loans $ 243 (20) $ 223 $ 2,062 8 $ 2,070
Taxable investment securities (73) 189 116 (186) (68) (254)
Tax-exempt investment securities 406 (2) 404 160 (51) 109
Federal funds sold 190 2 192 3 2 5
------- ------- ------- ------- ------- -------
Total interest earning assets $ 766 $ 169 $ 935 $ 2,039 $ (109) $ 1,930
======= ======= ======= ======= ======= =======
Interest expense on:
Demand deposits $ 340 $ (63) $ 277 $ 38 $ 169 $ 207
Savings deposits 29 (5) 24 189 3 192
Time deposits 10 51 61 400 34 434
Federal funds purchased (42) 0 (42) 10 (1) 9
Subordinated notes (9) 0 (9)
Other borrowings 331 (62) 269 33 (27) 6
------- ------- ------- ------- ------- -------
Total interest bearing liabilities $ 668 $ (79) $ 589 $ 661 $ 178 $ 839
======= ======= ======= ======= ======= =======
Net Interest Income $ 98 $ 248 $ 346 $ 1,378 $ (287) $ 1,091
======= ======= ======= ======= ======= =======
</TABLE>
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<PAGE> 10
INVESTMENT PORTFOLIO
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.
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997 1996
---------------------------------------------------------------------------------
FAIR CARRYING FAIR CARRYING FAIR CARRYING
(Dollars in thousands) VALUE VALUE VALUE VALUE VALUE VALUE
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
US Treasury and other US
Government agencies
and corporations $ 9,087 $ 9,087 $ 6,262 $ 6,262 $15,320 $15,320
States and political
subdivisions 37,903 37,006 20,885 20,560 19,342 19,035
Corporate securities 15,942 15,902 15,590 15,564 19,566 19,588
Other securities 5,899 5,899 2,688 2,688 2,657 2,656
------- -------- ------- -------- ------- -------
Total investment
securities $68,831 $ 67,894 $45,425 $ 45,074 $56,885 $56,599
======= ======== ======= ======== ======= =======
</TABLE>
The following table sets forth the carrying value of the maturities (or
anticipated call date, if earlier) and weighted average yield for each range of
maturities at December 31, 1998.
<TABLE>
<CAPTION>
MATURING
- ----------------------------------------------------------------------------------------------------------------
(Dollars in WITHIN 1 YEAR 1 TO 5 YEARS 5 TO 10 YEARS AFTER 10 YEARS
thousands)
- ----------------------------------------------------------------------------------------------------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
US Treasury and other US
Government agencies and
corporations $ 2,687 4.46% $ 6,400 5.22%
- ----------------------------------------------------------------------------------------------------------------
States and political
subdivisions 12,002 4.91 15,239 5.32 $ 7,152 4.74% $ 2,613 5.30%
- ----------------------------------------------------------------------------------------------------------------
Corporate securities 12,110 6.37 3,792 6.23
- ----------------------------------------------------------------------------------------------------------------
Other securities 2,487 4.76 2,133 5.96 1,279 6.87
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
Total $29,286 5.46% $27,564 5.47% $ 7,152 4.74% $ 3,892 5.82%
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
The weighted average interest yields were computed by multiplying the
carrying value of each security by its interest yield to give an annual
dollar yield per security, adding the dollar yields per category an
dividing the sum by the total carrying value of securities of that
category. Interest yields given above are not on a tax equivalent
basis.
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<PAGE> 11
LOAN PORTFOLIO
Type of Loans
The following table sets forth the classification of loans by major
category:
<TABLE>
<CAPTION>
DECEMBER 31
(Dollars in thousands) 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial, financial, and
agricultural $ 82,533 $ 74,819 $ 72,108 $ 51,940 $ 49,514
Real estate mortgage 51,567 50,057 47,561 41,293 43,054
Installment 29,203 33,865 33,009 30,004 27,771
-------- -------- -------- -------- --------
Total Loans $163,303 $158,741 $152,678 $123,237 $120,339
======== ======== ======== ======== ========
</TABLE>
Maturities
The following table sets forth the maturities of the loan portfolio at
December 31, 1998. 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 Years Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial, financial, and
agricultural $ 32,005 $ 25,401 $ 25,127 $ 82,533
- ------------------------------------------------------------------------------------------------------------
Real estate mortgages 3,703 5,426 42,438 51,567
- ------------------------------------------------------------------------------------------------------------
Installment 2,255 20,221 6,727 29,203
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total $ 37,963 $ 51,048 $ 74,292 $163,303
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Loans maturing after one
year with:
- ------------------------------------------------------------------------------------------------------------
Fixed interest rates 36,899 11,582
- ------------------------------------------------------------------------------------------------------------
Variable interest rates 14,149 62,710
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Total $ 51,048 $ 74,292
- ------------------------------------------------------------------------------------------------------------
</TABLE>
(A) Amounts include demand loans, loans having no stated schedule of
repayments, or no stated maturity and overdrafts.
11
<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) 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Nonaccrual Loans:
Commercial, financial, and
agricultural $ 343 $ 1,026 $ 448 $ 380 $ 142
Real estate mortgage 0 0 0 24 0
Installment 0 61 2 40 10
-----------------------------------------------------------------
343 1,087 450 444 152
Loans contractually past due
90 days or more:
Commercial, financial, and
agricultural 807 1,067 82 353 6
Real estate mortgage 161 630 129 56 0
Installment 120 966 165 4 5
-----------------------------------------------------------------
1,088 2,663 376 413 11
-----------------------------------------------------------------
Total $ 1,431 $3,750 $ 826 $ 857 $ 163
======= ====== ====== ======= =======
Percent of total loans
outstanding .88% 2.36% .54% .70% .14%
======= ====== ====== ======= =======
</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 $19,000 and $73,000 was realized on nonaccrual loans during
1998 and 1997, respectively. Under original terms for these loans,
interest income which would have been recorded approximates $91,000 and
$137,000 in 1998 and 1997, respectively. There are no loan commitments
outstanding to extend credit to these customers.
12
<PAGE> 13
Potential Problem Loans
At December 31, 1998, the Company had approximately $3,931,000 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) 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 1,863 $ 1,814 $ 1,609 $ 1,498 $ 1,365
- -----------------------------------------------------------------------------------------------------
Charge offs:
- -----------------------------------------------------------------------------------------------------
Commercial, financial, and
agricultural 227 122 13 87 69
- -----------------------------------------------------------------------------------------------------
Installment 352 386 157 124 93
Real estate 0 0 0 0 0
- -----------------------------------------------------------------------------------------------------
579 508 170 211 162
- -----------------------------------------------------------------------------------------------------
Recoveries:
- -----------------------------------------------------------------------------------------------------
Commercial, financial, and
agricultural 41 31 43 43 30
- -----------------------------------------------------------------------------------------------------
Installment 101 66 62 54 82
- -----------------------------------------------------------------------------------------------------
Real estate 0 3 3 3
- -----------------------------------------------------------------------------------------------------
142 97 108 100 115
- -----------------------------------------------------------------------------------------------------
Net charge offs (437) (411) (62) (111) (47)
- -----------------------------------------------------------------------------------------------------
Provision for loan losses 600 460 267 222 180
- -----------------------------------------------------------------------------------------------------
Balance at end of year $ 2,026 $ 1,863 $ 1,814 $ 1,609 $ 1,498
=====================================================================================================
Average loans outstanding $160,666 $158,193 $137,273 $123,684 $119,637
=====================================================================================================
Ratio of net charge offs to average
loans outstanding .27% .26% .05% .09% .04%
=====================================================================================================
</TABLE>
13
<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 profits.
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.
The 1996 and 1995 provisions increased from 1994 levels to provide for loan
growth. The 1997 provision was increased to provide for loan growth and the
increase in charge-offs and delinquencies. Several customers, including a large
commercial borrower, declared bankruptcy during 1997 resulting in increased
charge-offs. The 1998 provision increased to provide for increased charge-offs
and delinquencies, primarily as a result of increased customer bankruptcies.
14
<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 probable
problems in collection, results of examination by regulatory agencies and
current economic conditions. The entire allowance is available to absorb any
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
1998 1997 1996
-----------------------------------------------------------------
Percent of Percent of Percent of
Loans Loans Loans
in each in each in each
category of category of category of
(Dollars in thousands) Allowance Total Loans Allowance Total Loans Allowance Total Loans Allowance
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------
Commercial, financial, and
agricultural $ 777 50.5% $ 628 47.1% $ 351 47.2% $ 313
- -------------------------------------------------------------------------------------------------------------------
Real estate mortgage 103 31.6 98 31.0 95 31.2 83
- -------------------------------------------------------------------------------------------------------------------
Installment 521 17.9 321 21.9 177 21.6 157
- -------------------------------------------------------------------------------------------------------------------
Unallocated 625 816 1,191 1,056
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
$ 2,026 100.0% 1,863 100.0% $ 1,814 100.0% $ 1,609
===================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31
1995 1994
------------------------------------------
Percent of Percent of
Loans Loans
in each in each
category of category of
(Dollars in thousands) Total Loans Allowance Total Loans
------------------------------------------
<S> <C> <C> <C>
Commercial, financial, and
agricultural 42.1% $ 369 41.1%
- --------------------------------------------------------------------
Real estate mortgage 33.5 86 35.8
- --------------------------------------------------------------------
Installment 24.4 147 23.1
- --------------------------------------------------------------------
Unallocated 896
- --------------------------------------------------------------------
- --------------------------------------------------------------------
100.0% $1,498 100.00%
- --------------------------------------------------------------------
</TABLE>
15
<PAGE> 16
DEPOSITS
The following table sets forth the average amount of deposits and rates paid for
deposits:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
----------------------------------------------------------------------
(Dollars in thousands) AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non interest bearing demand
deposits $ 30,570 $ 30,004 $ 24,557
- ------------------------------------------------------------------------------------------------------
Interest bearing demand
deposits 74,154 3.3% 63,856 3.4% 62,657 3.1%
- ------------------------------------------------------------------------------------------------------
Saving deposits 44,356 3.4 43,505 3.4 37,971 3.4
- ------------------------------------------------------------------------------------------------------
Time deposits 68,177 5.4 67,993 5.3 60,466 5.3
- ------------------------------------------------------------------------------------------------------
$ 217,257 $ 205,358 $ 185,651
======================================================================
</TABLE>
The following table sets forth as of December 31, 1998, the aggregate amount of
outstanding deposits (certificates of deposits) of $100,000 or more by maturity
(in thousands of dollars):
<TABLE>
<CAPTION>
<S> <C>
Three months or less $ 5,983.
Over three months through six months 5,184.
Over six months through twelve months 3,645.
Over twelve months 6,246.
---------
$ 21,058.
</TABLE>
RETURN ON EQUITY AND ASSETS
The following table sets forth consolidated operating and capital ratios:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
- ----------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Return on average assets 1.42% 1.30% 1.45%
- ----------------------------------------------------------------------------------------
Return on average equity 17.48 14.96 16.09
- ----------------------------------------------------------------------------------------
Dividend payout ratio 35.56 36.58 32.73
- ----------------------------------------------------------------------------------------
Average equity to average assets ratio 8.11 8.69 9.03
- ----------------------------------------------------------------------------------------
</TABLE>
Average equity used in the above table excludes common stock subject to
repurchase obligation.
