<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 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 under Section 12(b) of the Act: None
Securities Registered under Section 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 ask prices) held by
non-affiliates of the registrant as of March 1, 2000 was $36,039,382. For
purposes of this computation, all executive officers, directors and 5%
shareholders of the registrant have been assumed to be affiliates. Certain of
such persons may disclaim that they are affiliates of the registrant.
The number of shares outstanding of the registrant's common stock as of
March 1, 2000 was 1,958,498 shares.
<PAGE> 2
PART I
ITEM 1. BUSINESS
Overview
The registrant, Southern Michigan Bancorp, Inc. (the "Company"), is a
registered bank holding company incorporated under the laws of the State of
Michigan, headquartered in Coldwater, Michigan. The Company was formed in 1982
for the purpose of acquiring all of the outstanding shares of Southern Michigan
National Bank, which it did in November 1982. In December 1992, Southern
Michigan National Bank converted its charter to that of a Michigan state banking
corporation and changed its name to, Southern Michigan Bank & Trust (the
"Bank"), with its main office located at 51 West Pearl Street, Coldwater,
Michigan 49036. The Bank operates twelve (12) branch offices in the primarily
rural areas of Branch, Hillsdale, and Calhoun counties in southwestern Michigan.
In addition to the operations of the Bank described below, the Company owns and
leases certain real estate to the Bank and third parties (see Item 2. Properties
below); and SMB&T Financial Services, Inc., a subsidiary of the Bank, has been
established to provide insurance and investment services, which services are
currently limited to the sale of certain insurance products to the Bank. None of
such activities are significant to the operations of the Company
In February 2000, the Company and Sturgis Bank & Trust Company ("Sturgis")
entered into an Agreement and Plan of Consolidation pursuant to which Sturgis
will become a wholly-owned subsidiary of the Company. Sturgis shareholders will
receive .398 shares of the Company's common stock for each share of Sturgis'
common stock. The transaction is subject to normal regulatory approvals and the
approval of the shareholders of Sturgis. The transaction is expected to close in
the second half of 2000. Sturgis and the Bank will continue to operate as
stand-alone banks.
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
larger banks, which correspondent relationships concern check clearing
operations, transfer of funds, loan participations, 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.
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Supervision and Regulation
General
Bank holding companies and banks are highly regulated by both state and
federal agencies. As a bank holding company, the Company is subject to
supervision and regulation by the Federal Reserve Board ("FRB") pursuant to 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 as to be a proper incident thereto. The
BHCA requires a bank holding company to obtain the prior approval of the FRB
before acquiring a nonbanking company, or 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.
Under FRB regulations, the Company is required to serve as a source of
financial and managerial strength to the Bank and must conduct its operations in
a safe and sound manner.
The Bank is subject to regulation, supervision, and regular bank
examinations by the Federal Deposit Insurance Corporation (the "FDIC") and the
Michigan Financial Institutions Bureau (the "FIB"). The FIB is the Bank's
chartering authority and primary regulator. Under FIB and FDIC regulations, the
Bank is required to maintain reserves against its deposits and to maintain
certain levels of capital and surplus. In addition, the Bank is subject to
restrictions on the nature and amount of loans which may be made, the types and
amounts of investments it may make, and certain limitations on the payment of
dividends to its sole shareholder, the Company.
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 dividends to its shareholder. Under the
Michigan Banking Code of 1969, as amended (the "1969 Code") and the Michigan
Banking Code of 1999 (which became effective March 1, 2000 and repealed the 1969
Code), no dividend may be declared by the Bank in an amount greater than net
income 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 income of the Bank for the preceding 6 months in
the case of quarterly or semiannual dividends or not less than 10% of its net
profits for the preceding two consecutive 6 month periods in the case of annual
dividends. Dividends cannot be paid from the Bank's capital or surplus. Based on
the Bank's balance sheet as of December 31, 1999, the Bank could pay a dividend
to the Company in the amount of $3,752,000 without prior regulatory approval.
The payment of dividends by the Company and the Bank is also affected by
various regulatory requirements and policies, such as the requirement to
maintain adequate capital above regulatory guidelines. The "prompt corrective
action" provisions of the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") impose further restrictions on the payment of dividends by
insured banks which fail to meet specified capital levels and, in some cases,
their parent bank holding companies. FDICIA generally prohibits a depository
institution from making any capital distribution (including payment of a
dividend) or paying any management fee to its holding company if the depository
institution would thereafter be undercapitalized (see "Capital Requirements").
These regulations and restrictions may limit the Company's ability to obtain
funds
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<PAGE> 4
from the Bank for the Company's cash needs, including funds for acquisitions,
payments of dividends and interest, and the payment of operating expenses.
The FDIC may prevent an insured bank from paying dividends if the bank is
in default of payment of any assessment due to the FDIC. In addition, payment of
dividends by a bank may be prevented by the applicable federal regulatory
authority if such payment is determined, by reason of the financial condition of
such bank, to be an unsafe and unsound banking practice. The Federal Reserve
Board has issued a policy statement providing that bank holding companies and
insured banks should generally only pay dividends out of current operating
earnings.
Federal Regulation
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.
Gramm-Leach-Bliley
Enacted late in 1999, the Gramm-Leach-Bliley Act ("Gramm-Leach-Bliley"),
broadens the scope of financial services that banks may offer to consumers,
essentially removing the barriers erected during the Depression that separated
banks and securities firms, closes the loophole which permitted commercial
enterprises to own and operate a thrift institution, and provides some new
consumer protections with respect to privacy issues and ATM usage fees.
Gramm-Leach-Bliley permits affiliations between banks, securities firms and
insurance companies (which affiliations were previously prohibited under the
Glass-Steagall Act). Under Gramm-Leach-Bliley, a bank holding company may
qualify as a financial holding company and thereby offer expanded range of
financial oriented products and services which products and services may not be
offered by bank holding companies. To qualify as a financial holding company, a
bank holding company's subsidiary depository institutions must be well-managed,
well-capitalized and have received a "satisfactory" rating on its latest
examination under the Community Reinvestment Act. Gramm-Leach-Bliley provides
for some regulatory oversight by the Securities and Exchange Commission for bank
holding companies engaged in certain activities, and reaffirms that insurance
activities are to be regulated on the state level. States, however, may not
prevent depository institutions and their affiliates from engaging in insurance
activities. Commercial enterprises are no longer able to establish or acquire a
thrift institution and thereby become a unitary thrift holding company. Thrift
institutions may only be established or acquired by financial organizations.
Gramm-Leach-Bliley provides new consumer protections with respect to the
transfer and use of a consumer's nonpublic personal information and generally
enables financial institution customers to "opt-out" of the dissemination of
their personal financial information to unaffiliated third parties. ATM
operators who charge a fee to non-customers for use of its ATM must disclose the
fee on a sign placed on the ATM and before the transaction is made as a part of
the on-screen display or by a paper notice issued by the machine.
Riegle-Neal
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 FRB is now generally authorized to approve bank acquisitions by
out-of-state bank holding
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<PAGE> 5
companies that are adequately capitalized and managed irrespective of the
permissibility of such acquisition under state law, but subject to any state
requirement that the bank has been organized and operating for a minimum period
of time, not to exceed five (5) years.
Each State is permitted to prohibit interstate branch acquisitions (i.e.,
acquisition of a branch without acquisition of the entire target bank or the
establishment of de novo branches) and to examine acquired and de novo branches
of out-of-state banks with respect to compliance with certain host State laws.
FDICIA
In December 1991, FDICIA was enacted, substantially revising the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and
making revisions to several other federal banking statutes. Among other things,
FDICIA requires the federal banking agencies to take "prompt corrective action"
in respect of depository institutions that do not meet minimum capital
requirements. FDICIA establishes five capital tiers: "well-capitalized,"
"adequately capitalized," "undercapitalized," "significantly under capitalized"
and "critically undercapitalized." A depository institution's capital tier will
depend upon where its capital levels are in relation to various relevant capital
measures, which will include a risk-based capital measure and a leverage ratio
capital measure, and certain other factors. The Bank is considered to be
well-capitalized.
FDICIA also contains a variety of other provisions that may affect the
operations of depository institutions including new reporting requirements,
regulatory standards for real estate lending, "truth in savings" provisions, the
requirement that a depository institution give 90 days prior notice to customers
and regulatory authorities before closing any branch and a prohibition on the
acceptance or renewal of brokered deposits by depository institutions that are
not well capitalized or are adequately capitalized and have not received a
waiver from the FDIC.
FIRREA
Under the Financial Institutions Reform and Recovery and Enforcement Act of
1989 ("FIRREA"), a depository institution insured by the FDIC is liable for any
loss incurred by, or reasonably expected to be incurred by, the FDIC in
connection with (i) the default of a commonly controlled FDIC-insured depository
institution, or (ii) any assistance provided by the FDIC to any commonly
controlled FDIC-insured depository institution "in danger of default." "Default"
is defined generally as the appointment of a conservator or receiver and "in
danger of default" is defined as the existence of certain conditions indicating
that a default is likely to occur in the absence of regulatory assistance.
Transactions with Affiliates and Insiders
The Bank and the Company are affiliates of each other and, as such, are
subject to certain federal restrictions with respect to loans and extensions of
credit to the Company and other Company affiliates, investments in the Company's
and its affiliates' securities, acceptance of such securities as collateral for
loans to any borrowers, and leases, services and other agreements between the
Bank and the Company. Additionally, regulations allow a bank to extend credit to
the bank's and its affiliates' executive officers, directors and principal
shareholders or their related interests, only if the loan is made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with non-insiders, and if
credit underwriting standards are followed that are no less stringent than those
applicable to comparable transactions with non-insiders. Moreover, loans to
insiders must not involve more than the normal risk of repayment or present
other unfavorable features and must in certain circumstances be approved in
advance by a majority of the entire board of directors of the Bank. The
aggregate amount that can be lent to all insiders is limited to the Bank's
unimpaired capital and surplus.
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<PAGE> 6
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. 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, 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. The Bank has been given the designation of
well managed and well capitalized. As a result of such classification, the Bank
pays the lowest assessment rate possible to the FDIC. In 1997, the Bank began
making payments to the FDIC for certain Financing Corporation ("FICO") Bonds
that had been previously issued. 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, 1999, the Company's Total Capital to
risk-weighted assets was 12.0 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, 1999 was 8.4 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
applicable to bank holding companies. At December 31, 1999, the Bank met all
applicable capital requirements.
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.
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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, 1999, 141 persons were employed by the Bank; 123 were
full time employees and 18 were part time employees.
Selected Statistical Information
The following tables describe certain aspects of the Company's business in
statistical form.
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I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL
The following are the average balance sheets for the years ending December 31:
(Dollars in Thousands)
<TABLE>
<CAPTION>
1 9 9 9 1 9 9 8
------------------------------------- --------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
-------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
Loans (A) (B) (C) $ 178,906 $ 16,606 9.3% $ 160,666 $ 15,816 $ 9.8%
Taxable investment securities (D) 35,784 2,235 6.2 32,449 2,305 7.1
Tax-exempt investment
securities (A) 22,716 1,715 7.6 22,342 1,657 7.4
Federal funds sold 2,154 107 5.0 4,782 266 5.6
---------- --------- ---------- ------
Total interest earning assets 239,560 20,663 8.6 220,239 20,044 9.1
Non-interest earning assets:
Cash and due from banks 12,679 15,591
Other assets 18,028 16,415
Less allowance for loan loss (2,161) (1,955)
---------- ----------
Total assets $ 268,106 $ 250,290
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits $ 77,664 $ 2,482 3.2% $ 74,154 $ 2,440 3.3%
Savings deposits 45,722 1,496 3.3 44,356 1,509 3.4
Time deposits 73,553 3,760 5.1 68,177 3,673 5.4
Federal funds purchased 2,044 97 4.7 - - -
Other borrowings 9,716 600 6.2 6,146 410 6.7
--------- --------- ---------- ---------
Total interest bearing
liabilities 208,699 8,435 4.0 192,833 8,032 4.2
Non-interest bearing liabilities:
Demand deposits 32,982 30,570
Other 1,261 1,124
Common stock subject to
repurchase obligation 5,009 5,464
Shareholders' equity 20,155 20,299
---------- ----------
Total liabilities and
shareholders' equity $ 268,106 $ 250,290
========== ==========
Net interest earnings $ 12,228 $ 12,012
========= =========
Net yield on interest
earning assets 5.1% 5.5%
===== =====
</TABLE>
<TABLE>
<CAPTION>
1 9 9 7
---------------------------------------
Average Yield/
Balance Interest Rate
--------- -------- ----
<S> <C> <C> <C>
ASSETS
Interest earning assets:
Loans (A) (B) (C) $ 158,193 $ 15,593 9.9%
Taxable investment securities (D) 33,538 2,189 6.5
Tax-exempt investment
securities (A) 16,864 1,253 7.4
Federal funds sold 1,357 74 5.5
----------- ---------
Total interest earning assets 209,952 19,109 9.1
Non-interest earning assets:
Cash and due from banks 10,442
Other assets 14,871
Less allowance for loan loss (1,866)
-----------
Total assets $ 233,399
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Demand deposits $ 63,856 $ 2,163 3.4%
Savings deposits 43,505 1,485 3.4
Time deposits 67,993 3,612 5.3
Federal funds purchased 784 42 5.4
Other borrowings 1,404 141 10.0
----------- ---------
Total interest bearing
liabilities 177,542 7,443 4.2
Non-interest bearing liabilities:
Demand deposits 30,004
Other 1,355
Common stock subject to
repurchase obligation 4,227
Shareholders' equity 20,271
-----------
Total liabilities and
shareholders' equity $ 233,399
===========
Net interest earnings $ 11,666
=========
Net yield on interest
earning assets 5.6%
=====
</TABLE>
(A) Includes tax equivalent adjustment of interest (assuming a 34% tax rate)
for securities and loans of $583,000 and $29,000, respectively for 1999;
$563,000 and $35,000, respectively for 1998; and $392,000 and $48,000
respectively for 1997.
(B) Average balance includes average nonaccrual loan balances of $593,000 in
1999; $815,000 in 1998; and $500,000 in 1997.
(C) Interest income includes loan fees of $663,000 in 1999; $563,000 in 1998;
and $617,000 in 1997.
(D) Average balance includes average unrealized gain (loss) of $(104,000)
in 1999; $128,000 in 1998; and $(13,000) in 1997 on available for sale
securities. The yield was calculated without regard to this average
unrealized gain (loss).
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I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL (CONTINUED)
(Dollars in Thousands)
The following table sets forth for the periods indicated a summary of changes in
interest income and interest expense, based upon a tax equivalent basis,
resulting from changes in volume and changes in rates:
Volume Variance - change in volume multiplied by the previous year's rate.
Rate Variance - change in rate multiplied by the previous year's volume.
Rate/Volume Variance - change in volume multiplied by the change in rate. This
variance was allocated to volume variance and rate variance in proportion to the
relationship of the absolute dollar amount of the change in each.
Interest on non-taxable securities has been adjusted to a fully tax equivalent
basis using a statutory tax rate of 34% in 1999, 1998 and 1997.
<TABLE>
<CAPTION>
1999 Compared to 1998 1998 Compared to 1997
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 $ 1,727 $ (937) $ 790 $ 243 $ (20) $ 223
Taxable investment securities 224 (294) (70) (73) 189 116
Tax-exempt investment securities 28 30 58 406 (2) 404
Federal funds sold (133) (26) (159) 190 2 192
-------- ------- ------ ------ ------ ------
Total interest earning assets $ 1,846 $(1,227) $ 619 $ 766 $ 169 $ 935
======== ======= ====== ====== ====== ======
Interest expense on:
Demand deposits $ 113 $ (71) $ 42 $ 340 $ (63) $ 277
Savings deposits 46 (59) (13) 29 (5) 24
Time deposits 281 (194) 87 10 51 61
Federal funds purchased 97 - 97 (42) - (42)
Other borrowings 222 (32) 190 331 (62) 269
--------- --------- ------ ------ ------ ------
Total interest bearing liabilities $ 759 $ (356) $ 403 $ 668 $ (79) $ 589
========= ========= ====== ====== ====== ======
Net interest income $ 1,087 $ (871) $ 216 $ 98 $ 248 $ 346
========= ========= ====== ====== ====== ======
</TABLE>
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II. INVESTMENT PORTFOLIO
(Dollars in Thousands)
The following table sets forth the fair value and amortized cost of securities
at December 31:
<TABLE>
<CAPTION>
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
Fair Amortized Fair Amortized Fair Amortized
Value Cost Value Cost Value Cost
----- ---- ----- ---- ----- ----
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Government agencies
and corporations $ 15,541 $ 15,885 $ 9,087 $ 9,087 $ 6,262 $ 6,262
States and political subdivisions 28,411 28,529 37,903 37,006 20,885 20,560
Corporate securities 6,172 6,203 15,942 15,902 15,590 15,564
Other securities 4,105 4,201 5,899 5,899 2,688 2,688
--------- --------- --------- -------- -------- ---------
Total investment securities $ 54,229 $ 54,818 $ 68,831 $ 67,894 $ 45,425 $ 45,074
========= ========= ========= ======== ======== =========
</TABLE>
The following table sets forth the amortized cost of securities by maturity (or
anticipated call date, if earlier) and weighted average yield for each range of
maturities at December 31, 1999:
<TABLE>
<CAPTION>
-----------------------------------Maturing-----------------------------------
Within One Year 1 to 5 Years 5 to 10 Years After 10 Years
----------------- ------------ ------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Government agencies
and corporations $ 5,031 5.64% $ 10,854 5.53% $ - -% $ - -%
States and political subdivisions (1) 9,197 5.19 16,183 5.57 3,109 5.85 40 6.10
Corporate securities 2,850 6.26 3,353 6.56
Other securities 654 5.64 2,155 5.36 469 5.73 923 8.63
--------- -------- -------- ------
Total (1) $ 17,732 5.45% $ 32,545 5.63% $ 3,578 5.83% $ 963 8.63%
========= ===== ======== -==== ======== ===== ====== ====
</TABLE>
(1) Yields are not presented on a tax-equivalent basis.
The weighted average interest rates are based on coupon rates for securities
purchased at par value and on effective interest rates considering amortization
or accretion if the securities were purchased at a premium or discount.
Except as indicated and for U.S. Treasury and other U.S. Government agencies,
total securities of any state (including all its political subdivisions) were
less than 10% of shareholders' equity. At year-end 1999 and 1998, the amortized
cost of securities issued by the state of Michigan and all its political
subdivisions totaled $13,114,000 and $19,883,000 with an estimated market value
of $13,132,000 and $20,729,000, respectively.
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<PAGE> 11
III. LOAN PORTFOLIO
(Dollars in Thousands)
Types of Loans
The following table sets forth the classification of loans by major category at
December 31:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial, financial, and
agricultural $ 96,758 $ 82,533 $ 74,819 $ 72,108 $ 51,940
Real estate mortgage (1) 63,423 51,567 50,057 47,561 41,293
Installment 33,190 29,203 33,865 33,009 30,004
----------- ----------- ----------- ----------- -----------
Total loans $ 193,371 $ 163,303 $ 158,741 $ 152,678 $ 123,237
=========== =========== =========== =========== ===========
</TABLE>
(1) Includes loans held for sale
Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table sets forth the maturities of the loan portfolio at December
31, 1999. Also provided are the amounts due after one year classified according
to interest rate sensitivity.
<TABLE>
<CAPTION>
Within 1 1 to 5 After 5
Year (A) Years Years Total
-------- ----- ----- -----
<S> <C> <C> <C> <C>
Commercial, financial, and agricultural $ 34,461 $ 38,999 $ 23,298 $ 96,758
Real estate mortgages 6,431 1,935 55,057 63,423
Installment 1,816 18,096 13,278 33,190
----------- ----------- ----------- -----------
Total $ 42,708 $ 59,030 $ 91,633 $ 193,371
=========== =========== =========== ===========
Loans maturing after one year with:
Fixed interest rates $ 44,786 $ 23,127
Variable interest rates 14,244 68,506
----------- -----------
Total $ 59,030 $ 91,633
=========== ===========
</TABLE>
(A) Amounts include demand loans, loans having no stated schedule of
repayments, or no stated maturity and overdrafts.
11
<PAGE> 12
III. LOAN PORTFOLIO (CONTINUED)
Non-Performing Loans
Non performing loans include impaired loans, nonaccrual 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
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Non accrual loans:
Commercial, financial and
agricultural $ 306 $ 343 $ 1,026 $ 448 $ 380
Real estate mortgage 23 - - - 24
Installment - - 61 2 40
----------- ----------- ----------- ----------- -----------
329 343 1,087 450 444
Loans contractually past due 90 days
or more:
Commercial, financial, and
agricultural 432 807 1,067 82 353
Real estate mortgage 134 161 630 129 56
Installment 34 120 966 165 4
----------- ----------- ----------- ----------- -----------
600 1,088 2,663 376 413
----------- ----------- ----------- ----------- -----------
Total $ 929 $ 1,431 $ 3,750 $ 826 $ 857
=========== =========== =========== =========== ===========
Percent of total loans outstanding .48% .88% 2.36% .54% .70%
=========== =========== =========== =========== ===========
</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 $9,000 and $19,000 was realized on nonaccrual loans during 1999 and
1998, respectively. Under original terms for these loans, interest income which
would have been recorded approximates $50,000 and $91,000 in 1999 and 1998,
respectively. There are no loan commitments outstanding to extend credits to
these customers.
Potential Problem Loans
At December 31, 1999, the Company had approximately $2,683,000 in commercial,
financial, 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.
12
<PAGE> 13
IV. SUMMARY OF LOAN LOSS EXPERIENCE
(Dollars in Thousands)
The following table sets forth changes in the allowance for loan losses:
<TABLE>
<CAPTION>
Year Ended December 31
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $ 2,026 $ 1,863 $ 1,814 $ 1,609 $ 1,498
Charge offs:
Commercial, financial and agricultural (505) (227) (122) (13) (87)
Installment (492) (352) (386) (157) (124)
Real estate (53) - - - -
--------- --------- -------- -------- ---------
(1,050) (579) (508) (170) (211)
Recoveries:
Commercial, financial and agricultural 171 41 31 43 43
Installment 132 101 66 62 54
Real estate 1 - - 3 3
--------- --------- -------- -------- ---------
304 142 97 108 100
--------- --------- -------- -------- ---------
Net charge offs (746) (437) (411) (62) (111)
Provision for loan losses 852 600 460 267 222
--------- --------- -------- -------- ---------
Balance at end of year $ 2,132 $ 2,026 $ 1,863 $ 1,814 $ 1,609
========= ========= ======== ======== =========
Average loans outstanding $ 178,906 $ 160,666 $158,193 $137,273 $ 123,684
========= ========= ======== ======== =========
Ratio of net charge offs to average loans outstanding .42% .27% .26% .05% .09%
======= ========= ======== ======== =========
</TABLE>
13
<PAGE> 14
IV. SUMMARY OF LOAN LOSS EXPERIENCE (CONTINUED)
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 risk
which might be allocated to the respective loan categories.
The following table sets forth the allocation of the allowance for loan losses
at December 31:
<TABLE>
<CAPTION>
--------1 9 9 9-------- --------1 9 9 8-------- --------1 9 9 7---------
------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category Category Category
Of Total Of Total Of Total
Allowance Loans Allowance Loans Allowance Loans
Commercial, financial and agricultural $ 924 50.0% $ 777 50.5% $ 628 47.1%
Real estate mortgage 127 32.8 103 31.6 98 31.0
Installment 601 17.2 521 17.9 321 21.9
Unallocated 480 - 625 - 816 -
--------- ------- --------- ------- --------- ------
$ 2,132 100.0% $ 2,026 100.0% $ 1,863 100.0%
========= ======= ========= ======= ========= ======
</TABLE>
<TABLE>
<CAPTION>
---------1 9 9 6--------- ---------1 9 9 5---------
------- -------
<S> <C> <C> <C> <C>
Percent of Percent of
Loans in Loans in
Each Each
Category Category
Of Total Of Total
Commercial, financial and agricultural Allowance Loans Allowance Loans
Real estate mortgage
Installment $ 351 47.2% $ 313 42.1%
Unallocated 95 31.2 83 33.5
177 21.6 157 24.4
1,191 - 1,056 -
--------- ------- --------- -------
$ 1,814 100.0% $ 1,609 100.0%
========= ======= ========= =======
</TABLE>
The allowance for loan losses is maintained at a level which, in management's
opinion, is adequate to absorb loan losses in the portfolio. In assessing the
adequacy of the allowance, management reviews the characteristics of the loan
portfolio in order to determine overall quality and risk profiles. 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 provision increased from 1995 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 1999 and 1998 provisions increased to provide for higher charge-offs and
delinquencies, primarily as a result of increased customer bankruptcies. Net
commercial loan charge-offs totaled $334,000 in 1999; $267,000 of this was
attributable to three commercial borrowers that discontinued business operations
during 1999.
14
<PAGE> 15
V. DEPOSITS
(Dollars in Thousands)
The following table sets forth the average amount of deposits and rates paid for
deposits for the years ended December 31:
<TABLE>
<CAPTION>
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
Amount Rate Amount Rate Amount Rate
<S> <C> <C> <C> <C> <C> <C>
Non interest bearing demand deposits $ 32,982 $ 30,570 $ 30,004
Interest bearing demand deposits 77,664 3.2% 74,154 3.3% 63,856 3.4%
Savings deposits 45,722 3.3 44,356 3.4 43,505 3.4
Time deposits 73,553 5.1 68,177 5.4 67,993 5.3
--------- --------- ---------
$ 229,921 $ 217,257 $ 205,358
========= ========= =========
</TABLE>
The following table sets forth as of December 31, 1999, the aggregate amount of
outstanding deposits (certificates of deposit) of $100,000 or more by maturity
(in thousands of dollars):
<TABLE>
<S> <C>
Three months or less $ 8,858
Over three months through six months 5,686
Over six months through twelve months 3,850
Over twelve months 4,719
----------
$ 23,113
==========
</TABLE>
VI. RETURN ON EQUITY AND ASSETS
The following table sets forth consolidated operating and capital ratios for the
years ended December 31:
<TABLE>
<CAPTION>
1 9 9 9 1 9 9 8 1 9 9 7
------- ------- -------
<S> <C> <C> <C>
Return on average assets 1.23% 1.42% 1.30%
Return on average equity (1) 16.37 17.48 14.96
Dividend payout ratio (2) 41.61 35.56 36.58
Average equity to average assets (1) 7.52 8.11 8.69
</TABLE>
(1) Average equity used in the above table excludes common stock subject to
repurchase obligation but includes average unrealized appreciation or
depreciation on securities available for sale.
(2) Dividends declared divided by net income.
15
<PAGE> 16
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 Company 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 Company's and the Bank's facilities are maintained in good
condition and are adequately insured. Management of Company 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 Company 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 Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
<PAGE> 17
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is regularly quoted on the OTC Bulletin
Board (OTCBB). The bid prices described below are quotations reflecting
inter-dealer prices, without retail markup, markdown or commissions, and may not
necessarily represent actual transactions. There were 469 shareholders of record
at February 29, 2000.
The following table sets forth the range of high and low bid
information and dividends declared for the Company's two most recent fiscal
years:
<TABLE>
<CAPTION>
1999 1998
------------------------------------------ -------------------------------------------
BID PRICE CASH BID 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 $ 33.08 $ 27.00 $ .16 $ 37.80 $ 30.60 $ .13
June 30 32.40 27.23 .17 46.13 37.13 .13
September 30 29.70 26.10 .17 40.50 37.13 .15
December 31 30.60 27.23 .18 37.80 29.48 .19
</TABLE>
There are restrictions that currently limit the Company's ability to pay cash
dividends. Information regarding dividend payment restrictions is described in
Note L to the consolidated financial statements for the year ended December 31,
1999.
All market price per share amounts have been adjusted for a 10% stock dividend
declared in 1999.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31
1999 1998 1997 1996 1995
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total interest income $ 20,051 $ 19,446 $ 18,669 $ 16,787 $ 15,476
Net interest income 11,616 11,414 11,226 10,183 9,096
Provision for loan losses 852 600 460 267 222
Net income 3,300 3,549 3,032 3,058 2,615
Per share data:
Basic and diluted earnings per share 1.64 1.70 1.44 1.46 1.27
Cash dividends .68 .60 .52 .48 .45
Balance sheet data:
Other borrowings 15,000 5,000 3,000 - -
Capital note - - - - 1,000
Common stock subject to repurchase 3,990 6,029 4,899 3,555 2,232
Equity 19,990 19,345 20,590 19,616 18,497
Total assets 275,825 266,851 238,531 235,562 209,977
Return on average assets 1.23% 1.42% 1.30% 1.45% 1.31%
Return on average equity 16.37% 17.48% 14.96% 16.09% 14.64%
</TABLE>
All per share amounts have been adjusted for a 10% stock dividend declared in
1999, a 1997 stock split effected in the form of a 100% stock dividend and a 2
for 1 stock split in 1995.
17
<PAGE> 18
ITEM 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. The
analysis should be read in conjunction with such financial statements.
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 18.4% in 1999 and 2.9% in 1998. The loan growth occurred in
all loan categories and is the result of continued good economic conditions
within the Company's market area. Commercial loans increased 17.2% as local
businesses expanded to meet the growth demands of the region. Consumer loans
increased 13.7% as the Bank competitively priced its boat and recreational
vehicle loans and offered dealer incentives to obtain such loans. Real estate
mortgage loans increased 23.0% as the Bank engaged in a home equity loan
promotion and offered an attractive short-term fixed rate mortgage loan product.
Gains recognized on the sale of real estate mortgage loans to the
secondary market decreased in 1999 from $1,085,000 in 1998 to $758,000. The
secondary market loan activity declined in 1999 as mortgage rates increased and
the refinancing activity of 1998 declined. Loans held for sale at December 31,
1999 were $991,000. The real estate portfolio largely consists of residential
mortgages within the local area with a low risk of loss.
The loan growth in 1998 occurred in commercial loans, which increased
by 10.3% as local businesses expanded and took advantage of lower interest
rates. Consumer loans declined in 1998 as a result of competition from both
financial and non-financial companies which offer borrowers other low cost
financing options. The real estate portfolio increased primarily due to the
offering of competitive home equity products.
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 $37,949,000 and $31,175,000 at December 31,
1999 and 1998, respectively. Most of these commitments 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 or industry. However, substantially all loans are granted to customers
primarily in Southern Michigan.
Another significant component of cash flow is the securities portfolio.
Total securities decreased by 20.1% in 1999 and increased by 50.6% in 1998. The
funds received from maturing securities were used to fund the 1999 loan growth
since the Bank was not able to fund this growth with deposits. The 1998 increase
is the result of a significant increase in deposits.