16
<PAGE> 17
ITEM 2. PROPERTIES
The Bank's main office is located at 51 West Pearl Street, Coldwater, Michigan
and is owned by the Bank. 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 1,700 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
office, 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
17
<PAGE> 18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY
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, 1998 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, 1998 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 11 of the Annual Report to Shareholders for the
year ended December 31, 1998 is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
"Quantitative and Qualitative Disclosures About Market Risk" on pages 11 and 12
of the Annual Report to Shareholders for the year ended December 31, 1998 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, 1998 are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
None
18
<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, 1999 principal occupations and year in which each was elected.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S) YEAR FIRST BECAME
NAME OF DIRECTOR (1) AGE FOR PAST 5 YEARS (2) DIRECTOR OF REGISTRANT
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jerry L. Towns (3) 64 Chairman of Southern Michigan 1982
Bancorp, Inc. (Chairman of
Southern Michigan Bank & Trust)
President and Chief Executive
Financial Officer of Southern
James T. Grohalski (3) 58 Michigan Bancorp, Inc. 1982
(President and Chief Executive
Officer of Southern Michigan
Bank & Trust
James P. Briskey 65 Owner-Briskey Elevator (grain 1982
elevator operator)
H. Kenneth Cole 50 Treasurer - Hillsdale College 1998
Co-owner and Chief Executive
William E. Galliers 56 Officer-G & W Display Fixtures, 1993
Inc.
Nolan E. Hooker 47 Owner-Hooker Oil Co. (distributor 1991
of heating oil)
Gregory J. Hull 50 Farmer 1995
Thomas E. Kolassa 51 Owner-The Planning Group 1995
(insurance)
James J. Morrison 50 Owner-Morrison & Associates 1991
(insurance)
Jane L. Randall 77 Owner-Dally Tire Co. (tire 1982
distributor)
Freeman E. Riddle 66 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) served as President and
Chief Executive Officer and Executive Vice-President and
Chief Financial Officer, respectively, from the organization
of the Registrant in 1982 until Mr. Towns' retirement on
December 31, 1998.
19
<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, 1998 to the Company's Chief
Executive Officer and the only other executive officer whose combined salary and
bonus exceeded $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) (1) COMPENSATION ($)(2)
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jerry L. Towns
Chairman of the Registrant and 1998 $151,844 $5,878
Chairman of the Bank 1997 $146,059 $5,978
1996 $149,201 $5,978
James T. Grohalski
President and Chief 1998 $133,813 $7,400
Executive Officer of the 1997 $135,225 $7,202
Registrant and President and 1996 $123,968 $7,191
Chief Executive Officer
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 1998: (i) employer
contributions to accounts in the ESOP and the Deferred
Compensation Plan of $2,500 and $3,000, respectively for Mr.
Towns; and $3,994 and $3,000 respectively for Mr. Grohalski;
(ii) $378 and $406 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 Retirement 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 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:
20
<PAGE> 21
PENSION PLAN TABLE
<TABLE>
<CAPTION>
YEARS OF SERVICE
- ----------------------------------------------------------------------------------------------------------------------------------
REMUNERATION 25 30 35
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Jerry L. Towns has 27 years of credited service and $139,000 current covered
remuneration. James T. Grohalski has 32 years of credited service and $125,000
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 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 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 $6,108, which will be indexed for inflation in
1999. In addition, outside directors are compensated $150 for each Committee
meeting attended and participate in a bonus program based upon the achievement
of growth and profitability goals. The 1998 bonus paid to each outside director
was $1,595.
21
<PAGE> 22
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 28, 1999, 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>
- --------------------------------------------------------------------------------------------------------------------
NAME & ADDRESS OF AMOUNT & NATURE OF PERCENT
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP(1) OF CLASS
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common Stock Southern Michigan Bank & Trust
51 West Pearl Street 323,463 (a) 17.42
Coldwater, Michigan 49036
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Common Stock Southern Michigan Bank & Trust
Employee Stock Ownership Plan 133,609 (b) 7.19
51 West Pearl Street
Coldwater, Michigan 49036
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------
Common Stock Harvey B. Randall
8391 Old U.S. 27 South 132,839 (c) 7.15
Marshall, Michigan 49068
- --------------------------------------------------------------------------------------------------------------------
</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. Shares have been rounded to the nearest
whole share.
(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.
22
<PAGE> 23
The following table sets forth, as of February 28, 1999, 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
NUMBER OF PERSONS IN AMOUNT AND NATURE OF PERCENT OF
GROUP BENEFICIAL OWNERSHIP (1) TOTAL CLASS
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
James P. Briskey 9,680 19,360 1.04
9,680(a)
H. Kenneth Cole 150 150 (2)
William E. Galliers 1,517(a) 1,517 (2)
James T. Grohalski 19,667(b) 19,667 1.06
Nolan E. Hooker 750(a) 750 (2)
Gregory J. Hull 789(a) 789 (2)
Thomas E. Kolassa 1,356 1,356 (2)
James J. Morrison 2,272(a) 2,272 (2)
Jane L. Randall 5,129 5,129 (2)
Freeman E. Riddle 4,120 6,344 (2)
2,224(a)
Jerry L. Towns 212(a) 11,930 (2)
11,718(c)
All directors and executive officers
as a group (11 persons) 69,264 69,264 3.72
</TABLE>
23
<PAGE> 24
(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. Shares have
been rounded to the nearest whole share.
(a) Shared voting and investment power
(b) Includes 16,662 shares held by the
Bank's Employee Stock Ownership Plan
as to which Mr. Grohalski has voting power.
(c) Includes 11,718 shares held by the
Bank's Employee Stock Ownership Plan
as to which Mr. Towns has voting power.
(2) Less than one percent (1%).
24
<PAGE> 25
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Directors and Officers of the Registrant and their associates were customers of,
and had transactions with the Bank in the ordinary course of business during
1998. All loans and commitments included in such transactions were made in the
ordinary course of business on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features.
25
<PAGE> 26
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) 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, 1998 are incorporated by reference
in Item 8:
- Report of Crowe, Chizek and Company LLP, independent auditors
- Consolidated balance sheets - December 31, 1998 and 1997
- Consolidated statements of shareholders' equity - Years ended
December 31, 1998, 1997 and 1996
- Consolidated statements of income - Years ended December 31,
1998, 1997 and 1996
- Consolidated statements of cash flows - Years ended December 31,
1998, 1997 and 1996
- Notes to consolidated financial statements - December 31, 1998
(a)(2) 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.
(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 Registrant's Annual
Report on Form 10-K for the year
ended December 31, 1991 (file number
2-78178).
Amended and Restated By-Laws are
incorporated by reference to Exhibit
3 to the Registrant's Annual Report
on Form 10-K for the year ended
December 31, 1997 (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
Registrant's 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 1998 Annual Report to
Shareholders.
With the exception of the
information incorporated by
reference included in Items 5, 6, 7,
7A and 8 and 13, the 1998 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.
26
<PAGE> 27
Exhibit 23 - Consent of Independent Auditors.
Exhibit 24 - Not applicable.
Exhibit 27 - Financial Data Schedule.
(b) No reports on Form 8-K were filed in the last Quarter
of the period 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.
27
<PAGE> 28
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 29, 1999 By: JAMES T GROHALSKI
----------------------------------
James T. Grohalski
President and
Chief Executive Officer
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 P. BRISKEY THOMAS E KOLASSA
- -------------------------------- ----------------------------------
James P. Briskey - Director Thomas E. Kolassa - Director
H. KENNETH COLE JAMES J MORRISON
- -------------------------------- ----------------------------------
H. Kenneth Cole - Director James J. Morrison - Director
WILLIAM E GALLIERS JANE L RANDALL
- -------------------------------- ----------------------------------
William E. Galliers - Director Jane L. Randall - Director
JAMES T. GROHALSKI FREEMAN E RIDDLE
- -------------------------------- ----------------------------------
James T. Grohalski - Freeman E. Riddle - Director
President, Chief Executive Officer
and Director
(Principal Financial & Accounting Officer)
NOLAN E HOOKER JERRY L TOWNS
- -------------------------------- ----------------------------------
Nolan E. Hooker - Director Jerry L. Towns - President
Chairman & Director
GREGORY J HULL MARCH 29, 1999
- -------------------------------- ----------------------------------
Gregory J. Hull - Director Date
28
<PAGE> 29
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
Exhibit 3 - Articles of Incorporation and By-Laws incorporated by
reference to Exhibit 3 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1991 (file number
2-78178).
Amended and Restated By-Laws are incorporated by reference
to Exhibit 3 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997 (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 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
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1994 (file number 2-78178).
Exhibit 13 - Registrant's 1998 Annual Report to Shareholders.
With the exception of the information incorporated by
reference included in Items 5,6,7,7A and 8, the 1998
Annual Report to Shareholders is furnished for the
Commission's information only and is not deemed filed as
part of this report.
Exhibit 21 - Subsidiary of Registrant.
Exhibit 23 - Consent of Independent Auditors.
Exhibit 27 - Financial Data Schedule.
<PAGE> 1
EXHIBIT 13
1998
-
ANNUAL
-
REPORT
[PHOTOS]
SOUTHERN
-
MICHIGAN
-
BANCORP, INC.
<PAGE> 2
RETIREMENTS
Southern Michigan Bank & Trust had two long-time employees retire in 1998. Jerry
L. Towns, chairman and CEO, retired 26 years with SMB&T, and Jane Gillette
retired after 20 years in the data processing department at SMB&T.
[Jerry Towns photo]
Jerry Towns, whose banking career began in 1958 in Toledo, Ohio and featured a
stop in Chicago before he became a fixture in Coldwater beginning in 1972,
announced his intention to retire from day-to-day banking, effective Dec. 31.
Jerry joined Southern Michigan Bank & Trust as a vice president in the
commercial lending department in 1972. He subsequently served six years as
executive vice president before becoming president in 1979. For the past 15
years he has been chairman & CEO of Southern Michigan Bancorp. After his
retirement, Jerry will continue to serve as the holding company's board
chairman.
A native of nearby Hillsdale and a 1948 graduate of Hillsdale College, Jerry
served two years in the U.S. Marine Corp. He is a 1964 graduate of the Graduate
School of Banking at the University of Wisconsin.
Active in banking trade association matters for much of his career, Jerry holds
the distinction of being the only banker to serve two terms (1987-89) as
president of the Michigan Association of Community Bankers. He also served as
state director to the IBAA, was active in the Ohio Bankers Association and has
held committee assignments with the ABA. Beginning in 1982, he moved through
the chairs of elected office in the MACB, concluding with the two terms as that
association's president. On two separate occasions, Jerry served as a member of
the MBA's executive and legislative committees in Lansing.
He has been active in community organizations such as the Rotary, the Coldwater
Industrial Growth Corp., the local Chamber of Commerce, the Branch County
Economic Growth Alliance and the Branch County Community Foundation. Many of
these responsibilities have been passed along to others. He remains on the
board of the Kellogg Community College Foundation of Battle Creek.
Jerry, an avid golfer, plans to play golf "at least four times per week" now
that he is retired. He will spend winters in Florida and the remainder of the
year here in Coldwater.
[Jane Gillette photo]
Jane Gillette, a dedicated employee for 20 years, also retired on December 31,
1998. In her 20 years, Jane missed only one day of work due to illness. She was
always helpful, cheerful and able to get to the bottom of a problem and solve
it. One word describes Jane, "stic-to-it-tiveness."