The available-for-sale portfolio had net unrealized losses of $589,000
in 1999 and gains of $394,000 in 1998. During 1999, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities" and transferred the entire
portfolio of held to maturity securities to available for sale. The transfer was
done so that the securities would be available to sell should the Company's
liquidity needs require it. None of these securities were sold during 1999.
There is no concentration of securities in the portfolio which would constitute
an unusual risk except at year-end 1999 and
18
<PAGE> 19
1998, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $13,114,000 and $19,883,000 with an estimated
market value of $13,132,000 and $20,729,000, respectively.
Deposits traditionally represent the Company's principal source of
funds. Total deposits remained stable in 1999 and increased 12.7% in 1998. The
Bank was not able to increase its deposit base in 1999 because of increased
competition within the Bank's market area. Local competitors have offered
premium rates for deposits and the Bank has chosen not to match such rates. Also
contributing to the lack of deposit growth was an increase in customer cash
withdrawals late in the year in preparation for the Year 2000 rollover. The 1998
increase in deposits is the result of a complete overhaul of the Bank's personal
checking accounts which 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 opened secondary accounts to
supplement their new checking accounts.
Attracting and keeping traditional deposit relationships will continue
to be a challenge to the Bank, particularly with the increased competition from
nondeposit products. As an alternate funding source, the Bank obtains putable
advances from the Federal Home Loan Bank (FHLB) of Indianapolis. The advances
are 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, U.S. Treasury and Government agencies and highly rated private
mortgage-backed securities. FHLB advances can be a less expensive way to obtain
longer term funds than paying a premium for long term deposits.
Premises and equipment decreased by 4.7% in 1999 and increased by 25.9%
in 1998. The 1999 decrease was due to a lack of significant additions and
increased depreciation because of the high level of additions in 1998. 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. In 2000, the Bank will spend approximately $2,300,000 to
renovate the Coldwater main office and the Beckley Road office.
On February 15, 2000, the Company announced that it had agreed to merge
with Sturgis Bank & Trust Company of Sturgis, Michigan ("Sturgis"). The
transaction is anticipated to be a tax-free exchange. It is subject to
regulatory approvals and approval by the shareholders of Sturgis, and is
anticipated to be effective the second half of 2000. The exchange ratio is .398
shares of the Company's common stock for one share of Sturgis' common stock.
CAPITAL RESOURCES
The Company maintains a strong capital base to take advantage of
business opportunities while ensuring that it has resources to absorb the risks
inherent in the business.
The Federal Reserve Board (FRB) has imposed risk-based capital
guidelines applicable to the Company. These guidelines require that bank holding
companies maintain capital commensurate with both on and off balance sheet
credit risks of their operations. Under the guidelines, a bank holding company
must have a minimum ratio of total capital to risk-weighted assets of 8 percent.
In addition, a bank holding company must maintain a minimum ratio of Tier 1
capital equal to 4 percent of risk-weighted assets. Tier 1 capital includes
common shareholders' equity, qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries less goodwill.
As a supplement to the risk-based capital requirements, the FRB has
also adopted leverage capital ratio requirements. The leverage ratio
requirements are intended to insure that adequate capital is maintained against
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
19
<PAGE> 20
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 FASB Statement 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 O to the financial
statements. The ratios include the common stock subject to repurchase obligation
in the Company's employee stock ownership plan (ESOP) and the unearned ESOP
shares. As seen in Note O, 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 1999 and 1998, total average assets grew 7.1% and 7.2%. At
the same time, average equity (including common stock held by the ESOP)
decreased 2.3% in 1999 and increased 5.2% in 1998. Equity grew at lower levels
than assets in both 1999 and 1998 because of the repurchase and retirement of
common stock shares (82,442 shares in 1999 and 51,079 in 1998). Future growth
opportunities will focus on maintaining the existing customer base and growing
within selected other markets identified as providing significant growth
potential.
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 $17,732,000
at December 31, 1999 representing 32.7% of the amortized cost of the investment
securities portfolio, a decrease from the 43.4% level of 1998. Loans maturing
within 1 year were $42,708,000 at December 31, 1999 representing 22.1% of the
loan portfolio, a slight decrease from the 23.2% level of 1998.
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, 1999, there was a net decrease in
cash and cash equivalents of $4,182,000. The major sources of cash in 1999 were
loan sales and maturing securities. The major uses of cash in 1999 were loan
growth and loans originated for sale.
During the year ended December 31, 1998, there was a net decrease in
cash and cash equivalents. of $620,000. The major sources of cash in 1998 were
loan sales and the increase in deposits. The major uses of cash in 1998 were the
purchase of investment securities and loans originated for sale.
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.
20
<PAGE> 21
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. State law also places restrictions on the
payment of dividends by the Bank to the Company. Note L to the Consolidated
Financial Statements discusses these dividend limitations.
Interest rate risk arises when the maturity or repricing
characteristics of assets differ significantly from the maturity or the
repricing characteristics of liabilities. Accepting this risk can be an
important source of profitability and shareholder value, however excessive
levels of interest rate risk could pose a significant threat to the Company's
earnings and capital base. Accordingly, effective risk management that maintains
interest rate risk at prudent levels is essential to the Company's safety and
soundness.
The Company measures the impact of changes in interest rates on net
interest income through a comprehensive analysis of the Bank's interest rate
sensitive assets and liabilities. Interest rate sensitivity varies with
different types of interest-earning assets and interest-bearing liabilities.
Overnight federal funds and mutual funds on which 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, 1999:
<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 $ 54,348 $ 6,439 $ 56,815 $ 108,904 $ 21,749
Interest-bearing liabilities 53,968 84,526 42,013 25,260 10,000
----------------------------------------------------------------------
Interest sensitivity gap $ 380 $ (78,087) $ 14,802 $ 83,644 $ 11,749
======================================================================
</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 1.8% in 1999, 1.7% in 1998 and 10.2% in 1997. The
1999 increase is due to the reinvestment of funds held in the investment
securities portfolio
21
<PAGE> 22
into the higher yielding loan portfolio, partially offset by increased interest
expense as a result of increased FHLB advances. The 1998 increase is due to the
reinvestment of funds held in overnight federal funds accounts into higher
yielding investment securities. The 1997 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 2000. Depending on these interest rate fluctuations, there may be continued
market pressure to raise deposit rates in 2000 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 rate decreases 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 potential losses
in the loan portfolio. Some factors considered by management in determining the
level at which the allowance is maintained include specific credit reviews, past
loan loss experience, current economic conditions and trends, results of
examinations by regulatory agencies and the volume, growth and composition of
the loan portfolio.
The provision for loan losses was $852,000 in 1999, $600,000 in 1998
and $460,000 in 1997. The 1999 provision increase occurred to provide for loan
growth and increased charge-offs, primarily as a result of increased customer
bankruptcies. Net commercial loan charge-offs totaled $334,000 in 1999; $267,000
of this was attributable to three commercial borrowers that discontinued
business operations during 1999. 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. It is anticipated that the Company will continue to
experience higher than normal losses in 2000. 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, decreased by
5.4% in 1999 and increased by 30.2% in 1998 and 15.2% in 1997. The 1999 decrease
is due primarily to a decline in gains recognized on the sale of real estate
mortgage loans to the secondary market. 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 time
of the sale and receives a fee in order to service the loans. As fixed rate
mortgage rates increased in 1999, the number of new loans and refinancing
activities declined.
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. During this period of relatively low interest
rates, the Bank generated large volumes of fixed rate mortgage loans which were
sold to the secondary market. 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 nondepository 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
22
<PAGE> 23
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.
Security gains of $5,000 were recognized in 1997. No sales occurred in
1999 or 1998.
Non-interest expense increased by 2.2% in 1999, 1.8% in 1998 and 16.0%
in 1997. In 1999, salaries and benefit expenditures increased as additional loan
department employees were added to assist with the increased loan volume.
Occupancy and equipment costs were higher in 1999 as a result of the addition of
the new Hillsdale branch and its equipment additions, increasing maintenance on
the Bank's older properties and technological upgrades to the Bank's mainframe
and personal computers. Professional and outside services were higher in 1999 as
a result of increased usage of consultants for general bank consulting purposes.
Advertising and marketing expenses were down for 1999 as a result of higher
expenses paid to promote the Bank's new checking product in 1998.
The primary expense categories that increased in 1998 were occupancy
and equipment and professional and outside services. Occupancy and equipment
costs increased as a result of the opening of the new Hillsdale branch and
continued upgrades to the Bank's technology base. Professional and outside
services increased as a result of increased usage of consultants for general
bank consulting purposes.
The 1997 increase was due to additional personnel costs, occupancy and
equipment costs, advertising and marketing 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.
Income tax expense was $1,005,000 in 1999, $1,185,000 in 1998 and
$1,085,000 in 1997. Tax-exempt income continues to have a major impact on the
Company's tax expense. The lower coupon rate on municipal instruments is offset
by 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 $358,000 in 1999, $350,000 in 1998 and $254,000 in 1997.
Results of operations can be measured by various ratio analyses. Two
widely recognized performance indicators are the return on equity and the return
on assets. The Company's return on average equity was 16.4% in 1999, 17.5% in
1998 and 15.0% in 1997. The return on average assets was 1.2% in 1999, 1.4% in
1998 and 1.3% in 1997.
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.
23
<PAGE> 24
YEAR 2000
The Company had a successful Year 2000 rollover. The Company has not
experienced any significant Year 2000 problems as a result of the rollover, and
is not aware of any customers that have experienced material Year 2000 problems.
This success can be attributed to the fact that the Company began addressing
Year 2000 issues in mid 1997. The Company followed a plan to identify all
critical business processes and established a priority schedule for assessment
of each process. As the Company worked through its Year 2000 plan, any hardware,
software, equipment or vendor provided services that were identified as not Year
2000 compliant were either upgraded or retired. While no Year 2000 problems have
been identified to date, monitoring will continue for most of 2000 to assure
that all Year 2000 issues have been addressed.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, accruing loans past due
90 days or more, and other real estate which includes foreclosures and deeds in
lieu of foreclosure.
A loan generally is classified as nonaccrual when full collectibility
of principal or interest is doubtful or a loan becomes 90 days past due as to
principal or interest, unless management determines that the estimated net
realizable value of the collateral is sufficient to cover the principal balance
and accrued interest. When interest accruals are discontinued, unpaid interest
credited to income in the current year is reversed, and unpaid interest accrued
in prior years is charged to the allowance for loan losses. Nonperforming loans
are returned to performing status when the loan is brought current and has
performed in accordance with contract terms for a period of time.
The following table sets forth the aggregate amount of nonperforming
loans in each of the following categories:
<TABLE>
<CAPTION>
December 31
1999 1998 1997
-------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual loans:
Commercial, financial and agricultural $ 306 $ 343 $ 1,026
Real estate mortgage 23 - -
Installment - - 61
---------------------------------------------
329 343 1,087
Loans contractually past due 90 days or more:
Commercial, financial and agricultural 432 807 1,067
Real estate mortgage 134 161 630
Installment 34 120 966
---------------------------------------------
600 1,088 2,663
---------------------------------------------
Total nonperforming loans 929 1,431 3,750
Other real estate owned 4 166 103
---------------------------------------------
Total nonperforming assets $ 933 $ 1,597 $ 3,853
---------------------------------------------
Nonperforming loans to year-end loans .48% .88% 2.36%
=== === ====
Nonperforming assets to year-end loans
and other real estate owned .48% .98% 2.43%
=== === ====
</TABLE>
Nonperforming loans are subject to continuous monitoring by management
and are specifically reserved for in the allowance for loan losses where
appropriate.
24
<PAGE> 25
At December 31, 1999, the Company had approximately $2,683,000 in
commercial, financial and agricultural loans for which payments are presently
current but the borrowers are experiencing certain financial and/or operational
difficulties. These loans are subject to frequent management review and their
classification is reviewed on a monthly basis.
In management's evaluation of the loan portfolio risks, any significant
future increases in nonperforming loans is dependent to a large extent on the
economic environment. In a deteriorating or uncertain economy, management
applies more conservative assumptions when assessing the future prospects of
borrowers and when estimating collateral values. This may result in a higher
number of loans being classified as nonperforming.
REGULATORY MATTERS
Representatives of the Financial Institutions Bureau, a division of the
Department of Commerce of the State of Michigan, completed an examination at the
Company's subsidiary bank using financial information as of May 24, 1999. 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 direct 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,
1999 and 1998. The Company had no derivative financial instruments, or trading
portfolio, at either date. 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.
25
<PAGE> 26
<TABLE>
<CAPTION>
1999 Principal Amount Maturing in: Fair Value
2000 2001 2002 2003 2004 Thereafter Total 12/31/99
---- ---- ---- ---- ---- ---------- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate sensitive assets:
Fixed interest rate loans $11,510 $ 5,997 $ 10,769 $ 11,439 $ 16,581 $ 23,127 $ 79,423 $ 78,477
Average interest rate 8.98 9.01 9.03 9.52 9.72 9.31 9.12
Variable interest rate loans 84,171 5,636 4,514 6,928 10,934 1,765 113,948 113,948
Average interest rate 8.65 8.92 8.89 9.03 8.90 9.17 8.75
Fixed interest rate securities 9,638 7,985 11,546 11,217 2,902 10,941 54,229 54,229
Average interest rate 5.45 5.57 5.64 5.87 5.44 5.32 5.60
Other interest bearing assets 655 655 655
Average interest rate 5.14% 5.14%
Rate sensitive liabilities
Interest bearing demand
deposits 82,498 82,498 82,498
Average interest rate 3.19 3.19
Passbook savings 30,793 30,793 30,793
Average interest rate 2.40 2.40
Time deposits 57,453 8,044 5,765 574 29 71,865 71,959
Average interest rate 5.11 5.65 5.55 5.15 5.14 5.23
Other deposits 6,482 2,792 1,265 234 4,250 15,023 14,911
Average interest rate 4.87 5.25 5.29 5.30 5.31 5.11
Fixed interest rate
borrowings 13,588 2,000 15,588 15,588
Average interest rate 5.32 5.77 5.38
</TABLE>
<TABLE>
<CAPTION>
1998 Principal Amount Maturing in: Fair Value
1999 2000 2001 2002 2003 Thereafter Total 12/31/98
---- ---- ---- ---- ---- ---------- ----- --------
<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 77,513 5,190 4,157 6,380 10,069 1,626 104,935 104,935
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
Passbook savings 31,797 31,797 31,797
Average interest rate 2.30 2.30
Time deposits 54,704 10,774 5,164 1,797 72,439 72,899
Average interest rate 5.11 4.83 4.74 4.81 5.00
Other deposits 6,461 2,825 1,282 235 4,289 15,092 16,209
Average interest rate 4.35 5.81 5.72 5.65 5.60 5.40
Fixed interest rate
borrowings 3,588 2,000 5,588 5,588
Average interest rate 5.47 5.47 5.47
</TABLE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the Section
entitled "Quantitative and Qualitative Disclosures about Market Risk" included
under Item 7 of this report and is incorporated herein by reference.
26
<PAGE> 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See consolidated financial statements of the Company which are included
in Item 14., Exhibits, Financial Statement Schedules and Reports on Form 8-K,
and begin on page FS-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table lists the names of the directors and their ages as
of February 29, 2000, their principal occupations and the year in which each
became a director. Mr. Grohalski is the only executive officer of the Company.
<TABLE>
<CAPTION>
YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR PAST 5 DIRECTOR OF THE COMPANY
NAME OF DIRECTOR AGE YEARS(1)
----------------------------------- --------- ---------------------------------------- ---------------------------
<S> <C> <C> <C>
James P. Briskey 66 Owner - Pittsford Grain Incorporated 1982
(grain elevator operator)
H. Kenneth Cole 51 Treasurer - Hillsdale College 1998
William E. Galliers 57 Co-Owner and Chief Executive Officer - 1993
G & W Display Fixtures, Inc.
(manufacturer of display fixtures)
James T. Grohalski 59 President and Chief Executive Officer 1982
of the Company and the Bank since
December 31, 1998; Executive Vice
President and Chief Financial Officer
of the Company and President of the
Bank from January 1, 1984 until
December 31, 1998; Mr. Grohalski
joined the Bank in 1967.
Nolan E. Hooker 48 Owner - Hooker Oil Co. (distributor of 1991
heating oil)
Gregory J. Hull 51 Farmer 1955
Thomas E. Kolassa 52 Owner - The Planning Group (insurance) 1995
James J. Morrison 52 Owner - Morrison & Associates 1991
(insurance)
</TABLE>
27
<PAGE> 28
<TABLE>
<CAPTION>
YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR PAST 5 DIRECTOR OF THE COMPANY
NAME OF DIRECTOR AGE YEARS(1)
----------------------------------- --------- ---------------------------------------- ---------------------------
<S> <C> <C> <C>
Jane L. Randall 78 Owner - Dally Tire Co. (tire 1982
distributor)
Freeman E. Riddle 67 Owner - Spoor & Parlin, Inc. (farm 1982
equipment)
Jerry L. Towns 65 President and Chief Executive Officer 1982
of the Company and Chairman and Chief
Executive Officer of the Bank until
retirement on December 31, 1998
</TABLE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth compensation paid by the Company and the
Bank with respect to the fiscal year ended December 31, 1999 to the Company's
Chief Executive Officer. Mr. Grohalski is the only executive officer of the
Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($)(1) COMPENSATION ($)(2)
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
James T. Grohalski
President and Chief Executive
Officer of the 1999 $140,570 $7,344
Company and the
Bank 1998 $133,813 $7,400
1997 $135,225 $7,202
</TABLE>
(1) The amounts shown include amounts deferred under the 401(k)
provisions of the ESOP and the Bank's Executives' Deferred
Compensation Plan.
(2) The amounts shown include the following for 1999: (i) employer
contributions to accounts in the ESOP and the Deferred
Compensation Plan of $4,000 and $3,000 respectively for Mr.
Grohalski; and (ii) $344 constituting the value of insurance
premiums paid by the Bank for term life insurance for Mr.
Grohalski's benefit.
Retirement Benefits
Officers of the Company participate in the Southern Michigan Bank &
Trust Retirement Plan (the "Retirement Plan") which has been adopted by the
Bank. 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
28
<PAGE> 29
annual benefits payable on a straight-life annuity basis upon retirement at age
65 and are not subject to deduction for social security benefits:
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>
James T. Grohalski has 32 years of credited service and $132,500 current covered
remuneration.
The Bank also has in effect supplemental retirement arrangements in the
form of Executive Employee Salary Continuation Agreements with Messrs. Grohalski
and Towns under which a specified annual benefit, in addition to that provided
under the Retirement Plan, is payable to the participant upon retirement at age
65. The participant is entitled to a reduced benefit if his retirement occurs
between the ages of 62 and 65. No benefit is payable if the participant
voluntarily terminates his employment or is discharged for cause prior to the
age of 62. However, the specified benefit is payable beginning at age 65, if the
participant's employment is terminated after a "change in control" of the
Company, and in connection with such change, his title, responsibility or
compensation is significantly lessened or the status 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 participant would have received under the Retirement Plan but for a
plan amendment which changed the Retirement Plan's benefit formula to comply
with changes in pension laws and which substantially reduced the participants'
benefits. For James T. Grohalski, the specified benefit payable upon retirement
at age 65 under the supplemental retirement arrangement is $22,060 per year for
15 years. The Board of Directors may increase the benefit by not more than 2%
per year prior to retirement.
The Bank also has an Executives' Deferred Compensation Plan (the
"Deferred Compensation Plan") for directors and certain 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 or her designated
beneficiary is entitled to a benefit equal to the amount of the participant's
deferrals to the Deferred Compensation 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 Deferred Compensation
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
Deferred Compensation Plan.
Compensation Committee Report on Executive Compensation
Executive Compensation Policies.
29
<PAGE> 30
The Company's executive compensation policies are designed to support
the corporate objective of maximizing the long-term value of the Company to its
shareholders and employees. To achieve this objective, the Compensation
Committee believes it is important to provide competitive levels of compensation
to attract and retain the most qualified executives, to recognize individuals
who exceed expectations and to link closely overall corporate performance and
executive pay.
The Company has established two primary components of the Company's
executive compensation plan. The two components are: (a) base compensation; and
(b) stock-based performance compensation through stock option grants, subject to
the shareholders' approval of the Southern Michigan Bancorp, Inc. 2000 Stock
Option Plan described below.
Base Compensation.
The Compensation Committee annually reviews base salaries of executive
officers. Factors which influence decisions made by the Compensation Committee
regarding base salaries are levels of responsibility and potential for future
responsibilities, salary levels offered by competitors and overall performance
of the Company. The Compensation Committee's practice in establishing salary
levels is based in part upon overall Company performance and is not based upon
any specific objectives or policies, but reflects the subjective judgment of the
Compensation Committee. However, specific annual performance goals are
established for each executive officer. Based on the Compensation Committee's
comparison of the Company's overall compensation levels as a percent of revenues
and net income to comparable companies in the industry, the Compensation
Committee believes its overall compensation levels are in the middle of the
range.
Stock Option Grants.
Executive compensation to reward past performance and to motivate
future performance will also be provided through stock options granted under the
Southern Michigan Bancorp, Inc. 2000 Stock Option Plan if approved by the
shareholders. The purpose of the plan is to encourage executive officers to
maintain a long-term stock ownership position in the Company in order that their
interests are aligned with those of the Company's shareholders. The Board of
Directors, in its discretion, has the authority to determine participants in the
plan, the number of shares to be granted and the option price and term.
Consideration for stock option awards are evaluated on a subjective basis and
granted to participants until an ownership position exists which is consistent
with the participant's current responsibilities.
Chief Executive Officer Compensation.
The Compensation Committee established Mr. Grohalski's base salary
based primarily on a subjective evaluation of the Company's prior year's
financial results, past salary levels and compensation paid to other chief
executive officers in the Company's industry. Based on the Compensation
Committee's comparison of the Company's overall compensation level for Mr.
Grohalski as a percent of revenue and net income to comparable companies in the
industry, the Compensation Committee believes his overall compensation level is
in the middle of the range.
RESPECTFULLY SUBMITTED BY THE MEMBERS OF THE COMPENSATION COMMITTEE, James J.
Morrison, H. Kenneth Cole and James P. Briskey.
Director Compensation
Currently, each director of the Company whose principal occupation is
not with the Company or the Bank receives an annual fee of $6,200 which will be
indexed for inflation in 2000. In addition, outside directors are compensated
$150 for each committee meeting attended and participate in a bonus program
based upon the
30
<PAGE> 31
achievement of growth and profitability goals. No bonus was paid to outside
directors for 1999. Subject to approval by the shareholders as described below,
the directors will be eligible to receive stock options under the Southern
Michigan Bancorp, Inc. 2000 Stock Option Plan.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 29, 2000, the names and
addresses of all beneficial owners of 5% or more of the Common 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 169,500(a) 8.65%
& Trust
51 West Pearl Street
Coldwater, MI 49036
Common Stock Harvey B. Randall 146,075(b) 7.46%
8391 Old U.S. 27 South
Marshall, MI 49068
</TABLE>
(1) Based upon information furnished to the Company by the beneficial
owners 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 the Trust Department of Southern Michigan
Bank & Trust (the "Bank") in various fiduciary capacities.
16,270 of such shares are voted by the Bank with no
investment power.
(b) Includes 146,022 shares held by Mr. Randall as trustee.
The following table sets forth, as of February 29, 2000, the total
number of shares of the Common Stock beneficially owned, and the percent of such
shares so owned, by each director and by all directors and executive officers of
the Company as a group.
<TABLE>
<CAPTION>
NAME OF BENEFICIAL OWNER OR AMOUNT AND NATURE OF TOTAL PERCENT OF
NUMBER OF PERSONS IN GROUP BENEFICIAL OWNERSHIP(1) CLASS
----------------------------------------------------------------------------------------
<S> <C> <C> <C>
James P. Briskey 10,648 21,296 1.09
10,648 (a)
H. Kenneth Cole 169 169 (2)
William E. Galliers 2,260 (a) 2,260 (2)
James T. Grohalski(3) 21,868 (b) 21,868 1.12
Nolan E. Hooker 950 (a) 950 (2)
Gregory J. Hull 1,099 (a) 1,099 (2)
Thomas E. Kolassa 1,527 (a) 1,527 (2)
James J. Morrison 346 2,904 (2)
2,558 (a)
</TABLE>
31
<PAGE> 32
<TABLE>
<CAPTION>
NAME OF BENEFICIAL OWNER OR AMOUNT AND NATURE OF TOTAL PERCENT OF
NUMBER OF PERSONS IN GROUP BENEFICIAL OWNERSHIP(1) CLASS
----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jane L. Randall 5,774 (c) 5,774 (2)
Freeman E. Riddle 4,554 7,000 (2)
2,446 (a)
Jerry L. Towns (4) 126 (a) 7,048 (2)
6,922 (d)
All directors and executive 71,895 71,895 3.67%
officers as a group (11 persons)
</TABLE>
(1) Based upon information furnished to the Company 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 19,385 shares held by the Bank's Employee Stock
Ownership Plan (the "ESOP") as to which Mr. Grohalski has
voting power only.
(c) Shares indicated are held as trustee.
(d) Shares are voted by the Bank as IRA custodian unless
otherwise directed by Mr. Towns.
(2) Less than one percent (1%).
(3) Mr. Grohalski is the only executive officer of the Company.
(4) Mr. Towns served on the Board of Directors since 1982 and is
retiring as a director effective April 17, 2000. Mr. Towns' three
year term as a director expires as of the 2000 Annual Meeting.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Directors and officers of the Company and their associates were
customers of, and had transactions with the Bank in the ordinary course of
business during 1999. 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.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)The following consolidated financial statements of the Company
are filed as a part of this report and are included herewith
beginning on page FS-1:
- Report of Crowe, Chizek and Company LLP, independent
auditors
- Consolidated Balance Sheets - December 31, 1999 and 1998
32
<PAGE> 33
- Consolidated Statements of Changes in Shareholders' Equity -
Years ended December 31, 1999, 1998 and 1997
- Consolidated Statements of Income - Years ended December 31,
1999, 1998 and 1997
- Consolidated Statements of Cash Flows - Years ended December
31, 1999, 1998 and 1997
- Notes to Consolidated Financial Statements - December 31,
1999
(a)(2)Not applicable.
(a)(3)Exhibits (Numbered in accordance with Item 601 of Regulation
S-K).
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 2 Agreement and Plan of Consolidation dated February
15, 2000 by and between the Company and Sturgis
Bank & Trust Company, a Michigan savings bank.
Exhibit 3(i) Articles of Incorporation incorporated by reference
to Exhibit 3 to the Company's Annual Report on Form
10-K for the year ended December 31, 1991 and
Exhibit 3 to Form S-3D filed April 30, 1998.
Exhibit 3(ii) Amended and Restated By-Laws are incorporated by
reference to Exhibit 3 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997.
Exhibit 4 Instruments Defining the Rights of Security Holders
of the Company are the Articles of Incorporation
and By-Laws (see Exhibits 3(i) and (ii) above).
Exhibit 9 Not applicable.
Exhibit 10(a) 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 Company's Annual Report on Form 10-K for
the year ended December 31, 1994.
Exhibit 10(b) Southern Michigan Bancorp, Inc. 2000 Stock Option
Plan.
Exhibit 11 Not applicable.
Exhibit 12 Not applicable.
Exhibit 13 Not applicable.
Exhibit 16 Not applicable.
Exhibit 18 Not applicable.
Exhibit 19 Not applicable.
33
<PAGE> 34
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 21 Subsidiaries of the Company.
Exhibit 22 Not applicable.
Exhibit 23 Consent of Independent Auditors.
Exhibit 27 Financial Data Schedule.
(b) No reports on Form 8-K were filed in the last Quarter of the
period covered by this report.
(c) Exhibits - See Item 14(a)(3) above.
(d) Financial Statement Schedules - Omitted due to inapplicability or
because required information is shown in the Financial Statements
and Notes thereto.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO
SECTION 12 OF THE ACT
(a) On March 24, 2000, the Company delivered to the Commission via
EDGAR its proxy statement dated March 24, 2000 which was prepared
for its 2000 Annual Meeting of Shareholders and, which proxy
statement included, in Appendix B, the information required in
its 2000 Annual Report.
(The remainder of this page is intentionally blank. The next page is FS-1).
34
<PAGE> 35
REPORT OF INDEPENDENT AUDITORS
[CROWE CHIZEK LOGO]
Shareholders and Board of Directors
Southern Michigan Bancorp, Inc.
Coldwater, Michigan
We have audited the accompanying consolidated balance sheets of Southern
Michigan Bancorp, Inc. as of December 31, 1999 and 1998 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1999. 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, 1999 and 1998 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999 in conformity with generally accepted accounting principles.
As disclosed in Note C, on July 1, 1999 the Company changed its method of
accounting for derivative instruments and hedging activities to comply with new
accounting guidance.
Crowe, Chizek and Company LLP
South Bend, Indiana
February 11, 2000
FS-1
<PAGE> 36
CONSOLIDATED BALANCE SHEETS
(In thousands, except number of shares)
<TABLE>
<CAPTION>
December 31,
1999 1998
---------------------------
<S> <C> <C>
ASSETS
Cash $ 4,217 $ 3,021
Due from banks 7,829 13,207
---------------------------
Cash and cash equivalents 12,046 16,228
Federal funds sold 4,000
Securities available for sale 54,229 36,138
Securities held to maturity (fair value $32,693 - 1998) 31,756
Loans, net of allowance for loan losses $2,132 - 1999 ($2,026 - 1998) 191,239 161,277
Premises and equipment 6,705 7,036
Accrued interest receivable 2,442 2,418
Net cash surrender value of life insurance 5,251 5,026
Other assets 3,913 2,972
---------------------------
TOTAL ASSETS $ 275,825 $ 266,851
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 33,124 $ 34,778
Interest bearing 200,179 198,583
---------------------------
Total deposits 233,303 233,361
Accrued expenses and other liabilities 3,542 3,116
Other borrowings 15,000 5,000
---------------------------
TOTAL LIABILITIES 251,845 241,477
Common stock subject to repurchase obligation in
Employee Stock Ownership Plan, shares outstanding - 130,502 in 1999
(150,727 in 1998) 3,990 6,029
Shareholders' equity
Preferred stock, 100,000 shares authorized; none issued or outstanding
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 1,969,259 shares in 1999 (1,872,677 in 1998)
Outstanding - 1,838,757 shares in 1999 (1,721,950 in 1998) 4,597 4,305
Additional paid-in capital 8,421 3,863
Retained earnings 7,949 11,505
Accumulated other comprehensive income (loss), net of tax $200 - 1999,
$(134) - 1998 (389) 260
Unearned Employee Stock Ownership Plan shares (588) (588)
---------------------------
TOTAL SHAREHOLDERS' EQUITY 19,990 19,345
---------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 275,825 $ 266,851
===========================
</TABLE>
See accompanying notes to consolidated financial statements.