Jane went to college to study data processing, a field she worked in all of her
working years.
Married to Carl for 42 years this May, Jane has 3 sons, one daughter and 12
grandchildren. During her retirement she intends to pursue her hobby of
gardening, enjoy her grandchildren and her mother with whom she was recently
reunited.
Southern Michigan Bank & Trust will miss both Jerry and Jane tremendously and
wish them both all the best for many happy retirement years.
<PAGE> 3
TABLE OF CONTENTS
SELECTED FINANCIAL DATA 2
FIVE YEAR FINANCIAL PERFORMANCE 3
LETTER TO SHAREHOLDERS 4
MANAGEMENT'S REPORT 5
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL INFORMATION 12
CONSOLIDATED BALANCE SHEETS 13
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY 14
CONSOLIDATED STATEMENTS OF INCOME 15
CONSOLIDATED STATEMENTS OF CASH FLOWS 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17
REPORT OF INDEPENDENT AUDITORS 29
BOARD OF DIRECTORS AND STRATEGIC MANAGEMENT TEAM 30
OFFICERS 31
EMPLOYEES 32
FACTS ABOUT SOUTHERN MICHIGAN BANCORP, INC. STOCK
Registrar and Transfer Company acts as transfer agent for the Company's stock.
For information concerning the transfer of the Company's stock, call Ms. Pamela
Green, Corporate Relations, at (800) 456-0596, extension 2510.
The Coldwater, Michigan office of Hilliard Lyons "makes the market" for the
Company's stock. For more information call (517) 278-4333 or (800) 211-5257.
Southern Michigan Bancorp, Inc. provides an automatic dividend reinvestment plan
that allows shareholders to increase their holdings without brokerage fees. For
more information call Mr. Nick Giancaspro of Registrar and Transfer Company at
(800) 456-0596, extension 2526.
ANNUAL MEETING
The Annual Meeting of Southern Michigan Bancorp, Inc. will be held on April 19,
1999 at 4:00 p.m. at Southern Michigan Bank & Trust, 51 W. Pearl Street,
Coldwater, Michigan.
10-K INFORMATION
To order Form 10-K, the Annual Report for 1998 to the Securities and Exchange
Commission, address request to Southern Michigan Bancorp, Inc., 51 West Pearl
Street, Coldwater, Michigan 49036, Attention: Secretary.
1
<PAGE> 4
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996 1995 1994
---------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Total interest income $ 19,446 $ 18,669 $ 16,787 $ 15,476 $ 12,680
Net interest income 11,414 11,226 10,183 9,096 7,738
Provision for loan losses 600 460 267 222 180
Net income 3,549 3,032 3,058 2,615 2,018
Per share data:
Basic and diluted earnings per share 1.87 1.59 1.62 1.41 1.11
Cash dividends .67 .58 .53 .50 .38
Balance sheet data:
Long-term borrowings 5,000 3,000 0 0 0
Capital note 0 0 0 1,000 1,000
Common stock subject to repurchase 6,029 4,899 3,555 2,232 1,464
Equity 19,933 20,590 19,616 18,497 16,855
Total assets 266,851 238,531 235,562 209,977 195,625
Return on average assets 1.42% 1.30% 1.45% 1.31% 1.11%
Return on average equity 17.48% 14.96% 16.09% 14.64% 12.36%
</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, 1998.
High and low market prices and dividends for the last two years were:
<TABLE>
<CAPTION>
1998 1997
-------------------------------- ---------------------------------
MARKET PRICE CASH Market Price Cash
------------- DIVIDENDS -------------------- Dividends
HIGH BID LOW BID DECLARED High Bid Low Bid Declared
Quarter Ended
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
March 31 $42.00 $34.00 $ .15 $23.50 $21.50 $ .12
June 30 51.25 41.25 .15 24.63 22.50 .13
September 30 45.00 41.25 .16 28.00 24.13 .13
December 31 42.00 32.75 .21 34.00 28.00 .20
</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,
1998.
All per share amounts have been adjusted for a 1997 stock split effected in the
form of a 100% stock dividend, and a 2 for 1 stock split in 1995.
2
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 5
FIVE YEAR FINANCIAL PERFORMANCE
Net income and dividends per share
[LINE GRAPH]
[PLOT POINTS TO COME]
Per share amounts have been adjusted for a 2 for 1 stock split in 1995 and a
1997 stock split effected in the form of a 100% stock dividend.
Return on assets
(net income divided by average assets)
[LINE GRAPH]
[PLOT POINTS TO COME]
Return on assets is a standard measure of financial performance in the banking
industry.
Net interest margin
(fully taxable equivalent basis)
[LINE GRAPH]
[PLOT POINTS TO COME]
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]
[PLOT POINTS TO COME]
Capital as a percentage of risk-weighted assets indicates the Company's ability
to continue growing while ensuring that it has resources to absorb the risk
inherent in the business.
Ratio of average equity to average assets
[LINE GRAPH]
[PLOT POINTS TO COME]
Average equity to average assets measures the extent to which the shareholders'
investment has been leveraged.
3
1998 Annual Report to Shareholders
<PAGE> 6
LETTER TO SHAREHOLDERS
To Our Shareholders:
Last year we told you that "every organization that is committed to growth and
independence must, first of all, be prepared and willing to adapt to change".
Southern Michigan Bancorp seized the opportunity, provided by years of
increasing profits, to invest in changes that will greatly strengthen long-term
shareholder value.
As you read the 1998 Annual Report of Southern Michigan Bancorp, Inc. you will
see that the investment in change made in 1997 already is starting to bear
fruit. You will note, for example, that we had substantial growth in 1998 to go
along with record profits. These changes will continue to strengthen long-term
shareholder value.
[PHOTO OF JERRY L. TOWNS & JAMES T. GROHALSKI]
The opening of our new Hillsdale branch office was a very exciting event that
took place in the fourth quarter. This new facility serves as a prototype of the
financial services office that we will open in the future. The "centers" within
are available for customers to receive advice and assistance in obtaining
mortgages, financial services for business, and non-deposit investment products,
such as stocks, bonds and mutual funds. The office also is uniquely equipped and
staffed to handle traditional banking transactions, such as teller services,
drive-through banking and ATM's.
Almost everyone that we talked to lately has had some concerns about the Year
2000 problem, or Y2K, and how Southern Michigan Bank & Trust is addressing the
problem.
Before we address that concern, a short definition of the Y2K is required.
Simply put, computers cannot tell the difference between the year 1900 and 2000.
Initially, programmers dropped off the first two digits of the 19XX year in
order to save memory space in the computer. Consequently, the year 2000 might be
read as 1900.
How is Southern Michigan Bank & Trust addressing the problem? All computers and
software the Bank utilizes are purchased from third party vendors. What does
this mean? The Bank continuously monitors our vendors for their progress towards
Y2K compliance. This process will continue until we receive certification from
each critical hardware and software provider. Initial communication with these
vendors has not resulted in any Y2K concerns.
We began testing procedures on all hardware and software used by the Bank months
ago. This was done to determine past and current Y2K conditions and to validate
the statements made by our third party vendors. While this is going on,
alternate vendors will be contacted as part of our overall contingency plan and
these vendors will be asked for their Y2K compliance plans, as well.
Be assured that Southern Michigan Bank & Trust is doing everything possible to
address all questions concerning the Y2K problem. We are confident that the
transition to the Year 2000 will be a smooth one for our customers and
shareholders alike.
Creating profit and increasing shareholder value will continue to be our goal as
we approach the new Millennium.
/s/ Jerry L. Towns /s/ James T. Grohalski
Jerry L. Towns James T. Grohalski
Chairman President & C.E.O.
4
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS 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 2.9% in 1998 and 4.0% in 1997. Commercial loans increased by 10.3%
in 1998 as local businesses expanded and took advantage of lower interest rates.
Installment loans declined as the result of competition from both financial and
non-financial companies which offer borrowers other low cost financing options.
The real estate mortgage portfolio increased primarily due to the offering of
competitive home equity products. The Bank's real estate mortgage loan sales to
the secondary market continued to increase in 1998. Gains of $1,085,000 (after
the capitalization of mortgage servicing rights) were recognized in 1998 and
gains of $550,000 were recognized in 1997. There were no loans held for sale at
December 31, 1998. The real estate portfolio largely consists of residential
mortgages within the local area with a low risk of loss. The Bank anticipates
that the sale of loans in the secondary market will continue to increase subject
to the impact of economic factors and levels of interest rates.
The loan growth in 1997 occurred in all loan categories and is the result of
continued good economic conditions within the Company's market area. Despite a
significant increase in secondary market loan sales, the Bank's mortgage
portfolio increased in 1997 due to the offering of some attractive adjustable
rate mortgage products and the Bank's continued efforts to become a market
leader in the consumer lending area.
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 $31,175,000 and $23,049,000 at December 31, 1998 and
1997, respectively. All of these commitments, with the exception of unused
credit cards ($1,616,000 in 1998 and $2,539,000 in 1997), are priced at a
variable interest rate thus minimizing the Bank's risk in a changing interest
rate environment.
There were 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 50.6% in 1998 and decreased by 20.4% in 1997. The 1998
increase is the result of a significant increase in deposits. The funds received
from maturing investments were used to fund the 1997 loan growth since the Bank
was not able to fund this growth with deposits.
The available for sale portfolio had net unrealized gains of $394,000 in 1998
and $39,000 in 1997. Net unrealized gains in the investment portfolio classified
as held to maturity totaled $937,000 in 1998 and $351,000 in 1997. 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 require
additional liquidity. 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 12.7% in 1998 and decreased 1.1% in 1997. A complete overhaul
of the Bank's personal checking accounts at the beginning of 1998 allowed the
Bank to increase the number of deposit accounts. The Bank experienced an
increase not only in demand deposit accounts, but in other deposit accounts as
well as customers opening secondary accounts to supplement their new checking
accounts. The 1997 decrease is the result of the maturing of short-term
municipal and school deposits that were acquired late in 1996.
Attracting and keeping traditional deposit relationships will continue to be a
challenge for the Bank, particularly with the increased competition from
non-deposit products. In order to have an alternate funding source, the Bank
obtained a $3,000,000 putable advance from the Federal Home Loan Bank (FHLB) in
December 1997. This advance carries a five year maturity and is secured by a
blanket collateral agreement with the FHLB giving the FHLB an unperfected
security interest in the Bank's one-to-four family whole mortgage loans,
government and agency securities and highly rated mortgage-backed securities.
The Bank obtained an additional $2,000,000 advance in February 1998. FHLB
advances have been a less expensive way to obtain longer term funds rather than
paying a premium for long term deposits.
Premises and equipment increased by 25.9% in 1998 and 6.9% in 1997. The Bank
opened a new branch office in Hillsdale in October 1998 at an approximate cost
of $2,000,000. The Bank made this significant investment because of the growth
potential in Hillsdale. The 1997 increase was due to the continued upgrading of
the Bank's technology.
CAPITAL RESOURCES
The Company maintains a strong capital base to take advantage of business
opportunities while ensuring that it has resources to absorb the risk inherent
in the business.
5
1998 Annual Report to Shareholders
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 risk 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 in Note N to the financial statements. The ratios include the common
stock subject to repurchase obligation in the Company's employee stock ownership
plan (ESOP). As seen in Note N, the Company exceeds the well capitalized
requirements.
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 1998 and 1997, total average assets grew 7.2% and 10.8%. At the same
time, average equity (including common stock held by the ESOP) increased 5.2% in
1998 and 11.9% in 1997. Equity grew at a lower level than assets in 1998 because
of the repurchase and retirement of 51,079 shares of common stock. 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 $29,286,000 at
December 31, 1998 representing 43.4% of the amortized cost of the investment
securities portfolio, an increase from the 30.4% level of 1997. Loans maturing
within 1 year were $37,963,000 at December 31, 1998 representing 23.2% of the
loan portfolio, a slight increase from the 20.6% level of 1997.
Financial institutions are subject to prepayment risk in falling rate
environments. Prepayments of assets carrying higher rates reduce the Company's
interest income and overall asset yields. Certain portions of an institution's
liabilities may be short-term or due on demand, while most of its assets may be
invested in long-term loans or investments. Accordingly, the Company seeks to
have in place sources of cash to meet short-term demands. These funds can be
obtained by increasing deposits, borrowing, or selling assets. Also, Federal
Home Loan Bank advances and short-term borrowings provide additional sources of
liquidity for the Company.
During the year ended December 31, 1998, there was a net decrease in cash and
cash equivalents of $620,000. The major source of cash in 1998 was the increase
in deposits. The major use of cash in 1998 was the purchase of investment
securities.
During the year ended December 31, 1997, there was a net increase in cash and
cash equivalents of $3,328,000. The major sources of cash in 1997 were loan
sales and maturing securities. The major uses of cash in 1997 were loan growth
and loans originated for sale.
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.
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 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.
Interest rate risk arises when the maturity or repricing characteristics of
assets differ significantly from the maturity or the repricing characteristics
of liabilities. Accepting this risk can be an important source of profitability
and shareholder value, however excessive levels of interest rate risk could pose
a significant threat to the Company's earnings and capital base. Accordingly,
effective risk management that maintains interest rate risk at prudent levels is
essential to the Company's safety and soundness.
6
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company measures the impact of changes in interest rates on net interest
income through a comprehensive analysis of the Bank's interest rate sensitive
assets and liabilities. Interest rate sensitivity varies with different types of
interest-earning assets and interest-bearing liabilities. Overnight federal
funds and mutual funds on which rates change daily and loans which are tied to
the prime rate or a comparable index differ considerably from long-term
investment securities and fixed-rate loans. Similarly, certificates of deposit
and money market investment accounts are much more interest sensitive than
passbook savings accounts. The shorter term interest rate sensitivities are key
to measuring the interest sensitivity gap, or excess interest-earning assets
over interest-bearing liabilities. In addition to reviewing the interest
sensitivity gap, the Company also analyzes projected changes in market interest
rates and the resulting effect on net interest income.
The following table shows the interest sensitivity gaps for five different time
intervals as of December 31, 1998:
<TABLE>
<CAPTION>
0-30 31-90 91-365 1-5 Over 5
Days Days Days Years Years
-------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest-earning assets $61,675 $ 9,101 $54,303 $88,058 $24,670
Interest-bearing liabilities 51,976 81,005 39,236 31,366
-------------------------------------------------
Interest sensitivity gap $ 9,699 $(71,904) $15,067 $56,692 $24,670
=================================================
</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 accounts 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.
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 1.7% in 1998, 10.2% in 1997 and 12.0% in 1996. The
1998 increase is due to the reinvestment of funds held in overnight federal
funds accounts into higher yielding investment securities. The 1997 and 1996 net
interest income 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 uncertain economic environment and potential fluctuations in interest rates
are expected to continue to impact the Company and the industry in 1999.
Depending on these interest rate fluctuations, there may be market pressure to
raise deposit rates in 1999 and to lower loan rates. The Company monitors
deposit rates on a weekly basis and adjusts deposit rates as the market
dictates. Loan rates are subject to change as the national prime rate changes
and are also influenced by competitor's rates. An increase in deposit rates
occurring at the same time as loan rates decrease would cause the Company's net
interest income 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 probable 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.
The provision for loan losses was $600,000 in 1998, $460,000 in 1997 and
$267,000 in 1996. The 1998 provision was increased to provide for increased
charge-offs and delinquencies, primarily as a result of increased customer
bankruptcies. The 1997 provision was increased to provide for loan growth and
the increase in charge-offs and delinquencies. Several customers, including a
large commercial borrower, declared bankruptcy, during 1997 resulting in
increased charge-offs. Net charge-offs were $431,000 in 1998, $411,000 in 1997
and $62,000 in 1996. The provision in 1996 was increased to provide for
significant loan growth. It is anticipated that the Company will continue to
experience higher than normal losses in 1999 . The provision 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 30.2% in
1998, 15.2% in 1997 and 28.8% in 1996. The 1998 increase is due to increased
service charge income, increased gains recognized on the sale of secondary
market real estate mortgage loans and increased income from the Bank's automatic
teller machines (ATMs). The Bank increased its deposit base by 12.7% in 1998 and
generated additional service charges as a result of the growth. In order to
reduce the risk associated with changing interest rates, the Bank regularly
sells fixed rate real estate mortgage loans on the secondary market. The Bank
recognizes a profit at the
7
1998 Annual Report to Shareholders
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
time of the sale and receives a fee in order to service the loans. During this
period of relatively low interest rates, the Bank has generated large volumes of
fixed rate mortgage loans. During 1998, the Bank began assessing a fee to
noncustomers who use the Bank's ATMs and thus increased fees generated.
The 1997 increase is due to increased service charges on deposit accounts as a
result of the additional deposits purchased in connection with the acquisition
of two branches late in 1996, increased gains recognized on the sale of
secondary market real estate mortgage loans in 1997 due to an increase in
activity, increased fees from the sale of non-depository investment products in
1997 due to an increase in activity and unrecognized losses on real estate
mortgage loans held for sale recorded in 1996. These increases were partially
offset by a decline in trust income due to a decline in trust assets and a
decline in earnings on Bank owned life insurance policies due to an increase in
premium payments.
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
in 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.
Security gains of $0 in 1998, $5,000 in 1997 and $10,000 in 1996 were
recognized.
Non-interest expense increased by 1.8% in 1998, 16.0% in 1997 and 10.6% in 1996.
The primary expense categories that increased in 1998 were occupancy, equipment
and marketing. Occupancy and equipment costs increased as a result of the
opening or the new Hillsdale branch and continued upgrades to the Bank's
technology base. Marketing expenditures increased as the Bank revamped its
checking account products.
The 1997 increase is due to additional personnel costs, occupancy costs,
marketing and advertising expenditures, training costs and intangible asset
amortization as a result of the acquisition of two branches late in 1996. Trust
department expenses also increased in 1997 as professional consultants and new
trust administrators were added in order to increase the trust department's
market share. Equipment costs increased in 1997 as the Company invested in
significant technological upgrades.
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.
Income tax expense was $1,185,000 in 1998, $1,085,000 in 1997 and $1,150,000 in
1996. 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 $350,000 in 1998, $254,000 in 1997 and $227,000 in 1996.
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 equity was 17.48% in 1998, 14.96% in 1997 and
16.09% in 1996. The return on average assets was 1.42% in 1998, 1.30% in 1997
and 1.45% in 1996.
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.
YEAR 2000
The Company has developed a plan to assess Year 2000 issues. The concern is
whether or not computers, elevators, telephone systems and other electronic
items will recognize the Year 2000 as a valid date. For banks, this is a concern
not only for the bank's operations, but for those of their customers and
vendors. As part of the Year 2000 plan, the Company has identified all critical
business processes and established a priority schedule for assessment of each
process.
8
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The first step in the plan is the testing of the Company's critical hardware
systems to verify that the systems are Year 2000 compliant. The critical
hardware systems include the mainframe computer system and some personal
computers. The testing of all critical hardware will be completed by March 31,
1999.
The next step in the Company's plan is to perform testing on all critical
software. The Company has no software that is internally programmed; all
software is purchased from external vendors. The Company has implemented a
verification process to establish that critical software purchased from software
vendors is Year 2000 compliant. Critical software includes mainframe operating
software, trust systems, Microsoft operating systems and systems providing
connectivity of network hardware. The testing of critical software will be
substantially completed by March 31, 1999.
As part of its Year 2000 plan, the Company has initiated formal communications
with its critical service providers to determine the extent to which the Company
is vulnerable to any failure of those third parties to remedy their own Year
2000 issues. Critical service providers include phone companies and energy
providers. This review of service providers will be completed by June 30, 1999.
There can be no assurance that the systems of other companies on which the
Company's systems rely will be remedied in a timely manner or that there will be
no adverse effect on the Company's systems. Therefore, the Company could be
negatively impacted to the extent that other entities not affiliated with the
Company are unsuccessful in properly addressing Year 2000 issues.
A key step in the Company's Year 2000 plan is the development of a Remediation
Contingency Plan to mitigate risks associated with a failure to successfully
complete renovation, validation and implementation of the Company's Year 2000
plan. The Remediation Contingency Plan will provide for alternate service
providers and software vendors in the event that the Company's current service
providers and software vendors are not fully Year 2000 compliant by March 31,
1999, in the case of software vendors, and June 30, 1999, in the case of service
providers. The Remediation Contingency Plan will be developed by mid March 1999.
Also by June 30, 1999, the Company will have in place an expanded Business
Resumption Plan. This Plan will be an addition to the Company's current Business
Resumption Plan and will specifically address Year 2000 issues and the
interruption of the Company's business operations by such things as a power
outage. The Business Resumption Plan will include the identification of the
Company's core business processes and a specific recovery plan for the possible
failure of each core business process. A sustained power outage or similar
disruption will have an adverse effect on the Company's operations; however,
management is not aware of any facts which would indicate that such disruptions
are likely.
Another important step in the Company's Year 2000 plan is the identification of
all significant customers whose own Year 2000 compliance status may pose a risk
to the Company. As part of this step, the Company will determine the actions
these customers are taking to avoid significant disruptions that could result
from the Year 2000 date change. This step will be completed by mid March 1999.
The Company's Board of Directors reviews the status of the Year 2000 issues on a
monthly basis. The Company will incur remediation and testing costs relating to
Year 2000 issues through the Year 2000, but does not anticipate that material
incremental costs will be incurred in any single period. The costs of the
project and the date on which the Company plans to complete Year 2000
modifications are based upon management's best estimates.
The Company has been engaged in activities addressing Year 2000 issues since mid
1997. In January, 1999, the Bank entered into discussions with the Federal
Deposit Insurance Corporation ("FDIC") regarding the Bank's Year 2000
preparedness. As a result of such discussions, the Board of Directors entered
into an agreement with the FDIC describing certain actions to be taken by the
Bank to address Year 2000 issues. The Company is actively pursuing all such
actions (which actions are summarized above) and anticipates that it will
complete all such actions in a timely manner.
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.