FS-2
<PAGE> 37
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except number of shares and per share data)
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Additional Income, Unearned
Common Paid-In Retained (Loss) ESOP
Stock Capital Earnings Net of Tax Shares TOTAL
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 $ 2,174 $ 2,734 $ 14,687 $ 21 $ $ 19,616
Net income for 1997 3,032 3,032
Cash dividends declared - $.52 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 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 - $.60 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
additional paid-in capital 5,000 (5,000)
Change in common stock subject
to repurchase (17) (1,113) (1,130)
Purchase of shares by ESOP
(14,000 shares) (588) (588)
Net change in unrealized gain on
available for sale securities, net of tax 234 234
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 4,305 3,863 11,505 260 (588) 19,345
Net income for 1999 3,300 3,300
Cash dividends declared - $.68 per share (1,373) (1,373)
10% stock dividend issued (179,024
shares) 447 5,036 (5,483)
Common stock repurchased and
retired (82,442 shares) (206) (2,466) (2,672)
Change in common stock subject
to repurchase 51 1,988 2,039
Net change in unrealized gain (loss) on
available for sale securities, net of tax (649) (649)
-----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 $ 4,597 $ 8,421 $ 7,949 $ (389) $ (588) $ 19,990
=============================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
FS-3
<PAGE> 38
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31,
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans, including fees $ 16,577 $ 15,781 $ 15,545
Securities:
Taxable 2,235 2,305 2,189
Tax-exempt 1,132 1,094 861
------------------------------------------
3,367 3,399 3,050
Other 107 266 74
------------------------------------------
Total interest income 20,051 19,446 18,669
Interest expense:
Deposits 7,738 7,622 7,260
Other 697 410 183
------------------------------------------
Total interest expense 8,435 8,032 7,443
------------------------------------------
NET INTEREST INCOME 11,616 11,414 11,226
Provision for loan losses 852 600 460
------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,764 10,814 10,766
Non-interest income:
Service charges on deposit accounts 1,064 978 835
Trust fees 486 500 528
Securities gains 5
Net gains on loan sales 758 1,085 550
Earnings on life insurance assets 208 220 181
Other 509 413 360
------------------------------------------
3,025 3,196 2,459
Non-interest expense:
Salaries and employee benefits 4,569 4,528 4,508
Occupancy 854 781 697
Equipment 979 872 762
Printing, postage and supplies 385 466 419
Advertising and marketing 287 417 444
Professional and outside services 428 326 242
Other 1,982 1,886 2,036
------------------------------------------
9,484 9,276 9,108
------------------------------------------
Income before income taxes 4,305 4,734 4,117
Federal income taxes 1,005 1,185 1,085
------------------------------------------
NET INCOME 3,300 3,549 3,032
Other comprehensive income:
Unrealized gains (losses) on securities arising during the year (1,599) 355 13
Net cumulative effect of adopting new accounting principle 616
Reclassification adjustment for accumulated (gains) losses
included in net income (5)
Tax effect 334 (121) (3)
------------------------------------------
Other comprehensive income (loss) (649) 234 5
------------------------------------------
COMPREHENSIVE INCOME $ 2,651 $ 3,783 $ 3,037
==========================================
BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 1.64 $ 1.70 $ 1.44
==========================================
</TABLE>
See accompanying notes to consolidated financial statements.
FS-4
<PAGE> 39
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,300 $ 3,549 $ 3,032
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 852 600 460
Depreciation 711 599 527
Net amortization of investment securities 206 182 138
Net realized gain on sales of investment securities (5)
Loans originated for sale (27,348) (34,550) (17,175)
Proceeds on loans sold 27,773 35,167 17,489
Net gains on loan sales (758) (1,085) (550)
Net change in:
Accrued interest receivable (24) (342) (161)
Other assets (607) 60 124
Accrued expenses and other liabilities 481 (459) 160
------------------------------------------
Net cash from operating activities 4,586 3,721 4,039
INVESTING ACTIVITIES
Net (increase) decrease in federal funds sold 4,000 500 (4,500)
Activity in available-for-sale securities:
Sales 255
Maturities and calls 19,238 9,522 12,187
Purchases (19,387) (32,808) (1,167)
Activity in held-to-maturity securities:
Maturities and calls 12,625 6,852 4,355
Purchases (6,213) (4,230)
Increase in net cash surrender value of life insurance (225) (612) (432)
Loan originations and payments, net (30,481) (4,531) (6,230)
Additions to premises and equipment (380) (2,047) (888)
------------------------------------------
Net cash from investing activities (14,610) (29,337) (650)
FINANCING ACTIVITIES
Net change in deposits (58) 26,296 (2,402)
Proceeds from other borrowings 10,000 2,000 3,000
Common stock issued 251 390
Cash dividends paid (1,428) (1,252) (1,049)
Repurchase of common stock (2,672) (2,299)
------------------------------------------
Net cash from financing activities 5,842 24,996 (61)
------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (4,182) (620) 3,328
Beginning cash and cash equivalents 16,228 16,848 13,520
------------------------------------------
ENDING CASH AND CASH EQUIVALENTS $ 12,046 $ 16,228 $ 16,848
==========================================
Transfers of securities from held to maturity
to available for sale $ 19,747 $ - $ -
</TABLE>
See accompanying notes to consolidated financial statements.
FS-5
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 banking
industry segment. The business of commercial and retail banking accounts for
more than 90% of its revenues, operating income and assets. While the Company's
chief decision makers monitor the revenue stream of various company products and
services, operations are managed and financial performance is evaluated on a
company-wide basis. Accordingly, all of the Company's banking operations are
considered by management to be aggregated into one operating segment. 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 business assets, commercial and
residential real estate, 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 affect 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, net periodic pension expense and prepaid pension costs.
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 and
shareholders' equity, net of tax. 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.
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. Securities are written down to fair value when a decline
in fair value is not temporary.
LOANS: Loans are reported at the principal balance outstanding, net of unearned
interest, deferred loan fees and costs, and an allowance for loan losses.
Interest income is reported on the interest method and includes amortization of
net deferred loan fees and costs over the loan term.
Interest income is not reported when full loan repayment is in doubt, typically
when payments are past due over 90 days, unless the loan is both well secured
and in the process of collection. Payments received on such loans are reported
as principal reductions.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation
allowance for probable credit losses, increased by the provision for loan losses
and decreased by charge-offs less recoveries. Estimating the risk of loss and
the amount of loss on any loans is necessarily subjective. Accordingly,
management estimates the allowance balance required based on past loan loss
experience, known and inherent risks in the portfolio, information about
specific borrower situations and estimated collateral values, economic
conditions, and other factors. Allocations of the allowance may be made for
specific loans, but the entire allowance is available for any loan that, in
management's judgment, should be charged-off. A problem loan is charged-off by
management as a loss when deemed uncollectible, although collection efforts
continue and future recoveries may occur.
FS-6
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loan impairment is reported 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 and consumer 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. Loans are
evaluated for impairment when payments are delayed, typically 90 days or more,
or when it is probable that all principal and interest amounts will not be
collected according to the original terms of the loan.
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. These assets are reviewed for
impairment when events indicate their carrying amount may not be recoverable
from future undiscounted cash flows. Maintenance, repairs and minor alterations
are charged to current operations as expenditures occur. Major improvements are
capitalized.
SERVICING RIGHTS: Servicing rights represent both purchased rights and the
allocated value of servicing rights retained on loans sold. Servicing rights are
expensed in proportion to, and over the period of, estimated net servicing
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. Identified intangibles represent the
value of depositor relationships purchased and are amortized on accelerated
methods over 10 years. Goodwill and identified intangibles are assessed for
impairment based on estimated undiscounted cash flows, and written down if
necessary. Goodwill was $745,000 and $807,000 and core deposit intangibles were
$376,000 and $464,000 at December 31, 1999 and 1998, respectively. These
balances are included in other assets.
OTHER REAL ESTATE: Other real estate was $161,000 and $166,000 at December 31,
1999 and 1998 and is included in other assets. Other real estate is comprised of
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 by a charge to the
allowance for loan losses. After foreclosure, valuations are periodically
performed by management and real estate is carried at the lower of cost or fair
value less estimated cost of disposal.
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 AND DIVIDENDS PER COMMON SHARE: Basic earnings per common share is
based on 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 reflects the
dilutive effect of any additional potential common shares. Earnings and
dividends per share are restated for all stock splits and stock dividends
through the date of issue of the financial statements.
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 the net change in
unrealized gains and losses on securities available for sale, net of tax, which
is also recognized as a separate component of shareholders' equity.
FS-7
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions. 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 50% 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 33% of the loan
portfolio and are collateralized by mortgages on residential real estate.
Consumer loan loans make up approximately 17% 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.
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 are such matters that will have a
material effect on the consolidated financial statements at December 31, 1999
and 1998.
RECLASSIFICATIONS: Some items in the prior year consolidated financial
statements have been reclassified to conform with the current year presentation.
NOTE B - BASIC AND DILUTED EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators of the computations of basic
and diluted earnings per common share for the years ended December 31, 1999,
1998 and 1997 is presented below:
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
BASIC EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,300 $ 3,549 $ 3,032
==========================================
Weighted average common shares outstanding 2,027,015 2,084,821 2,101,494
Less: Unallocated ESOP shares (15,400) (2,566) -
------------------------------------------
Weighted average common shares outstanding for basic
earnings per common share 2,011,615 2,082,255 2,101,494
==========================================
Basic earnings per common share $ 1.64 $ 1.70 $ 1.44
==========================================
DILUTED EARNINGS PER COMMON SHARE
Net income (in thousands) $ 3,300 $ 3,549 $ 3,032
==========================================
Weighted average common and dilutive
potential common shares outstanding 2,011,615 2,082,255 2,101,494
==========================================
Diluted earnings per common share $ 1.64 $ 1.70 $ 1.44
==========================================
</TABLE>
FS-8
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - SECURITIES
Year end investment securities were as follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE, 1999 COST GAINS LOSSES VALUE
---------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury and Government agencies $ 15,885 $ $ (344) $ 15,541
States and political subdivisions 28,529 106 (224) 28,411
Corporate securities 6,203 1 (32) 6,172
Mortgage-backed securities 3,278 (96) 3,182
---------------------------------------------------------
Total debt securities 53,895 107 (696) 53,306
Equity securities 923 923
---------------------------------------------------------
TOTAL $ 54,818 $ 107 $ (696) $ 54,229
=========================================================
There were no securities held to maturity as of December 31, 1999.
AVAILABLE FOR SALE, 1998
U.S. Treasury and Government agencies $ 9,019 $ 68 $ $ 9,087
States and political subdivisions 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
---------------------------------------------------------
TOTAL $ 35,744 $ 399 $ (5) $ 36,138
=========================================================
HELD TO MATURITY, 1998
States and political subdivisions $ 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
---------------------------------------------------------
TOTAL $ 31,756 $ 946 $ (9) $ 32,693
=========================================================
</TABLE>
Sales of available for sale securities were (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Proceeds $ 0 $ 0 $ 255
Gross gains 0 0 5
Gross losses 0 0 0
</TABLE>
Contractual maturities of debt securities at year-end 1999 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>
AMORTIZED FAIR
COST VALUE
---------------------------
<S> <C> <C>
Due in one year or less $ 8,994 $ 8,991
Due from one to five years 31,906 31,571
Due from five to ten years 7,057 6,863
Due after ten years 2,660 2,699
Mortgage-backed securities 3,278 3,182
---------------------------
$ 53,895 $ 53,306
===========================
</TABLE>
FS-9
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - SECURITIES (CONTINUED)
Investment securities with an amortized cost of $2,911,000 and $3,303,000 were
pledged as collateral for public deposits and for other purposes in 1999 and
1998.
Except as indicated, total securities of any state (including all its political
subdivisions) were less than 10% of shareholders' equity. At year-end 1999 and
1998, the amortized cost of securities issued by the state of Michigan and all
its political subdivisions totaled $13,114,000 and $19,883,000 with an estimated
market value of $13,132,000 and $20,729,000, respectively.
As of July 1, 1999, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities." Under SFAS No. 133, all derivative instruments are recorded at
their fair values. If derivative instruments are designated as hedges of fair
values, both the change in the fair value of the hedge and the hedged item are
included in current earnings. Fair value adjustments related to cash flow hedges
are recorded in other comprehensive income and reclassified to earnings when the
hedged transactions are reflected in earnings. Ineffective portions of hedges
are reflected in income currently. The Company does not have any derivative
instruments nor does the Company have any hedging activities. As permitted by
SFAS No. 133, the Company transferred securities with an amortized cost of
$19,131,000 and a fair value of $19,747,000 from the held to maturity portfolio
to the available for sale portfolio. None of these securities were sold during
1999.
NOTE D - LOANS
Loans at year-end were as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Commercial $ 96,758 $ 82,533
Consumer 33,190 29,203
Real estate mortgage 62,432 50,909
Loans held for sale, net of valuation allowance of $-0- in 1999 and 1998 991 658
---------------------------
193,371 163,303
Less allowance for loan losses (2,132) (2,026)
---------------------------
LOANS, NET $ 191,239 $ 161,277
===========================
</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. The following is a summary of loans (in thousands)
exceeding $60,000 in the aggregate to these individuals and their associates.
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Balance at January 1 $ 3,923 $ 3,722
New loans 6,222 7,767
Repayments (5,487) (7,624)
Other changes, net (156) 58
---------------------------
BALANCE AT DECEMBER 31 $ 4,502 $ 3,923
===========================
</TABLE>
The unpaid principal balance of mortgage loans serviced for others, which are
not included on the consolidated balance sheet, was $69,880,000 and $51,462,000
at December 31, 1999 and 1998, respectively. Related escrow deposit balances
were approximately $11,000 and $2,000 at December 31, 1999 and 1998,
respectively.
Activity for capitalized mortgage servicing rights was as follows (in
thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Balance at January 1 $ 595 $ 327
Additions 377 468
Amortized to expense (176) (200)
---------------------------
BALANCE AT DECEMBER 31 $ 796 $ 595
===========================
</TABLE>
No valuation allowance for capitalized mortgage servicing rights was necessary
at December 31, 1999 or 1998.
FS-10
<PAGE> 45
NOTE E - ALLOWANCES FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31 were as
follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $ 2,026 $ 1,863 $ 1,814
Provision for loan losses 852 600 460
Loans charged off (1,050) (579) (508)
Recoveries 304 142 97
------------------------------------------
Net charge-offs (746) (437) (411)
------------------------------------------
BALANCE AT DECEMBER 31 $ 2,132 $ 2,026 $ 1,863
==========================================
</TABLE>
<TABLE>
<CAPTION>
1999 1998
---------------------------
Information regarding impaired loans follows:
<S> <C> <C>
Year end loans with allowance for loan losses allocated $ 1,543 $ 1,259
Year end loans with no allowance for loan losses allocated 700 0
---------------------------
Total impaired loans $ 2,243 $ 1,259
===========================
Amount of allowance allocated to these loans $ 275 $ 367
Average balance of impaired loans during the year $ 2,415 $ 1,566
Cash basis interest income recognized during the year $ 191 $ 73
Interest income recognized during the year $ 200 $ 102
</TABLE>
NOTE F - PREMISES AND EQUIPMENT
Premises and equipment consist of (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Land $ 786 $ 786
Buildings and improvements 7,685 7,625
Equipment 3,442 3,157
---------------------------
11,913 11,568
Less accumulated depreciation (5,208) (4,532)
---------------------------
TOTALS $ 6,705 $ 7,036
===========================
</TABLE>
Depreciation and amortization expense charged to operations was approximately
$711,000, $599,000 and $527,000 in 1999, 1998 and 1997, respectively.