9
1998 Annual Report to Shareholders
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The following table sets forth the aggregate amount of nonperforming loans in
each of the following categories:
<TABLE>
<CAPTION>
December 31
1998 1997 1996
-------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual loans:
Commercial, financial and agricultural $ 343 $1,026 $448
Real estate mortgage 0 0 0
Installment 0 61 2
-------------------------
343 1,087 450
Loans contractually past due 90 days or more:
Commercial, financial and agricultural $ 807 $1,067 82
Real estate mortgage 161 630 129
Installment 120 966 165
-------------------------
1,088 2,663 376
-------------------------
Total nonperforming loans 1,431 3,750 826
Other real estate owned 166 103 76
-------------------------
Total nonperforming assets $1,597 $3,853 $902
=========================
Nonperforming loans to year-end loans .88% 2.36% .54%
Nonperforming assets to year-end loans
and other real estate owned .98% 2.43% .59%
</TABLE>
Nonperforming loans decreased in 1998 as some of 1997's problem loans were
charged off and the Company accelerated its collection activities. Some increase
in nonperforming loans was expected in 1997 due to the significant loan growth
that occurred in recent years. Customers experienced heavier debt loads due to
the ease of obtaining credit and this is resulted in an increase in bankruptcy
filings and delinquencies. Nonperforming loans are subject to continuous
monitoring by management and are specifically reserved for in the allowance for
loan losses where appropriate.
At December 31, 1998, the Company had approximately $3,931,000 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 FDIC completed an examination at the Company's subsidiary
bank using financial information as of December 31, 1997. 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk and to a lesser
extent liquidity risk. See Liquidity and Interest Rate Sensitivity, above.
Business is transacted in U.S. dollars with no foreign exchange rate risk or any
exposure to changes in commodity prices.
The following tables provide information about the Company's financial
instruments that are sensitive to changes in interest rates as of December 31,
1998 and 1997. The Company had no derivative financial instruments, or trading
portfolio, at either date.
10
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The expected maturity date values for loans receivable, mortgage-backed
securities and investment securities were calculated without adjusting the
instrument's contractual maturity date for expectations of prepayments. Expected
maturity date values for interest-bearing core deposits were not based upon
estimates of the period over which the deposits would be outstanding, but rather
the opportunity for repricing. Similarly, with respect to its variable rate
instruments, the Company believes that repricing dates, as opposed to expected
maturity dates may be more relevant in analyzing the value of such instruments
and are reported as such in the following table. Company borrowings are also
reported based on conversion or repricing dates.
<TABLE>
<CAPTION>
Principal Amount Maturing in: Fair Value
-----------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 Thereafter Total 12/31/98
-----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate sensitive assets:
Fixed interest rate loans $ 9,887 $ 6,679 $ 8,478 $ 10,259 $ 11,483 $ 11,582 $ 58,368 $ 58,653
Average interest rate 10.81% 9.98% 10.25% 10.50% 9.79% 9.01% 10.02%
Variable interest rate loans 28,076 1,848 3,728 3,032 5,541 62,710 104,935 104,935
Average interest rate 8.75% 8.63% 8.65% 8.79% 9.00% 8.72% 8.70%
Fixed interest rate securities 21,933 11,304 7,962 5,327 2,971 18,397 67,894 68,831
Average interest rate 4.71% 4.62% 4.59% 4.64% 4.58% 4.71% 4.60%
Other interest bearing assets 6,610 6,610 6,610
Average interest rate 4.84% 4.84%
Rate sensitive liabilities:
Interest bearing demand deposits 79,255 79,255 79,255
Average interest rate 3.05% 3.05%
Savings deposits 37,037 2,825 1,282 235 4,289 0 45,668 46,704
Average interest rate 2.30% 5.81% 5.72% 5.65% 5.60% 3.30%
Time deposits 55,925 10,774 5,164 1,797 0 0 73,660 74,201
Average interest rate 5.46% 4.83% 4.74% 4.81% 4.97%
Fixed interest rate borrowings 5,000 5,000 5,000
Average interest rate 5.47% 5.47%
</TABLE>
<TABLE>
<CAPTION>
Principal Amount Maturing in: Fair Value
-----------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 Thereafter Total 12/31/97
-----------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate sensitive assets:
Fixed interest rate loans $20,230 $12,383 $9,288 $7,163 $4,843 $4,414 $58,321 $57,958
Average interest rate 9.88% 10.03% 10.15% 10.18% 10.23% 10.04% 10.09%
Variable interest rate loans 12,543 564 449 9,443 11,029 66,392 100,420 100,420
Average interest rate 9.17% 9.28% 9.59% 9.55% 9.63% 9.87% 9.52%
Fixed interest rate securities 13,490 13,919 7,107 3,448 2,738 4,372 45,074 45,425
Average interest rate 5.85% 5.72% 5.98% 6.50% 4.98% 6.19% 5.75%
Other interest bearing assets 4,500 4,500 4,500
Average interest rate 5.43% 5.43%
Rate sensitive liabilities:
Interest bearing demand deposits 67,032 67,032 67,032
Average interest rate 3.39% 3.39%
Savings deposits 34,416 5,332 2,174 1,330 140 43,392 43,397
Average interest rate 2.78% 5.89% 5.58% 5.31% 5.74% 3.41%
Time deposits 51,701 7,802 5,481 683 12 39 65,718 65,705
Average interest rate 5.43% 5.66% 5.72% 5.70% 5.70% 5.70% 5.46%
Fixed interest rate borrowings 3,000 3,000 3,000
Average interest rate 5.71% 5.71%
</TABLE>
11
1998 Annual Report to Shareholders
<PAGE> 14
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 an 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, 1998, 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
Chairman President & C.E.O.
12
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 15
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
1998 1997
---- ----
<S> <C> <C>
ASSETS (In thousands)
Cash $ 3,021 $ 3,057
Due from banks 13,207 13,791
-------- --------
Cash and cash equivalents 16,228 16,848
Federal funds sold 4,000 4,500
Investment securities available for sale 36,138 12,853
Investment securities held to maturity
(fair value of $32,693 in 1998 and $32,572 in 1997) 31,756 32,221
Loans, net 161,277 156,878
Premises and equipment 7,036 5,588
Other assets 10,416 9,643
-------- --------
TOTAL ASSETS $266,851 $238,531
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 34,778 $ 30,923
Interest bearing 198,583 176,142
-------- --------
Total deposits 233,361 207,065
Accounts payable and other liabilities 2,528 2,977
Other borrowings 5,000 3,000
-------- --------
TOTAL LIABILITIES 240,889 213,042
Common stock subject to repurchase obligation in ESOP 6,029 4,899
Shareholders' equity:
Preferred stock, 100,000 shares authorized; none issued or outstanding
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 1,872,677 shares (1,916,921 in 1997)
Outstanding - 1,721,950 shares (1,772,839 in 1997) 4,305 4,432
Capital surplus 3,863 1,914
Retained earnings 11,505 14,218
Net unrealized gain on available-for-sale
securities, net of tax of $134 in 1998 and $13 in 1997 260 26
-------- --------
TOTAL SHAREHOLDERS' EQUITY 19,933 20,590
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $266,851 $238,531
======== ========
</TABLE>
See accompanying notes.
13
1998 Annual Report to Shareholders
<PAGE> 16
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
In thousands
<TABLE>
<CAPTION>
Net Unrealized
Gain (Loss)
On Available-
Common Capital Retained For-Sale
Stock Surplus Earnings Securities TOTAL
----- ------- -------- ---------- -----
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996 $ 2,145 $ 3,511 $ 12,630 $ 211 $ 18,497
Net income for 1996 3,058 3,058
Cash dividends declared - $.53 per share (1,001) (1,001)
Common stock issued under
dividend reinvestment plan (14,146 shares) 35 440 475
Change in common stock subject to repurchase (6) (1,217) (1,223)
Net change in unrealized gain (loss)
on available-for-sale securities, net of tax (190) (190)
--------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1996 2,174 2,734 14,687 21 19,616
Net income for 1997 3,032 3,032
Cash dividends declared - $ .58 per share (1,109) (1,109)
Common stock issued under dividend
reinvestment plan (9,879 shares) 25 365 390
100% stock dividend issued (956,695 shares) 2,392 (2,392)
Change in common stock subject to repurchase (159) (1,185) (1,344)
Net change in unrealized gain (loss)
on available-for-sale securities, net of tax 5 5
--------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1997 4,432 1,914 14,218 26 20,590
Net income for 1998 3,549 3,549
Cash dividends declared - $ .67 per share (1,262) (1,262)
Common stock issued under dividend
reinvestment plan (6,835 shares) 18 233 251
Common stock repurchased and
retired (51,079 shares) (128) (2,171) (2,299)
Transfer from retained earnings to surplus 5,000 (5,000)
Change in common stock subject to repurchase (17) (1,113) (1,130)
Net change in unrealized gain (loss)
on available-for-sale securities, net of tax 234 234
--------- --------- ---------- --------- ----------
BALANCE AT DECEMBER 31, 1998 $ 4,305 $ 3,863 $ 11,505 $ 260 $ 19,933
========= ========= ========== ========= ==========
</TABLE>
See accompanying notes.
14
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 17
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Interest income: (In thousands)
Loans, including fees $ 15,781 $ 15,545 $ 13,500
Investment securities:
Taxable 2,305 2,189 2,443
Tax-exempt 1,094 861 775
-------- -------- --------
3,399 3,050 3,218
Other 266 74 69
-------- -------- --------
Total interest income 19,446 18,669 16,787
Interest expense:
Deposits 7,622 7,260 6,427
Capital notes 9
Other 410 183 168
-------- -------- --------
Total interest expense 8,032 7,443 6,604
-------- -------- --------
NET INTEREST INCOME 11,414 11,226 10,183
Provision for loan losses 600 460 267
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,814 10,766 9,916
Non-interest income:
Service charges on deposit accounts 978 835 727
Trust fees 500 528 545
Securities gains 5 10
Gain on sales of loans 1,085 550 343
Earnings on life insurance policies 220 181 203
Other 413 360 313
-------- -------- --------
3,196 2,459 2,141
-------- -------- --------
14,010 13,225 12,057
Non-interest expenses:
Salaries and employee benefits 4,528 4,508 4,048
Occupancy 781 697 605
Equipment 872 762 712
Advertising 219 253 175
Other 2,876 2,888 2,309
-------- -------- --------
9,276 9,108 7,849
-------- -------- --------
Income before income taxes 4,734 4,117 4,208
Federal income taxes 1,185 1,085 1,150
-------- -------- --------
NET INCOME 3,549 3,032 3,058
Other comprehensive income:
Unrealized gains/losses on securities arising during the year 355 13 (279)
Reclassification adjustment for accumulated gains/losses
included in net income 0 5 10
Tax effect (121) (3) (99)
-------- -------- --------
Other comprehensive income 234 5 (190)
-------- -------- --------
COMPREHENSIVE INCOME $ 3,783 $ 3,037 $ 2,868
======== ======== ========
BASIC AND DILUTED EARNINGS PER SHARE $ 1.87 $ 1.59 $ 1.62
======== ======== ========
</TABLE>
See accompanying notes.
15
1998 Annual Report to Shareholders
<PAGE> 18
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES (In thousands)
<S> <C> <C> <C>
Net income $ 3,549 $ 3,032 $ 3,058
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 600 460 267
Depreciation 599 527 410
Net amortization of investment securities 182 138 166
Net realized gain on sales of investment securities (5) (10)
Loans originated for sale (34,550) (17,175) (11,073)
Proceeds on loans sold 35,167 17,489 11,269
Realized gain on sale of loans originated for sale (1,085) (550) (343)
Net change in:
Other assets (894) (469) (1,733)
Accrued expenses and other liabilities (459) 160 262
-------- -------- --------
Net cash from operating activities 3,109 3,607 2,273
INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold 500 (4,500) 4,500
Activity in available-for-sale investment securities:
Sales 255 509
Maturities and calls 9,522 12,187 15,652
Purchases (32,808) (1,167) (9,736)
Activity in held-to-maturity investment securities:
Maturities and calls 6,852 4,355 6,719
Purchases (6,213) (4,230) (14,842)
Loan originations and payments, net (4,531) (6,230) (29,564)
Additions to premises and equipment (2,047) (888) (1,675)
-------- -------- --------
Net cash from investing activities (28,725) (218) (28,437)
FINANCING ACTIVITIES
Acquisition of deposits 18,635
Net change in deposits 26,296 (2,402) 5,308
Proceeds from long-term borrowings 2,000 3,000
Payment of capital note (1,000)
Common stock issued 251 390 575
Cash dividends paid (1,252) (1,049) (1,014)
Repurchase of common stock (2,299)
-------- -------- --------
Net cash from financing activities 24,996 (61) 22,504
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS (620) 3,328 (3,660)
Beginning cash and cash equivalents 16,848 13,520 17,180
-------- -------- --------
ENDING CASH AND CASH EQUIVALENTS $ 16,228 $ 16,848 $ 13,520
======== ======== ========
</TABLE>
See accompanying notes.
16
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND INDUSTRY SEGMENTS: Southern Michigan Bancorp, Inc. is a
bank holding company. The Company's business is concentrated in the commercial
banking industry segment. The business of commercial and retail banking accounts
for more than 90% of its revenues, operating income and assets. Internal
financial information is primarily reported and aggregated in the line of
business of banking. The Bank offers individuals, businesses, institutions and
government agencies a full range of commercial banking services primarily in the
southern Michigan communities in which the Bank is located and in areas
immediately surrounding these communities. The Bank grants commercial, real
estate and consumer loans to customers. The majority of loans are secured by
specific assets and consumer assets. There are no foreign loans.
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.
USE OF ESTIMATES: 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,
deferred income tax provisions, fair values of certain securities and other
financial instruments and the actuarial present value of pension benefit
obligations and net periodic pension expense and prepaid pension costs.
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, with unrealized
gains and losses reported in other comprehensive income. 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: Loans are reported at the principal balance outstanding, net of unearned
interest, deferred loan fees and costs, and an allowance for loan losses. Loans
held for sale are reported at the lower of cost or market, on an aggregate
basis. 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. 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.
A loan is impaired when full payment under the loan terms is not expected.
Impairment is evaluated in total for smaller-balance loans of similar nature
such as residential mortgage, consumer and credit card loans, and on an
individual loan basis for other loans. If a loan is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value
of estimated future cash flows using the loan's existing rate or at the fair
value of collateral if repayment is expected solely from the collateral.
17
1998 Annual Report to Shareholders
<PAGE> 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
SERVICING RIGHTS: Servicing rights are recognized as assets for the allocated
value of retained servicing rights on loans sold. Servicing rights are expensed
in proportion to, and over the period of, estimated net servicing rights
revenues. Impairment is evaluated based on the fair value of the rights, using
groupings of the underlying loans as to interest rates and then, secondarily, as
to geographic and prepayment characteristics. Any impairment of a grouping is
reported as a valuation allowance.
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 are amortized on accelerated
methods over 10 years. Goodwill was $807,000 and $870,000 and core deposit
intangibles were $464,000 and $559,000 at December 31, 1998 and 1997
respectively, and these balances are included in other assets.
OTHER REAL ESTATE: Other real estate ($166,000 and $103,000 at December 31, 1998
and 1997 respectively), 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: Income tax expense is the total of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts for the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
EARNINGS PER COMMON SHARE: Basic earnings per common share is net income divided
by the weighted average number of common shares outstanding during the period.
ESOP shares are considered outstanding for this calculation unless unearned.
Diluted earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options. Earnings and dividends per
share are restated for all stock splits and dividends through the date of issue
of the financial statements. The weighted average common shares outstanding for
the years ended December 31, 1998, 1997 and 1996 were 1,895,292, 1,910,449 and
1,886,324, respectively.
18
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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. The Company reports net cash flows for customer loan and deposit
transactions.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale which are also recognized as separate
components of equity. The accounting standard that requires reporting
comprehensive income first applies for 1998, with prior information restated to
be comparable.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in Note M. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments and
other factors, especially in the absence of broad markets for particular items.
Changes in assumptions or in market conditions could significantly affect such
estimates.
CONCENTRATIONS OF CREDIT RISK: The Company grants commercial, real estate and
installment loans to customers mainly in Southern Michigan. Commercial loans
include loans collateralized by commercial real estate, business assets and
agricultural loans collateralized by crops and farm equipment. Commercial,
financial and agricultural loans make up approximately 51% of the loan portfolio
and the loans are expected to be repaid from cash flow from operations of
businesses. Residential mortgage loans make up approximately 31% of the loan
portfolio and are collateralized by mortgages on residential real estate.
Consumer loans make up approximately 18% of the loan portfolio and are primarily
collateralized by consumer assets.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: The Company, in the normal
course of business, makes commitments to extend credit which are not reflected
in the consolidated financial statements. A summary of these commitments is
disclosed in Note J.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
RECLASSIFICATIONS: Some items in the prior consolidated financial statements
have been reclassified to conform with the current presentation.
NEW ACCOUNTING PRONOUNCEMENTS: Beginning January 1, 2000, a new accounting
standard will require all derivatives to be recorded at fair value. Unless
designated as hedges, changes in these fair values will be recorded in the
income statement. Fair value changes involving hedges will generally be recorded
by offsetting gains and losses on the hedge and on the hedged item, even if the
fair value of the hedged item is not otherwise recorded. This is not expected to
have a material effect but the effect will depend on derivative holdings when
this standard applies.
NOTE B - INVESTMENT SECURITIES
Year end investment securities were as follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE, 1998 COST GAINS LOSSES VALUE
------- ------- ------- -------
<S> <C> <C> <C> <C>
U.S. Treasury and other U.S.
Government agencies $ 9,019 $ 68 $ 9,087
States and political
subdivisions thereof 20,236 315 $ 5 20,546
Corporate securities 1,302 8 1,310
Mortgage-backed securities 2,677 8 2,685
------- ------- ------- -------
Total debt securities 33,234 399 5 33,628
Equity securities 2,510 2,510
------- ------- ------- -------
TOTALS $35,744 $ 399 $ 5 $36,138
======= ======= ======= =======
</TABLE>
19
1998 Annual Report to Shareholders
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - INVESTMENT SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
Available for sale, 1997 COST GAINS LOSSES VALUE
------- ------- ------- -------
<S> <C> <C> <C> <C>
U.S. Treasury and other U.S.
Government agencies $ 6,259 $ 10 $ 7 $ 6,262
States and political
subdivisions thereof 3,464 36 3,500
Corporate securities 1,096 4 1,100
Mortgage-backed securities 1,646 1 5 1,642
------- ------- ------- -------
Total debt securities 12,465 51 12 12,504
Equity securities 349 349
------- ------- ------- -------
TOTALS $12,814 $ 51 $ 12 $12,853
======= ======= ======= =======
HELD TO MATURITY, 1998
States and political
subdivisions thereof $16,460 $ 897 $17,357
Corporate securities 14,592 49 $ 9 14,632
------- ------- ------- -------
Total debt securities 31,052 946 9 31,989
Equity securities 704 704
------- ------- ------- -------
TOTALS $31,756 $ 946 $ 9 $32,693
======= ======= ======= =======
Held to maturity, 1997
States and political
subdivisions thereof $17,060 $ 326 $ 1 $17,385
Corporate securities 14,464 41 15 14,490
------- ------- ------- -------
Total debt securities 31,524 367 16 31,875
Equity securities 697 697
------- ------- ------- -------
TOTALS $32,221 $ 367 $ 16 $32,572
======= ======= ======= =======
</TABLE>
Sales of available for sale securities were (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Proceeds 0 $255 $509
Gross gains 0 5 10
Gross losses 0 0 0
</TABLE>
Contractual maturities of debt securities at year-end 1998 were as follows (in
thousands). 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 $15,559 $15,592 $10,007 $10,046
Due from one to five years 11,182 11,468 17,663 17,938
Due from five to ten years 1,571 1,641 2,788 2,855
Due after ten years 2,740 3,287 99 104
Mortgage-backed securities 2,677 2,685
------- ------- ------- -------
$31,052 $31,988 $33,234 $33,628
======= ======= ======= =======
</TABLE>
Investment securities with an amortized cost of $3,303,000 and $3,675,000 were
pledged as collateral for public deposits and for other purposes in 1998 and
1997.
20
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - LOANS
Loans at year-end were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Commercial $ 82,533 $ 74,819
Consumer 29,203 33,865
Real estate mortgage 51 567 50,057
--------- ---------
163,303 158,741
Less allowance for loan losses (2,026) (1,863)
--------- ---------
LOANS, NET $ 161,277 $ 156,878
========= =========
</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 (in thousands) exceeding $60,000 in the aggregate to these
individuals and their associates.
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Balance at January 1 $ 3,722 $ 2,599
New loans 7,825 6,974
Repayments (7,624) (5,851)
------- -------
Balance at December 31 $ 3,923 $ 3,722
======= =======
</TABLE>
The unpaid principal balance of mortgage loans serviced for others, which are
not included on the consolidated balance sheet, was $51,462,000 and $31,085,000
at December 31, 1998 and 1997, respectively. The balance of loans serviced for
others related to servicing rights that have been capitalized was $49,565,000 in
1998 and $26,214,000 in 1997. 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 for capitalized mortgage servicing rights was as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Balance at January 1 $ 327 $ 142
Additions 468 236
Amortized to expense (200) (51)
----- -----
Balance at December 31 $ 595 $ 327
===== =====
</TABLE>
No valuation allowance was necessary at December 31, 1998 or 1997.
NOTE D - ALLOWANCES FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31 were as
follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance at January 1 $ 1,863 $ 1,814 $ 1,609
Provision for loan losses 600 460 267
Loans charged off (579) (508) (170)
Recoveries 142 97 108
------- ------- -------
Net charge-offs (437) (411) (62)
------- ------- -------
Balance at December 31 $ 2,026 $ 1,863 $ 1,814
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Information regarding impaired loans follows:
Average investment in impaired loans during the year $1,566 $1,501
====== ======
Interest income recognized on impaired loans on a cash basis
during the year $ 73 $ 118
====== ======
Total impaired loans at year end $1,259 $1,328
Less loans for which no allowance for loan losses is allocated $ 0 68
------ ------
Impaired loans for which an allowance for loan losses is allocated $1,259 $1,260
====== ======
Portion of allowance allocated to these loans $ 367 $ 358
====== ======
</TABLE>
21
1998 Annual Report to Shareholders
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E - PREMISES AND EQUIPMENT
Major classes of premises and equipment at December 31 follow (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Land $ 786 $ 540
Buildings and improvements 7,625 6,525
Equipment 3,157 2,534
------- -------
11,568 9,599
Less accumulated depreciation 4,532 4,011
------- -------
TOTALS $ 7,036 $ 5,588
======= =======
</TABLE>
Depreciation and amortization expense charged to operations was approximately
$599,000, $527,000 and $410,000 in 1998, 1997 and 1996, respectively.