NOTE G - DEPOSITS
The carrying amount of domestic deposits at year end follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Non-interest bearing checking $ 33,124 $ 34,778
Interest bearing checking 38,927 37,055
Passbook savings 30,793 31,797
Money market accounts 43,571 42,200
Time deposits 71,865 72,439
Individual retirement accounts and other deposits 15,023 15,092
---------------------------
TOTALS $ 233,303 $ 233,361
===========================
</TABLE>
FS-11
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - DEPOSITS (CONTINUED)
The carrying amount of time deposits over $100,000 was $23,113,000 and
$21,058,000 at December 31, 1999 and 1998, respectively. Interest expense on
time deposits over $100,000 was $1,198,000, $1,084,000 and $1,025,000 at
December 31, 1999, 1998 and 1997, respectively.
At year end, scheduled maturities of time deposits were as follows for the years
ending December 31 (in thousands):
<TABLE>
<S> <C>
2000 $ 57,453
2001 8,044
2002 5,765
2003 574
2004 29
-----------
TOTALS $ 71,865
===========
</TABLE>
Related party deposits were $2,061,000 and $1,374,000 at December 31, 1999 and
1998, respectively.
Cash paid for interest was $8,397,000, $8,054,000 and $7,464,000 for the years
ended December 31, 1999, 1998 and 1997, respectively.
NOTE H - OTHER BORROWINGS
Other borrowings represents putable advances obtained by the Bank from the
Federal Home Loan Bank (FHLB) of Indianapolis. The advances have fixed interest
rates ranging from 5.31% to 5.71% until the stated call date ranging from
February 22, 2000 to June 29, 2009. On the stated call 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 mortgage loans, U.S. Treasury and Government
agencies, and highly rated private mortgage-backed securities.
At year-end 1999, scheduled principal reductions on these advances were as
follows for the years ending December 31 (in thousands):
<TABLE>
<S> <C>
2000 $ -
2001 -
2002 3,000
2003 2,000
2004 -
Thereafter 10,000
-----------
TOTAL FHLB ADVANCES $ 15,000
===========
</TABLE>
NOTE I - INCOME TAXES
Income tax expense consists of:
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Current $ 1,021 $ 1,226 $ 1,066
Deferred (16) (41) 19
------------------------------------------
TOTALS $ 1,005 $ 1,185 $ 1,085
==========================================
</TABLE>
Income tax expense calculated at the statutory federal income tax rate of 34%
differs from actual income tax expense as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Statutory rates $ 1,464 $ 1,610 $ 1,400
Tax-exempt interest income (358) (350) (254)
Increase in net cash surrender value of life insurance policies (77) (82) (65)
Other items, net (24) 7 4
------------------------------------------
TOTALS $ 1,005 $ 1,185 $ 1,085
==========================================
</TABLE>
FS-12
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - INCOME TAXES (CONTINUED)
Year end deferred tax assets and liabilities consist of (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Deferred tax assets:
Net unrealized depreciation on available-for-sale securities $ 200 $
Allowance for loan losses 497 461
Deferred compensation liability 502 470
Pension liability 99 65
Other 185 175
---------------------------
Totals 1,483 1,171
Deferred tax liabilities:
Net unrealized appreciation on available-for-sale securities 134
Mortgage servicing rights 271 202
Other 41 14
---------------------------
Totals 312 350
---------------------------
NET DEFERRED TAX ASSET $ 1,171 $ 821
===========================
</TABLE>
The Company made income tax payments of $1,160,000 in 1999, $1,165,000 in 1998
and $1,130,000 in 1997. An allowance against the net deferred tax asset was not
considered necessary at December 31, 1999 or 1998.
NOTE J - 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>
1999 1998
---------------------------
<S> <C> <C>
Change in benefit obligation:
Beginning benefit obligation $ (2,326) $ (1,715)
Service cost (133) (140)
Interest cost (134) (115)
Actuarial (gain) loss 511 (435)
Benefits paid 667 79
---------------------------
Ending benefit obligation (1,415) (2,326)
Change in plan assets, at fair value:
Beginning plan assets 2,266 1,856
Actual return 144 335
Employer contribution 29 154
Benefits paid (667) (79)
---------------------------
Ending plan assets 1,772 2,266
---------------------------
Funded status 357 (60)
Unrecognized net actuarial gain (650) (185)
Unrecognized transition obligation 13 17
Unrecognized prior service cost 37 49
---------------------------
ACCRUED PENSION COST $ (243) $ (179)
===========================
</TABLE>
FS-13
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - RETIREMENT PLANS (CONTINUED)
The components of pension expense and related actuarial assumptions were as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Service cost $ 133 $ 140 $ 130
Interest cost 134 115 113
Actual return on plan assets (153) (345) (330)
Net amortization and deferral 16 188 205
------------------------------------------
NET $ 130 $ 98 $ 118
==========================================
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% 3.0% 3.5%
</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 $78,000, $90,000 and
$66,000 in 1999, 1998 and 1997. During 1999, the Company amended its ESOP plan
to adopt 401(k) provisions allowing for employee salary deferrals to purchase
either Company stock or mutual funds. Company matching is provided in Company
stock. Substantially all employees have converted their ESOP accounts to the
amended plan.
During 1998, the ESOP borrowed $588,000 to purchase 14,000 shares of company
stock which are currently held as unallocated ESOP shares.
Shares held by the ESOP at year-end are as follows:
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Allocated shares 130,502 150,727
Unallocated shares 15,400 14,000
---------------------------
TOTAL ESOP SHARES 145,902 164,727
===========================
</TABLE>
The fair value of the allocated shares held by the ESOP is approximately
$3,990,000 and $6,029,000 at December 31, 1999 and 1998, 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 $218,000, $229,000 and
$206,000 in 1999, 1998 and 1997. The liability for vested benefits was
$1,476,000 and $1,382,000 at December 31, 1999 and 1998, respectively.
FS-14
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - 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, 1999 and 1998, respectively, the Bank had commitments under
commercial letters of credit, used to facilitate customers' trade transactions,
of $414,000 and $133,000.
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,
1999 and 1998, respectively, commitments under outstanding standby letters of
credit were $626,000 and $385,000.
Loan commitments outstanding to extend credit are detailed below (in thousands):
<TABLE>
<CAPTION>
1999 1998
---------------------------
<S> <C> <C>
Fixed rate $ 4,570 $ 1,616
Variable rate 33,379 29,559
----------------------------
TOTALS $ 37,949 $ 31,175
============================
</TABLE>
The fixed rate commitments have stated interest rates ranging from 8.5% to
17.0%. 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.
At December 31, 1999, the Bank had line of credit agreements with the Federal
Home Loan Bank, Bank One and Fifth Third Bank for $3,000,000, $5,000,000 and
$750,000 respectively. The balances on all three of these lines was $0 at
December 31, 1999.
NOTE L - 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 2000, the Bank is
permitted to pay the Company an amount equal to $3,752,000 plus the Bank's 2000
net income, as dividends without prior regulatory approval.
FS-15
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION
Condensed financial statements of Southern Michigan Bancorp, Inc. follow (in
thousands):
<TABLE>
<CAPTION>
Balance Sheets December 31,
1999 1998
-----------------------
<S> <C> <C>
ASSETS
Cash $ 97 $ 16
Securities available for sale 3,273 3,170
Securities held to maturity 250
Investment in subsidiary 19,107 20,422
Premises and equipment 1,196 1,231
Other 704 700
---------------------------
TOTAL ASSETS $ 24,377 $ 25,789
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Dividends payable $ 340 $ 393
Other liabilities 57 22
Common stock subject to repurchase obligation in ESOP 3,990 6,029
Shareholders' equity 19,990 19,345
---------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,377 $ 25,789
===========================
</TABLE>
<TABLE>
<CAPTION>
Statements of Income Year ended December 31,
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Dividends from Bank $ 3,718 $ 3,620 $ 1,109
Interest income 154 167 137
Other income 269 226 206
Other expenses (98) (33) (49)
------------------------------------------
4,043 3,980 1,403
Federal income tax expense (35) (85) (68)
------------------------------------------
4008 3,895 1,335
Equity in undistributed/(excess) distributed net income of subsidiary (708) (346) 1,697
------------------------------------------
NET INCOME 3,300 3,549 3,032
------------------------------------------
Net change in unrealized gains (losses) on securities available for sale (649) 234 5
------------------------------------------
Other comprehensive income (649) 234 5
------------------------------------------
COMPREHENSIVE INCOME $ 2,651 $ 3,783 $ 3,037
==========================================
</TABLE>
<TABLE>
<CAPTION>
Statements of Cash Flows Year ended December 31,
1999 1998 1997
------------------------------------------
OPERATING ACTIVITIES
<S> <C> <C> <C>
Net income $ 3,300 $ 3,549 $ 3,032
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in (undistributed)/excess distributed net income of subsidiary 708 346 (1,697)
Depreciation 35 31 31
Net amortization of investment securities 25 16 13
Other 54 (253) (146)
------------------------------------------
Net cash from operating activities 4,122 3,689 1,233
</TABLE>
FS-16
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
Statements of Cash Flows Year ended December 31,
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
INVESTING ACTIVITIES
Activity in available for sale investment securities:
Maturities and calls 776 1,977 734
Purchases (717) (2,059) (1,248)
Activity in held to maturity investment securities:
Maturities and calls (250)
Additions to premises and equipment (60) (62)
------------------------------------------
Net cash from investing activities 59 (392) (576)
FINANCING ACTIVITIES
Common stock issued 251 390
Cash dividends paid (1,428) (1,252) (1,049)
Repurchase of common stock (2,672) (2,299)
------------------------------------------
Net cash from financing activities (4,100) (3,300) (659)
------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 81 (3) (2)
Beginning cash and cash equivalents 16 19 21
------------------------------------------
ENDING CASH AND CASH EQUIVALENTS $ 97 $ 16 $ 19
==========================================
Transfers of securities held to maturity to securities available for $ 250
sale
</TABLE>
NOTE N - FAIR VALUE INFORMATION
The following methods and assumptions were used by the Company in estimating
fair values for financial instruments:
CASH AND CASH EQUIVALENTS AND FEDERAL FUNDS SOLD: The carrying amounts
reported in the balance sheet for cash and due from banks approximate those
assets' fair values.
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.
FS-17
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - FAIR VALUE INFORMATION (CONTINUED)
DEPOSITS: 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 other borrowings is estimated using
discounted cash flows analysis based on the Bank's current incremental
borrowing rate for similar types of borrowing arrangements.
While these estimates of fair value are based on management's judgment of the
most appropriate factors, there is no assurance that if the Company had disposed
of such items at December 31, 1999 and 1998, the estimated fair values would
have been achieved. Market values may differ depending on various circumstances
not taken into consideration in this methodology. The estimated fair values at
December 31, 1999 and 1998 should not necessarily be considered to apply at
subsequent dates.
In addition, other assets and liabilities that are not defined as financial
instruments are not included in the following disclosures, such as property and
equipment. Also, non-financial instruments typically not recognized in financial
statements may have value but are not included in the following disclosures.
These include, among other items, the estimated earnings power of core deposit
accounts, the trained work force, customer goodwill and similar items.
The estimated fair values of the Company's financial instruments at year end are
as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
--------------------------- ---------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 12,046 $ 12,046 $ 16,228 $ 16,228
Federal funds sold 4,000 4,000
Securities available for sale 54,229 54,229 36,138 36,138
Securities held to maturity 31,756 32,693
Loans 193,371 192,425 163,303 163,588
Financial liabilities:
Deposits $ (233,303) $ (233,285) $ (233,361) $ (234,938)
Other borrowings (15,000) (15,000) (5,000) (5,000)
Unrecognized financial instruments:
Commercial letters of credit $ (8) $ (8)
Standby letters of credit (13) (3)
</TABLE>
NOTE O - 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 consolidated financial statements.
FS-18
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O - REGULATORY MATTERS (CONTINUED)
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, 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.
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>
1999
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $25,300 12.0% $16,869 8.0% $21,086 10.0%
BANK $20,425 9.8% $16,673 8.0% $20,842 10.0%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS)
CONSOLIDATED $23,168 11.0% $8,435 4.0% $12,652 6.0%
BANK $18,293 8.8% $8,337 4.0% $12,505 6.0%
TIER 1 CAPITAL (TO AVERAGE ASSETS)
CONSOLIDATED $23,168 8.4% $11,037 4.0% $13,797 5.0%
BANK $18,293 6.7% $10,917 4.0% $13,646 5.0%
1998
Total capital (to risk weighted assets)
Consolidated $25,808 13.4% $15,439 8.0% $19,298 10.0%
Bank $20,541 10.8% $15,238 8.0% $19,048 10.0%
Tier 1 capital (to risk weighted assets)
Consolidated $23,782 12.3% $7,719 4.0% $11,579 6.0%
Bank $18,515 9.7% $7,619 4.0% $11,428 6.0%
Tier 1 capital (to average assets)
Consolidated $23,782 9.2% $10,363 4.0% $12,954 5.0%
Bank $18,515 7.5% $9,845 4.0% $12,306 5.0%
</TABLE>
The Company and Bank, at year end 1999 and 1998, were categorized as well
capitalized.
NOTE P - MERGER AGREEMENT (EVENT SUBSEQUENT TO DATE OF AUDITOR'S REPORT)
On February 15, 2000, the Company announced that it had agreed to merge with
Sturgis Bank & Trust Company of Sturgis, Michigan ("Sturgis"). The transaction
is anticipated to be a tax-free exchange. It is subject to regulatory approvals
and approval by the shareholders of Sturgis, and is anticipated to be effective
the second half of 2000. The exchange ratio is .398 shares of the Company's
common stock for one share of Sturgis' common stock.
FS-19
<PAGE> 54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S><C>
SOUTHERN MICHIGAN BANCORP, INC.
Dated: March 20, 2000
By: /s/ James T. Grohalski
------------------------------------------
James T. Grohalski
Its: President and Chief Executive Officer
</TABLE>
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 Company
and in the capacities and on the dates indicated.
<TABLE>
<S><C>
/s/ James P. Briskey /s/ Thomas E. Kolassa
- ------------------------------------------ ------------------------------------------
James P. Briskey, Director Thomas E. Kolassa, Director
/s/ H. Kenneth Cole /s/ James J. Morrison
- ------------------------------------------ ------------------------------------------
H. Kenneth Cole, Director James J. Morrison, Director
/s/ William E. Galliers /s/ Jane L. Randall
- ------------------------------------------ ------------------------------------------
William E. Galliers, Director Jane L. Randall, Director
/s/ James T. Grohalski /s/ Freeman E. Riddle
- ------------------------------------------ ------------------------------------------
James T. Grohalski, President, Chief Freeman E. Riddle, Director
Executive Officer and Director
(Principal Financial & Accounting Officer)
/s/ Nolan E. Hooker /s/Jerry L. Towns
- ------------------------------------------ ------------------------------------------
Nolan E. Hooker, Director Jerry L. Towns, Director
/s/ Gregory J. Hull Dated: March 20, 2000
- ------------------------------------------
Gregory J. Hull, Director
</TABLE>
S-1
<PAGE> 55
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Annual Report on Form 10-K
For the Year Ended December 31, 1999
Index to Exhibits
Exhibits
SOUTHERN MICHIGAN BANCORP, INC.
(A Michigan corporation)
51 West Pearl Street
Coldwater, Michigan 49036
<PAGE> 56
INDEX TO EXHIBITS
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 2 Agreement and Plan of Consolidation dated February
15, 2000 by and between the Company and Sturgis Bank
& Trust Company, a Michigan savings bank.
Exhibit 3(i) Articles of Incorporation incorporated by reference
to Exhibit 3 to the Company's Annual Report on Form
10-K for the year ended December 31, 1991 and
Exhibit 3 to Form S-3D filed April 30, 1998.
Exhibit 3(ii) Amended and Restated By-Laws are incorporated by
reference to Exhibit 3 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1997.
Exhibit 4 Instruments Defining the Rights of Security Holders
of the Company are the Articles of Incorporation and
By-Laws (see Exhibits 3(i) and (ii) above).
Exhibit 9 Not applicable.
Exhibit 10(a) 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
Company's Annual Report on Form 10-K for the year
ended December 31, 1994.
Exhibit 10(b) Southern Michigan Bancorp, Inc. 2000 Stock Option
Plan.
Exhibit 11 Not applicable.
Exhibit 12 Not applicable.
Exhibit 13 Not applicable.
Exhibit 16 Not applicable.
Exhibit 18 Not applicable.
Exhibit 19 Not applicable.
Exhibit 21 Subsidiaries of the Company.
Exhibit 22 Not applicable.
Exhibit 23 Consent of Independent Auditors.
Exhibit 27 Financial Data Schedule.
<PAGE> 1
EXHIBIT 2
AGREEMENT AND PLAN OF CONSOLIDATION
This Agreement and Plan of Consolidation ("Agreement") is dated as of
February 15, 2000 by and between STURGIS BANK & TRUST COMPANY, a Michigan
savings bank ("Sturgis") and SOUTHERN MICHIGAN BANCORP, INC., a Michigan
corporation ("Bancorp").
RECITALS
WHEREAS, neither of the Board of Directors of Sturgis nor Bancorp seeks
to sell their respective entities at this time, but the Boards desire to enter
into a transaction structured as a strict consolidation of equals.
WHEREAS, Sturgis, with principal offices in Sturgis, Michigan, as of
the date hereof has Four Million (4,000,000) authorized shares of common stock,
par value $1.00 per share ("Sturgis Common Stock"), of which 3,094,866 shares
are outstanding.
WHEREAS, Bancorp, with its principal offices in Coldwater, Michigan
owns, among other things, one hundred percent (100%) of the issued and
outstanding capital stock of SOUTHERN MICHIGAN BANK & TRUST, a Michigan banking
corporation ("Southern"). As of the date hereof, Bancorp has 4,000,000
authorized shares of common stock, par value $2.50 per share ("Bancorp Common
Stock"), of which 1,963,818 shares are outstanding.
WHEREAS, promptly after execution of this Agreement, Bancorp will
organize Newbank, a Michigan savings bank ("Newbank"), which will be a wholly
owned subsidiary of Bancorp.
WHEREAS, the parties desire to consolidate Newbank in a reorganization
qualifying as a tax free reorganization under Section 368 of the Internal
Revenue Code with and into Sturgis (the "Consolidation"). As a result of the
Consolidation, Bancorp will own one hundred percent (100%) of the capital stock
of Sturgis and Southern with Sturgis and Southern each retaining their separate
identities as chartered financial institutions.
WHEREAS, Sturgis and Bancorp will select a new corporate name for
Bancorp.
WHEREAS, the parties desire to make certain representations, warranties
and agreements in connection with the Consolidation and also to prescribe
certain conditions to the Consolidation.
WHEREAS, the Boards of Directors of Sturgis and Bancorp (at meetings
duly called and held) have determined that this Agreement and the transactions
contemplated hereby are in the best interests of Sturgis and Bancorp,
respectively, and their respective shareholders and have approved this
Agreement.
NOW, THEREFORE, in consideration of the premises and representations,
warranties, covenants and agreements hereinafter set forth, the parties hereby
agree as follows:
ARTICLE ONE
THE CONSOLIDATION AND RELATED MATTERS
1.1 FORMATION OF NEWBANK. Promptly after execution of this Agreement,
Bancorp shall organize Newbank as a savings bank organized under the laws of the
State of Michigan with its principal office at 125 E. Chicago Road, Sturgis,
Michigan.
<PAGE> 2
1.2 MICHIGAN BANK CONSOLIDATION. At the Effective Time (as defined
below), Newbank shall be consolidated with and into Sturgis which shall be the
surviving corporation (hereinafter sometimes referred to as the "Surviving
Corporation") in accordance with the Michigan Savings Bank Act, as amended (the
"MSBA").
1.3 EFFECTIVE TIME. As soon as practicable after each of the conditions
set forth in ARTICLE FOUR hereof has been satisfied or waived, Sturgis and
Newbank will file, or cause to be filed, a Consolidation Agreement with the
Commissioner of the Financial Institutions Bureau (the "Commissioner") and any
other applicable filings or notices required by any State or federal
governmental authority for the Consolidation. The Consolidation Agreement shall
be in the form required by and executed in accordance with the provisions of the
MSBA. The Consolidation shall become effective at the time the Consolidation
Agreement is filed with the Commissioner ("Effective Time") which shall be
immediately following the Closing as defined in SECTION 1.15 hereof and on the
same day as the Closing if practicable or at such other date and time as may be
agreed to by the parties and specified in the Consolidation Agreement in
accordance with applicable law.
1.4 CONVERSION OF SHARES. At the Effective Time, by virtue of the
Consolidation and without any action on the part of Sturgis or Newbank or the
holder of shares of Sturgis or Newbank common stock:
(a) Each share outstanding of Sturgis Common Stock issued and
outstanding at the Effective Time, subject to clause (b) of this SECTION 1.4 and
SECTION 1.7 hereof and other than shares held by the Dissenting Shareholders (as
defined below), shall cease to be outstanding, shall cease to exist and shall be
converted into and represent solely .398 shares of Bancorp Common Stock (the
"Conversion Number") and shall no longer be a share of Sturgis Common Stock.
(b) Any shares of Sturgis Common Sock which are owned or held by any
party hereto or any of their respective subsidiary(s) defined in SECTION 2.1
hereof (other than in a fiduciary capacity) at the Effective Time shall cease to
exist, the certificates for such shares shall as promptly as practicable be
cancelled, such shares shall not be converted into or represent any shares of
Bancorp Common Stock and no shares of Bancorp Common Stock shall be issued or
exchanged therefor.
(c) Each share of Newbank common stock which is issued and outstanding
immediately before the Effective Time shall be converted into and become one
share of the Surviving Corporation immediately after the Effective Time.
(d) The holders of certificates representing shares of Sturgis Common
Stock shall cease to have any rights as shareholders of Sturgis as of the
Effective Time, except such rights, if any, as they may have pursuant to
Michigan law.
(e) Any issued and outstanding shares of Sturgis Common Stock held by
Dissenting Shareholders shall not be converted as described in this SECTION 1.4,
but from and after the Effective Time shall represent only the right to receive
such value as may be determined to be due to such Dissenting Shareholders
pursuant to the MSBA. The "Dissenting Shareholders" shall mean any holder of
Sturgis Common Stock who votes against the Consolidation at the Sturgis
Shareholders Meeting or who gives notice in writing to Sturgis at or prior to
the Sturgis Shareholders Meeting that such holder dissents from the
Consolidation where such holder, within thirty (30) days after the Effective
Time, and in compliance with the MSBA, delivers a written request to Sturgis
demanding the fair value of the shares of Sturgis Common Stock held by such
holder accompanied by the surrender of such holder's stock certificates.
<PAGE> 3
1.5 SURVIVING CORPORATION IN THE CONSOLIDATION.
(a) The name of the Surviving Corporation in the Consolidation shall be
"STURGIS BANK & TRUST COMPANY." At the Effective Time, the headquarters and
principal executive offices of Sturgis immediately prior to the Effective Time
shall become the headquarters and principal executive offices of the Surviving
Corporation.
(b) At the Effective Time, the Articles of Incorporation of Sturgis
immediately prior to the Effective Time shall become the Articles of
Incorporation of the Surviving Corporation until amended as provided therein.
(c) At the Effective Time, the Bylaws of Sturgis immediately prior to
the Effective Time shall become the Bylaws of the Surviving Corporation until
amended as provided therein and in the Articles of Incorporation of the
Surviving Corporation.
(d) At the Effective Time, the directors and executive officers of
Sturgis immediately prior to the Effective Time shall become the directors and
executive officers of Sturgis, as the Surviving Corporation, except as provided
in SECTION 5.2 below until such directors or officers are replaced or additional
directors or officers are elected or appointed in accordance with the provisions
of the Articles of Incorporation and Bylaws of Sturgis, as the Surviving
Corporation.
(e) From and after the Effective Time, the Consolidation shall have
the effect set forth in this Agreement and under the MSBA, including without
limitation all the following:
(i) The Surviving Corporation shall possess all of the rights,
interests, privileges, powers and franchises and is subject to all the
restrictions, disabilities, liabilities and duties of each of Sturgis
and Newbank. The title to all property, real, personal and mixed is
transferred to the Surviving Corporation and shall not revert or be in
any way impaired by reason of the Consolidation.
(ii) The Surviving Corporation shall hold and enjoy the same
and all rights of property, franchises and interests including
appointments, designations and nominations and all other rights and
interests in any fiduciary capacity, in the same manner and to the same
extent as those rights and interests were held or enjoyed by each of
Sturgis and Newbank at the time of the Consolidation.
1.6 AUTHORIZATION FOR ISSUANCE OF COMMON STOCK; EXCHANGE OF
CERTIFICATES.
(a) Prior to the Closing, Bancorp shall reserve for issuance a
sufficient number of shares of Bancorp Common Stock for the purpose of issuing
such shares to Sturgis' shareholders in accordance with this ARTICLE ONE. At or
prior to the Effective Time, Bancorp shall supply, or shall cause to be
supplied, to Registrar and Transfer Company (the "Exchange Agent") in trust for
the benefit of the holders of the Sturgis Common Stock, for exchange in
accordance with this SECTION 1.6 through the Exchange Agent: (i) certificates
evidencing the Bancorp Common Stock issuable pursuant to SECTION 1.4(A) in
exchange for outstanding Sturgis Common Stock and (ii) cash in an aggregate
amount sufficient to pay for fractional shares pursuant to SECTION 1.7 (the
shares and cash so deposited, together with any dividends or distributions with
respect to Bancorp Common Stock held by the Exchange Agent payable after the
Effective Time which shall also be deposited with the Exchange Agent, being
hereinafter referred to collectively as the "Exchange Fund"). Any interest,
dividends or other income earned on the investment of cash (not including the
Bancorp Common Stock) held in the Exchange Fund shall be for the account of and
payable to Bancorp.
<PAGE> 4
(b) After the Effective Time, holders of certificates theretofore
representing outstanding shares of Sturgis Common Stock (other than as provided
in SECTION 1.4(B) above and SECTION 1.4(E) above), upon surrender of such
certificates (together with the signed and completed transmittal form referred
to below and such other customary documents as may be required pursuant to such
instructions) to the Exchange Agent, shall be entitled to receive certificates
for the number of whole shares of Bancorp Common Stock into which shares of
Sturgis Common Stock theretofore evidenced by the certificate so surrendered
shall have been converted as provided in SECTION 1.4 hereof and cash payments in
lieu of fractional shares, if any, as provided in SECTION 1.7 hereof. As soon as
practicable after the Effective Time, the Exchange Agent will send a notice and
transmittal form to each Sturgis shareholder of record at the Effective Time
advising such shareholder: (i) of the effectiveness of the Consolidation and the
procedure for surrendering to the Exchange Agent outstanding certificates
formerly representing Sturgis Common Stock in exchange for new certificates of
Bancorp Common Stock; and (ii) if applicable, of such shareholder's right under
the MSBA to dissent within thirty (30) days of the Effective Time. Upon
surrender, each certificate representing Sturgis Common Stock shall be
cancelled.
(c) Until surrendered as provided in this SECTION 1.6, all outstanding
certificates of a holder which, before the Effective Time, represented Sturgis
Common Stock (other than those representing shares cancelled at the Effective
Time pursuant to SECTION 1.4(B) hereof) will be deemed for all corporate
purposes (except certificates of the Dissenting Shareholders) to represent the
number of whole shares of Bancorp Common Stock in which the shares of Sturgis
Common Stock formerly represented thereby were converted and the right to
receive cash in lieu of a fractional share interest. However, until such
outstanding certificates formerly representing Sturgis Common Stock are so
surrendered, no dividend or distribution payable to holders of record of Bancorp
Common Stock shall be paid to any holder of such outstanding certificates, but
upon surrender of such outstanding certificates by such holder there shall be
paid to such holder the amount of any dividends or distributions, without
interest, theretofore paid with respect to any such whole shares of Bancorp
Common Stock, but not paid to such holder, and which dividends or distributions
had a record date occurring on or after the Effective Time and the amount of any
cash, without interest, payable to such holder in lieu of a fractional share
interest pursuant to SECTION 1.7 hereof. After the Effective Time, there shall
be no further registration of transfers on the records of Sturgis of outstanding
certificates formerly representing shares of Sturgis Common Stock and, if a
certificate formerly representing such share is presented to Bancorp or Sturgis,
it shall be forwarded to the Exchange Agent for cancellation and exchange as
herein provided. Six months after the Effective Time, the Exchange Agent shall
return to Bancorp any certificates for Sturgis Common Stock and cash remaining
in the possession of the Exchange Agent (together with any dividends and
distributions in respect thereof) and thereafter shareholders of Sturgis shall
look exclusively to Bancorp for shares of Bancorp Common Stock and cash to which
they are entitled hereunder. Notwithstanding the foregoing, none of Sturgis,
Bancorp, the Exchange Agent or any other person shall be liable to any former
holder of shares of Sturgis Common Stock for any amount delivered in good faith
to a public official pursuant to applicable abandoned property, escheat or
similar law.
(d) All shares of Bancorp Common Stock issued or paid upon the
conversion of Sturgis Common Stock in accordance with the above terms and
conditions shall be deemed to have been issued or paid in full satisfaction of
all rights pertaining to such Sturgis Common Stock.
(e) If any new certificate for Bancorp Common Stock is to be issued in
a name other than that in which the certificate surrendered and exchanged
thereof is registered, it shall be a condition of the issuance therefore that
the certificate surrendered in exchange shall be properly endorsed and otherwise
in proper form for transfer and that the person requesting such transfer pay to
the Exchange Agent any transfer or other taxes required by reason of the
issuance of a new certificate representing shares of Bancorp Common Stock in any
name other than that of the registered holder of the certificate surrendered, or
establish to the satisfaction of the Exchange Agent that such tax has been paid
or is not payable.
<PAGE> 5
(f) In the event any certificate representing Sturgis Common Stock
shall have been lost, stolen or destroyed, the Exchange Agent shall issue in
exchange for such lost, stolen or destroyed certificate, upon the making of an
affidavit of that fact by the holder thereof, such shares of Bancorp Common
Stock as may be required pursuant hereto; provided, however, that Bancorp or the
Exchange Agent may, in its discretion and as a condition precedent to the
issuance or payment thereof, require the owner of such lost, stolen, or
destroyed certificate to deliver a bond in the sum as it may direct as indemnity
against any claim that may be made against Sturgis, Bancorp, the Exchange Agent
or any other person with respect to the certificate alleged to have been lost,
stolen or destroyed.