NOTE F - DEPOSITS
The carrying amount of domestic deposits at December 31 follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Non-interest bearing checking $ 34,778 $ 30,923
Interest bearing checking 37,055 32,085
Passbook savings 31,797 29,163
Money market accounts 42,200 34,271
Time deposits 72,439 64,301
Individual retirement accounts and other deposits 15,092 16,322
-------- --------
TOTALS $233,361 $207,065
======== ========
</TABLE>
The carrying amount of time deposits over $100,000 was $21,058,000 and
$16,437,000 at December 31, 1998 and 1997, respectively. Interest expense on
time deposits over $100,000 was $1,084,000, $1,025,000, and $837,000 at December
31, 1998, 1997 and 1996, respectively.
At December 31, 1998, scheduled maturities of time deposits were as follows:
<TABLE>
<S> <C>
1999 $ 54,704
2000 10,774
2001 5,164
2002 1,797
2003 0
Thereafter 0
--------
$ 72,439
========
</TABLE>
The amount of deposits accepted from certain officers and directors was
$1,374,000 and $1,762,000 at December 31, 1998 and 1997, respectively.
NOTE G - OTHER BORROWINGS
Other borrowings represents putable advances obtained by the Bank from the
Federal Home Loan Bank (FHLB) of Indianapolis. The advance matures on December
16, 2002 and bears a fixed interest rate of 5.71% until December 16, 2000. On
that date, the FHLB will have the option to convert the advances to a periodic
adjustable rate and will continue to have this option quarterly thereafter. The
advances may not be prepaid by the Bank prior to the FHLB exercising its option
to convert the advances to an adjustable rate. The advances are secured by a
blanket collateral agreement with the FHLB which gives the FHLB an unperfected
security interest in the Bank's one-to-four family whole mortgage loans,
government and agency securities and highly rated private mortgage-backed
securities.
Interest paid on deposits and other borrowings was $8,054,000 in 1998,
$7,464,000 in 1997 and $6,538,000 in 1996.
NOTE H - INCOME TAXES
The components of federal income taxes for the years ended December 31 were as
follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Currently payable $ 1,226 $ 1,066 $ 1,181
Deferred expense (benefit) (41) 19 (31)
------- ------- -------
$ 1,185 $ 1,085 $ 1,150
======= ======= =======
</TABLE>
22
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H - INCOME TAXES (CONTINUED)
A reconciliation of federal income taxes with amounts computed by applying the
statutory federal income tax rate is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Statutory tax on pretax income, including tax on security
gains ($0 in 1998, $2,000 in 1997 and $3,000 in 1996) $ 1,610 $ 1,400 $ 1,431
Effect of tax-exempt interest income (350) (254) (227)
Effect of life insurance policy cash surrender value increase (82) (65) (75)
Other items-net 7 4 21
------- ------- -------
$ 1,185 $ 1,085 $ 1,150
======= ======= =======
</TABLE>
The components of deferred tax assets and liabilities are comprised of the
following at December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 461 $ 405
Deferred compensation liability 470 430
Pension liability 65 81
Other 175 132
------ ------
1,171 1,048
Deferred tax liabilities:
Net unrealized appreciation on available-for-sale securities 134 13
Mortgage servicing rights 202 111
Other 14 23
------ ------
350 147
------ ------
Net deferred tax asset $ 821 $ 901
====== ======
</TABLE>
The Company made income tax payments of $1,165,000 in 1998, $1,130,000 in 1997
and $1,245,000 in 1996. An allowance against the deferred tax asset was not
considered necessary at December 31, 1998, 1997, or 1996.
NOTE I - RETIREMENT PLANS
The defined benefit pension plan covers 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 may be appropriate from time to time. 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.
Information about the pension plan was as follows (in thousands).
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Change in benefit obligation:
Beginning benefit obligation $(1,715) $(1,853)
Service cost (140) (130)
Interest cost (115) (113)
Actuarial (gain) loss (435) 188
Benefits paid 79 193
------- -------
Ending benefit obligation (2,326) (1,715)
Change in plan assets, at fair value:
Beginning plan assets 1,856 1,574
Actual return 335 330
Employer contribution 154 145
Benefits paid (79) (193)
------- -------
Ending plan assets 2,266 1,856
------- -------
Funded status (60) 141
Unrecognized net actuarial gain (185) (447)
Unrecognized transition obligation 17 21
Unrecognized prior service cost 49 61
------- -------
Accrued pension cost $ (179) $ (224)
======= =======
</TABLE>
23
1998 Annual Report to Shareholders
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - RETIREMENT PLANS (CONTINUED)
The components of pension expense and related actuarial assumptions were as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Service cost $ 140 $ 130 $ 139
Interest cost 115 113 112
Actual return on plan assets (345) (330) (195)
Net amortization and deferral 188 205 98
----- ----- -----
Net $ 98 $ 118 $ 154
===== ===== =====
Discount rate on benefit obligation 7.0% 7.0% 7.0%
Long-term expected rate of return on plan assets 8.0% 8.0% 8.0%
Rate of compensation increase 3.0% 3.5% 5.0%
</TABLE>
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 $90,000 in 1998,
$66,000 in 1997 and $71,000 in 1996.
As of December 31, 1998 and 1997, the ESOP held 150,727 and 144,082 shares of
the Company's stock all of which is allocated to employees. The fair value of
the shares held by the ESOP approximated $6,029,000 and $4,899,000 at December
31, 1998 and 1997, 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 $229,000 in 1998, $206,000 in
1997 and $189,000 in 1996. The liability for vested benefits was $1,382,000 at
December 31, 1998 and $1,264,000 at December 31, 1997. The Bank holds life
insurance contracts on the plan's participants. The cash surrender value of
these policies was $4,309,000 at December 31, 1998 and $3,725,000 at December
31, 1997 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, 1998, the Bank had commitments under commercial letters of
credit, used to facilitate customers' trade transactions, of $133,000 (1997 -
$136,000).
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,
1998 commitments under outstanding standby letters of credit were $385,000 (1997
- - $347,000).
Loan commitments outstanding to extend credit at December 31 are detailed below:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Fixed rate $ 1,616,000 $ 2,539,000
Variable rate 29,559,000 20,510,000
----------- -----------
$31,175,000 $23,049,000
=========== ===========
</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.
24
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 1999, the Bank is
permitted to pay the Company approximately $1,410,000 in addition to 1999 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.
NOTE L - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION
Condensed financial statements of Southern Michigan Bancorp, Inc. follow (in
thousands):
Balance Sheets
<TABLE>
<CAPTION>
December 31
1998 1997
---- ----
<S> <C> <C>
ASSETS
Cash $ 16 $ 19
Investment securities available for sale 3,170 3,096
Investment securities held to maturity 250
Investment in subsidiary 21,010 21,141
Premises and equipment 1,231 1,202
Other 700 414
------- -------
TOTAL ASSETS $26,377 $25,872
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 393 $ 383
Other liabilities 22
Common stock subject to repurchase obligation in ESOP 6,029 4,899
Shareholders' equity 19,933 20,590
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $26,377 $25,872
======= =======
</TABLE>
Statements of Income
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Dividends from Bank $ 3,620 $ 1,109 $ 1,001
Interest income 167 137 113
Other income 226 206 205
Other expenses (33) (49) (31)
------- ------- -------
3,980 1,403 1,288
Federal income tax expense (85) (68) (98)
------- ------- -------
3,895 1,335 1,190
Equity in undistributed net income (loss) of subsidiary (346) 1,697 1,868
------- ------- -------
NET INCOME $ 3,549 $ 3,032 $ 3,058
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
Statements of Cash Flows Year ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,549 $ 3,032 $ 3,058
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiary 346 (1,697) (1,868)
Depreciation 31 31 29
Net amortization of investment securities 16 13 14
Other (253) (146) 34
------- ------- -------
Net cash from operating activities 3,689 1,233 1,267
</TABLE>
25
1998 Annual Report to Shareholders
<PAGE> 28
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
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
INVESTING ACTIVITIES
Activity in available for sale investment securities:
Maturities and calls 1,977 734 2,614
Purchases (2,059) (1,248) (4,110)
Activity in held to maturity investment securities:
Maturities and calls 780
Purchases (250)
Additions to premises and equipment (60) (62) (116)
------- ------- -------
Net cash from investing activities (392) (576) (832)
FINANCING ACTIVITIES
Common stock issued 251 390 575
Cash dividends paid (1,252) (1,049) (1,014)
Repurchase of common stock (2,299)
------- ------- -------
Net cash from financing activities (3,300) (659) (439)
------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS (3) (2) (4)
Beginning cash and cash equivalents 19 21 25
------- ------- -------
ENDING CASH AND CASH EQUIVALENTS $ 16 $ 19 $ 21
======= ======= =======
</TABLE>
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.
26
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - FAIR VALUE INFORMATION (CONTINUED)
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.
OTHER BORROWINGS: The fair value of the Bank's other borrowings 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 (in thousands):
<TABLE>
<CAPTION>
1998 1997
------------------------------ ------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 16,228 $ 16,228 $ 16,848 $ 16,848
Federal funds sold 4,000 4,000 4,500 4,500
Investment securities available for sale 36,138 36,138 12,853 12,853
Investment securities held to maturity 31,756 32,693 32,221 32,572
Loans 163,303 163,588 158,741 158,378
</TABLE>
<TABLE>
<CAPTION>
1998 1997
------------------------------ ------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
Financial liabilities:
Deposits $ (233,361) $ (234,938) $ (207,065) $ (207,057)
Other borrowings (5,000) (5,000) (3,000) (3,000)
Unrecognized financial instruments:
Commercial letters of credit $ (8) $ (3)
Standby letters of credit (3) (7)
</TABLE>
27
1998 Annual Report to Shareholders
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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>
1998
Total capital (to risk weighted assets)
Consolidated $26,396 13.7% $15,439 8.0% $19,298 10.0%
Bank $21,129 11.1% $15,238 8.0% $19,048 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $24,370 12.6% $7,719 4.0% $11,579 6.0%
Bank $19,103 10.0% $7,619 4.0% $11,428 6.0%
Tier 1 capital (to average assets)
Consolidated $24,370 9.4% $10,363 4.0% $12,954 5.0%
Bank $19,103 7.8% $9,845 4.0% $12,306 5.0%
1997
Total capital (to risk weighted assets)
Consolidated $25,295 14.3% $14,143 8.0% $17,679 10.0%
Bank $21,002 12.0% $13,977 8.0% $17,471 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $23,432 13.3% $7,072 4.0% $10,607 6.0%
Bank $19,139 11.0% $6,988 4.0% $10,483 6.0%
Tier 1 capital (to average assets)
Consolidated $23,432 10.1% $9,250 4.0% $11,563 5.0%
Bank $19,139 8.3% $9,192 4.0% $11,490 5.0%
</TABLE>
The Company and Bank at year-end 1998 and 1997 were categorized as well
capitalized.
28
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 31
REPORT OF INDEPENDENT AUDITORS
[LOGO CROWE CHIZEK]
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, 1998 and 1997 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. 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 audit 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, l998 and 1997 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998 in conformity with generally accepted accounting principles.
/s/ Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
February 17, 1999
29
1998 Annual Report to Shareholders
<PAGE> 32
BOARD OF DIRECTORS AND STRATEGIC MANAGEMENT TEAM
BOARD OF DIRECTORS:
Jerry L.Towns, Chairman SMB&T
James T.Grohalski, President & Chief Executive Officer SMB&T
Freeman E. Riddle,Spoor-Parlin Farm Equipment
Jane L. Randall, Dally Tire Company
James P. Briskey, Briskey Elevator
Thomas E. Kolassa, The Planning Group
Gregory J.Hull, Farmer
Nolan E. (Rick) Hooker, Hooker Oil
James J. Morrison, Morrison & Associates
William E. (Buzz) Galliers, G & W Display Fixtures
H. Kenneth Cole, Hillsdale College
HONORARY DIRECTORS
John S. Furry
Gerald L. Hensley
James E. Koss
Raymond W. Smith
Howard M. Teeter*
Harvey Randall
STRATEGIC MANAGEMENT TEAM
Jerry L. Towns, Chairman
James T. Grohalski, President & Chief Executive Officer
Jaylen Johnson, Sr. Vice-President/Cashier
Stanley E. Tipton, Sr. Vice-President/Loan Administration
Michael Lammers, Vice-President/Sr. Trust Officer
Julie Waterbury, Vice-President/Controller
Andrew Karr, Vice-President/Human Resources
Mark Lambert, Vice-President/Marketing
Patrick J. Peruchietti, Vice-President/Retail Sales
[PHOTO]
*It is with great sadness we announce the passing of longtime
board member and honorary board member, Howard Teeter. Mr. Teeter
passed away suddenly on December 18, 1998. He will be sadly
missed by all at Southern Michigan Bank & Trust and in the
community.
30
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 33
OFFICERS
SOUTHERN MICHIGAN BANCORP, INC.
Jerry L. Towns, Chairman
James T. Grohalski, President & Chief Executive Officer
Jaylen T. Johnson, Senior Vice-President
Julie A. Waterbury, Vice-President & Controller
SOUTHERN MICHIGAN BANK & TRUST
EXECUTIVE OFFICERS
Jerry L. Towns, Chairman
James T. Grohalski, President & Chief Executive Officer
COMMERCIAL LOANS
Stanley Tipton, Sr. Vice-President/Loan Administrator
Joan Trenary, Vice-President
Craig Binkowski, Vice-President
Merl Grosvenor, Credit Department Manager
CONSUMER LOANS
Patrick Peruchietti, Vice-President/Retail Sales
Jodie Johnson, Vice-President/Loan Center Manager
Scott Galloway, Loan Officer
Valorie Vaughan, Loan Officer
HUMAN RESOURCES
Andrew Karr, Vice-President
Veronica Hannah, *Human Resource Assistant
MARKETING
Mark Lambert, Vice-President
Carol A. Hughes, *Marketing Coordinator
OPERATIONS
Jaylen Johnson, Sr. Vice-President/Cashier
Julie Waterbury, Vice-President/Controller
Barbara Junker, Customer Sales Officer
Ann-Marie Bentley, Coldwater Branch Manager
Leslie Reagle, Operations Officer/Compliance
Jerald VanBlarcom, Asst. Vice-President/
Data Processing Officer
Paul Mahle, Asst. Data Processing Officer
Marilyn Lepper, Asst. Vice President/
Accounting Dept. Manager
TRUST DEPARTMENT
Michael Lammers, Vice President/Sr. Trust Officer
Margo S. Brush, Asst. Vice-President/
Trust Administration Officer
Melissa Kent, Asst. Trust Officer
ATHENS OFFICE
Marcia Carman, Branch Manager
BATTLE CREEK REGION
Ray Killinger, Vice-President/Business Development
BECKLEY ROAD OFFICE
Sharon Warsop, Asst. Vice-President/Branch Manager
CAMDEN OFFICE
Vicki Morris, Asst. Vice-President/Branch Manager
EAST CHICAGO STREET OFFICE
Dawn Wheaton, *Branch Supervisor
HILLSDALE OFFICE
Vicki Morris, Asst. Vice-President/Branch Manager
Carol Teller, Customer Service Manager
HILLSDALE REGION
Robert Stanley, Vice-President/Business Development
KINDERHOOK OFFICE
Nancy Behnke,*Branch Supervisor
NORTH ADAMS OFFICE
Joyce Carpenter, Branch Manager
PENNFIELD OFFICE
Linda McKinney, Asst. Vice-President/Branch Manager
TEKONSHA OFFICE
Anne Walter, Branch Manager
UNION CITY OFFICE
Kenneth Brooks, Vice-President/Branch Manager
*Non-Officer Position
31
1998 Annual Report to Shareholders
<PAGE> 34
EMPLOYEES
1998 SOUTHERN MICHIGAN BANK & TRUST EMPLOYEES
COLDWATER OFFICE UNION CITY OFFICE PENNFIELD OFFICE
Michelle Archer Sue Adolph Beth Ayers
Andrea Austin Michele Crow Talena Hubbard
Michele Barone Linda Dormer Angela Lawver
Jerry Brierly Dora Fast Tracie Williams
Janet Carpenter Reba Ludwick
Juanita Carr Terri Orris ATHENS OFFICE
Heather Carter Joanne Parks Sharon Cross
Gary Chrisman Tara Powell Kris Motz
Greg Cooper Gail Schafer Georgia Stafford
Martha Counterman Krista Watkins
Deidre Cross NORTH ADAMS OFFICE
Misty Dempsey TEKONSHA OFFICE Rhonda Baker
Jane Gillette Dawn Copas Shelley Reed
Barbara Godfrey Cynthia Dora Leonce Towers
Amanda Greenwald Kay Rice
Linda Grindle Sarah Olds LOAN CENTER
Amy Harmon Debra Richar Stephanie Arlt
Debra Hinkley Karen Atkinson
Ellen Hopkins EAST CHICAGO OFFICE Diana Butler
Linda Hunnaman Jennifer Birch Dell Cook
Kelly Kiersey Elizabeth Danbury Regina Holroyd
Jean Lenon Cherie Green Carol Root
Jamie Lepper Lynn Roper
Marilyn Malcolm KINDERHOOK OFFICE Connie Swain
Ruth McBride Nicole Lowande Laurie Tate
Marcia McClellan Denise Neusbaum Diana Tompkins
Charity Mullen
Karan Myers CAMDEN OFFICE MORTGAGE CENTER
Brenna Paradine Amy Dauer Lisa Holder
Janice Rider Tere Drake Sallie Massa
Susan Rzepka Kolene Dubendorf
Sophia Shafal Constance Grate
Amy Smale
Marlana Spaulding HILLSDALE OFFICE
Nancy Sprow Penny Clark
Howard Street Chris Hagaman
Betty Supak Kathy Miller
Catherine Usher Marjorie Powell
Patricia VanDyke Cheryl Zellman
Shirley Vaughan
Marnell Vincent BATTLE CREEK OFFICE
Julie Wright Valerie Campbell
Yvonne Case
Dawn Kenny
Sue O'Connell
Martin Philp
Bronwyn Robb
Jean-Marie Warren
32
Southern Michigan Bancorp, Inc. and Subsidiary
<PAGE> 35
[SOUTHERN MICHIGAN BANK & TRUST PHOTO]
[OPENING DOORS IN THE COMMUNITY]
In October, 1998, the new Hillsdale office of Southern Michigan Bank & Trust
opened its doors. The office is a portrayal of another way SMB&T has shown its
commitment to the community of Hillsdale and its citizens, our customers, to
provide the best service possible. We call it Quality Customer Service -
Southern Style.
"Our primary goal is to establish an atmosphere that causes our employees to
routinely deliver high quality service, which reinforces our claim that we are
the "innovation leader" in customer service. We intend to create a banking
office that is a 'model' for the bank of the future. It's interior will be
sales oriented and highly interpersonal. We'll take customer service to a level
that will differentiate us by its uniqueness - in terms of personal commitment
and style of presentation."
- - SMB&T Marketing Plan - Hillsdale, 1997
One of our goals in constructing the 4,300 square foot building was to make
financial services more accessible to our customers and community at large. The
architectural design of the Hillsdale office was created to provide a branch
environment that encourages relationship banking.
In recognition of our new Hillsdale office, the Hillsdale County Chamber of
Commerce and Marshburn/Bunkley Architect Associates presented the 1998
Architectural/Renovation Award to Southern Michigan Bank & Trust "whose efforts
in design, restoration and beautification enhanced and improved the appearance
of the community." We are humbled, but proud of the Chamber's recognition and
our contribution to the Hillsdale community.
As mentioned, the interior is sales oriented and highly interpersonal. The
implementation of the concept demanded that the staff be proactive in both sales
and service as well as be aware of the functionality of the branch as a whole.
This meant the Bank needed to commit to a higher level of staffing. To this end,
we added three positions to the staffing level at our new location.
The Hillsdale office provides the full array of banking services including home
equity loans. Stop by and say hello to our friendly staff. They'll be happy to
see you.
<PAGE> 36
[SOUTHERN MICHIGAN BANCORP, INC. LOGO]
51 W. Pearl St.
Coldwater, MI 49036
(517) 279-5500
<PAGE> 1
EXHIBIT (21)
SUBSIDIARY OF REGISTRANT
NAME OF SUBSIDIARY STATE OR COUNTY OF
- ------------------ INCORPORATION
------------------
Southern Michigan Bank & Trust Michigan
Southern Michigan Bancorp, Inc. is the immediate parent and owns 100% of the
outstanding shares of Southern Michigan Bank & Trust.
<PAGE> 1
EXHIBIT 23
[CROWE CHIZEK LOGO]
CONSENT OF INDEPENDENT AUDITORS
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 February 17, 1999 on the consolidated financial statements of
Southern Michigan Bancorp, Inc., which report is included in the 1998 Annual
Report on Form 10-K of Southern Michigan Bancorp, Inc.
/s/ Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
March 24, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME AS 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> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 16228
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 36138
<INVESTMENTS-CARRYING> 31756
<INVESTMENTS-MARKET> 32693
<LOANS> 163303
<ALLOWANCE> 2026
<TOTAL-ASSETS> 266851
<DEPOSITS> 233361
<SHORT-TERM> 0
<LIABILITIES-OTHER> 8557
<LONG-TERM> 5000
0
0
<COMMON> 4305
<OTHER-SE> 15628
<TOTAL-LIABILITIES-AND-EQUITY> 266851
<INTEREST-LOAN> 15781
<INTEREST-INVEST> 3399
<INTEREST-OTHER> 266
<INTEREST-TOTAL> 19446
<INTEREST-DEPOSIT> 7622
<INTEREST-EXPENSE> 8032
<INTEREST-INCOME-NET> 11414
<LOAN-LOSSES> 600
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 9276
<INCOME-PRETAX> 4734
<INCOME-PRE-EXTRAORDINARY> 4734
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3549
<EPS-PRIMARY> 1.87
<EPS-DILUTED> 1.87
<YIELD-ACTUAL> 5.50
<LOANS-NON> 343
<LOANS-PAST> 1088
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 3931
<ALLOWANCE-OPEN> 1863
<CHARGE-OFFS> 579
<RECOVERIES> 142
<ALLOWANCE-CLOSE> 2026
<ALLOWANCE-DOMESTIC> 1401
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 625
</TABLE>