(g) Bancorp or the Exchange Agent shall be entitled to deduct and
withhold from the consideration paid in exchange for Sturgis Common Stock such
amounts as Bancorp or the Exchange Agent is required to deduct and withhold with
respect to the making of such payment under the Internal Revenue Code or any
provision of state, local or foreign tax law. To the extent that amounts are so
withheld by Bancorp or the Exchange Agent, such withheld amounts shall be
treated for all purposes of this Agreement as having been paid.
1.7 NO FRACTIONAL SHARES. Notwithstanding any term or provision hereof,
no fractional shares of Bancorp Common Stock, or any other evidence of ownership
thereof, will be issued upon the conversion of or in exchange for any shares of
Sturgis Common Stock; no dividend or distribution with respect to Bancorp shall
be payable on or with respect to any fractional share interest; and no such
fractional share interest shall entitle the owner thereof to vote or to any
other rights of a shareholder of Bancorp. In lieu of such fractional share
interest, any holder of Sturgis Common Stock who would otherwise be entitled to
a fractional share of Bancorp will, upon surrender of this certificate or
certificates representing Sturgis Common Stock outstanding immediately before
the Effective Time, be paid the applicable cash value of such fractional share
interest, which shall be equal to the product of the fraction of the share to
which such holder would otherwise be entitled and the closing price of Bancorp
Common Stock on the trading day immediately prior to the date of the Effective
Time. For purposes of determining such fractional share interest, such shares of
Sturgis Common Stock owned by a Sturgis shareholder shall be combined so as to
calculate the maximum number of whole shares of Bancorp issuable to such Sturgis
shareholder.
1.8 DISSENTER'S RIGHTS. Bancorp and Sturgis agree to comply in all
respects with the provisions of the MSBA whereby shareholders of Sturgis have
the right to dissent from the Consolidation and demand payment in cash for
shares of Sturgis Common Stock. As provided in SECTION 1.4(E) above, shares held
by a Dissenting Shareholder shall not be converted into Bancorp Common Stock and
cash in lieu of fractional shares.
1.9 ANTI-DILUTION. The consideration received with respect to each
share of Sturgis Common Stock shall be adjusted to reflect fully the effect of
any stock split, reverse split, stock dividend (including any dividend or
distribution of securities convertible into Bancorp Common Stock or Sturgis
Common Stock), reorganization, recapitalization or other like change with
respect to Bancorp Common Shares or Sturgis Common Stock, as appropriate,
occurring after the date hereof and prior to the Effective Time. Notwithstanding
the foregoing, no adjustment shall be made pursuant to this provision for any
stock option plan adopted by Bancorp and approved by its shareholders at an
annual or special meeting.
1.10 SHAREHOLDERS' MEETING. Sturgis shall, at the earliest practicable
date, hold a meeting of shareholders (the "Sturgis Shareholders Meeting") to
submit this Agreement for adoption by its shareholders. The affirmative vote of
two-thirds of the issued and outstanding shares of Sturgis Common Stock entitled
to vote shall be required for such adoption. With respect to the Sturgis
Shareholders Meeting, Sturgis shall comply with all notice and other
requirements of the MSBA.
<PAGE> 6
1.11 STURGIS STOCK OPTIONS.
(a) Section 1.11 of Sturgis' Disclosure Schedule sets forth a list of
each stock option outstanding on the date of this Agreement (collectively, the
"Sturgis Stock Options") to purchase Sturgis Common Stock heretofore granted
pursuant to the Sturgis Stock Option Plan dated April 28, 1989 and the Sturgis
Director's Option Plan dated April 28, 1989 (collectively the "Sturgis Option
Plans"). Section 1.11 of Sturgis' Disclosure Schedule sets forth with respect to
each Sturgis Option Plan the option exercise price, the number of shares subject
to the option, the dates of grant, vesting, exercisability and expiration of the
option and that the option is either a qualified or a non-qualified stock
option. Without the prior written consent of Bancorp, no additional stock
options shall, after the date of this Agreement, be granted under the Sturgis
Option Plans.
(b) At the Effective Time, each Sturgis Stock Option which is
outstanding and unexercised immediately prior thereto shall cease to represent a
right to acquire shares of Sturgis Common Stock and shall be converted
automatically into an option to purchase the shares of Bancorp Common Stock in
amount and at an exercise price (and subject to the terms of the Bancorp Option
Plan) determined as provided below: (i) the number of shares of Bancorp Common
Stock to be subject to the new options shall be equal to the product of the
number of shares of Sturgis Common Stock subject to the original Sturgis Stock
Option and the Conversion Number, provided that any fractional shares of Bancorp
Common Stock resulting from such multiplication shall be rounded down to the
nearest whole share, and (ii) the exercise price per share of Bancorp Common
Stock under the new option shall be equal to the exercise price per share of
Sturgis Common Stock under the original Sturgis Option Plan divided by the
Conversion Number, provided that such exercised price shall be rounded down to
the nearest whole cent.
(c) At the 2000 annual meeting of shareholders of Bancorp, the holders
of Bancorp Common Stock shall vote on approval of a Stock Option Plan whereby
qualified and non-qualified stock options may be issued in amounts sufficient to
convert the options on Section 1.11 of Sturgis' Disclosure Schedule pursuant to
this SECTION 1.11.
1.12 REGISTRATION STATEMENT; PROSPECTUS.
(a) For the purposes (i) of registering with the Securities and
Exchange Commission ("SEC") and with applicable state securities authorities the
Bancorp Common Stock to be issued to holders of Sturgis Common Stock in
connection with the Consolidation, and (ii) of holding the Sturgis Shareholders
Meeting, the parties shall cooperate in the preparation of an appropriate
registration statement (such registration statement together with all and any
amendments and supplements hereinafter referred to as the "Registration
Statement"), including the prospectus and proxy statement satisfying all
applicable requirements of applicable state laws, and of the Securities Act of
1933 (the "Securities Act"), the Securities Exchange Act of 1934 (the "Exchange
Act"), and the rules and regulations thereunder.
(b) Sturgis shall furnish such information concerning Sturgis and its
subsidiaries as is necessary in order to cause the prospectus and proxy
statement, insofar as it relates to such entities, to comply with SECTION
1.12(A) hereof. Sturgis agrees promptly to advise Bancorp if at any time before
the Sturgis Shareholders Meeting any information provided by Sturgis in the
prospectus and proxy statement (through incorporation by reference or otherwise)
becomes incorrect or incomplete in any material respect and to provide Bancorp
with the information needed to correct such inaccuracy or omission. Sturgis
shall furnish Bancorp with such supplemental information as necessary in order
to cause such prospectus and such proxy statement, insofar as it relates to
Sturgis and its subsidiaries, to comply with SECTION 1.12(A).
(c) Bancorp shall furnish Sturgis with such information concerning
Bancorp and its subsidiaries as is necessary in order to cause the prospectus
and proxy statement, insofar as it relates to such entities, to comply with
SECTION 1.12(A) hereof. Bancorp agrees promptly to advise Sturgis if at any time
before the Sturgis Shareholders Meeting (through incorporation by reference or
otherwise) becomes incorrect or incomplete in any
<PAGE> 7
material respect to provide Sturgis with the information needed to correct such
inaccuracy or omission. Bancorp shall furnish Sturgis with such supplemental
information as may be necessary in order to cause the prospectus and proxy
statement, insofar as it relates to Bancorp and its subsidiaries, to comply with
SECTION 1.12(A).
(d) Bancorp shall promptly file the Registration Statement with the SEC
and applicable state securities agencies. Sturgis and Bancorp shall use all
reasonable efforts to cause the Registration Statement to become effective under
the Securities Act and applicable state security laws at the earliest
practicable date. Sturgis authorizes Bancorp to utilize in the Registration
Statement the information concerning Sturgis and its subsidiaries incorporated
by reference in, and provided to Bancorp for the purpose of inclusion in, the
prospectus and proxy statement. Bancorp shall advise Sturgis promptly when the
Registration Statement has become effective and of any supplements or amendments
thereto and Bancorp shall furnish Sturgis with copies of all such documents.
Before the Effective Time or the termination of this Agreement, each party shall
consult with the other with respect to any material that might constitute a
"Prospectus" relating to the Consolidation within the meaning in the Securities
Act.
(e) The parties intend that the Consolidation shall qualify for
"pooling of interest" accounting treatment under Accounting Principles Board
Opinion No. 16 and SEC Accounting Series Releases 130 and 135, as amended, and
each of the parties shall use its best efforts and take all actions reasonably
necessary to cause the Consolidation to qualify for such accounting treatment;
provided, however, if the parties mutually determine that the "pooling of
interest" accounting treatment desired by the parties is not available or is not
practicable (for any reason, including but not limited to, the exercise of
dissenters rights by holders of Sturgis Common Stock), the following provisions
shall become effective and supercede any other provision or provisions in this
Agreement to the contrary:
(i) The parties shall cause the Consolidation to be treated as a
"purchase" for accounting purposes and not as a "pooling of interest",
and each of the parties shall use its best efforts and take all actions
reasonably requested to obtain approval of and close the Consolidation
under "purchase" accounting treatment.
(ii) The parties shall, in compliance with the terms of SECTIONS
1.12(A)-(D) above, revise and resubmit the Registration Statement to
the SEC as soon as practicable with the Consolidation treated as a
"purchase" for accounting purposes and not as a "pooling of interest".
(iii) The condition to closing set forth in SECTION 4.1(G) shall
be deemed waived without any further action on behalf of either party
and all other provisions in this Agreement requiring the Consolidation
to be treated as a "pooling of interest" for accounting purposes shall
be revised to require the Consolidation to be treated as a "purchase"
for accounting purposes.
(iv) If Sturgis has held a Sturgis Shareholders Meeting whereat
the shareholders voted on the Consolidation with the understanding that
the Consolidation would qualify for "pooling of interest" treatment,
Sturgis shall hold a second Sturgis Shareholders Meeting in compliance
with SECTION 1.10 above whereat the shareholders will vote on the
Consolidation with the understanding that the Consolidation would be
treated as a "purchase" for accounting purposes.
(v) The condition to closing set forth in SECTION 4.1(K) shall
be amended to read in entirety as follows: "Dissenter Rights. The
holders of not more than 770,000 shares of Sturgis Common Stock shall
have taken one or both of the following actions: (i) given notice in
writing to Sturgis at or prior to the Sturgis Shareholders Meeting that
such holder dissents from the Consolidation, or (ii) voted against the
Consolidation at the Sturgis Shareholders Meeting."
<PAGE> 8
1.13 COOPERATION AND REGULATORY APPROVALS. The parties, and their
respective affiliates and subsidiaries, shall cooperate in the preparation and
submission by them, as promptly as reasonably practical, of such applications,
petitions, and other filings as they may reasonably deem necessary or desirable
to any bank regulatory authority, the Department of Justice, SEC, Secretary of
State of Michigan, other regulatory or governmental authorities, holders of the
voting shares of common stock of Sturgis and any other persons for the purpose
of obtaining any approvals or consents necessary to consummate the transactions
contemplated hereby. Each party shall have the right to review and comment on
such applications, petitions and filings in advance and shall furnish to the
other copies thereof promptly prior to submission thereof. Any such materials
must be acceptable to both Sturgis and Bancorp prior to submission to any
regulatory or governmental entity or authority or transmission to shareholders
or other third parties, except to the extent that Sturgis or Bancorp is legally
required to proceed prior to obtaining the acceptance of the other party hereto.
Each party agrees to consult with the other with respect to obtaining all
necessary consents and approvals, and each will keep the other apprised of the
status of matters relating to such approvals and consents and the consummation
of the transactions contemplated hereby. At the date hereof, no party is aware
of any reason that any regulatory approval required to be obtained by it would
not be obtained or would be obtained subject to conditions that would have a
result in a material adverse effect on this Agreement or the transactions
contemplated herein.
1.14 BANCORP NAME. Prior to the Closing and pursuant to the Michigan
Business Corporation Act, as amended, , Bancorp shall adopt an assumed name
which is reasonably agreeable to Bancorp and Sturgis. It is the intent of the
parties that at the 2001 annual meeting of the shareholders of Bancorp, the
shareholders of Bancorp shall be entitled to vote to amend the Articles of
Incorporation of Bancorp to change Bancorp's legal corporate name to such
assumed name.
1.15 CLOSING. If (i) this Agreement has been duly approved by the
shareholders of Sturgis, (ii) an assumed name for Bancorp has been adopted
pursuant to SECTION 1.14, and (iii) all conditions of this Agreement have been
satisfied in all material respects or waived, a closing (the "Closing") shall
take place as promptly as practicable thereafter at the offices of Dresser,
Dresser, Gilbert & Haas, P.C., Sturgis, Michigan, or at such other place as the
parties agree, at which time the parties will exchange certificates, letters and
other documents as required hereby and will make the filings described in
SECTION 1.3 hereof. Such Closing will take place within thirty (30) days after
the satisfaction or waiver of all conditions and/or obligations precedent to
Closing contained in ARTICLE FOUR of this Agreement or at such other time as the
parties agree. The parties shall use their best efforts to cause this Closing to
occur on or before December 31, 2000.
1.16 TAX CONSEQUENCES; ACCOUNTING TREATMENT. It is intended that (i)
the Consolidation shall constitute a reorganization within the meaning of
Section 368 of the Internal Revenue Code, (ii) this Agreement constitutes a
"plan of reorganization" for purposes of Section 368 of the Internal Revenue
Code, and (iii) as provided in SECTION 1.12(E) above, if available, the
Consolidation shall qualify for "pooling of interest" accounting treatment under
Accounting Principles Board Opinion No. 16 and SEC Accounting Series Releases
130 and 135, as amended.
ARTICLE TWO
REPRESENTATIONS AND WARRANTIES
Sturgis (with respect to itself and with respect to each of its
Subsidiaries individually) represents and warrants to Bancorp, and Bancorp (with
respect to itself and with respect to each of its Subsidiaries individually)
represents and warrants to Sturgis, except as disclosed in the Disclosure
Schedule delivered by each party to the other pursuant to SECTION 2.29 hereof
(which Disclosure Schedule shall be prepared separately by each party and
include exceptions for such party and its Subsidiaries), as follows:
<PAGE> 9
2.1 ORGANIZATION. It is an entity duly organized, validly existing and
in good standing under the laws of the jurisdiction of its incorporation or
organization as set forth in Section 2.1 of its Disclosure Schedule. Section 2.1
of its Disclosure Schedule lists each "subsidiary" (the term "subsidiary" when
used with respect to any party means any entity (including without limitation
any corporation, partnership, joint venture or other organization, whether
incorporated or unincorporated) which is consolidated with such party for
financial reporting purposes) (individually a "Subsidiary" and collectively the
"Subsidiaries"). It has all requisite power and authority and, to the extent
required by applicable law, is licensed to own, lease and operate its properties
and conduct its businesses as now being conducted. It has delivered or made
available to the other party true, complete and correct copies of its Articles
of Incorporation, Bylaws and other organizational documents, as in effect on the
date of this Agreement. To the extent it is a depositary institution, all
eligible accounts thereof are insured by the Federal Deposit Insurance
Corporation ("FDIC"). It has full power and authority (including all licenses,
franchises, permits and governmental authorizations which are legally required)
to engage in all material respects in the business and activities now conducted
by it.
2.2 CAPITALIZATION. Its authorized capital stock and the number of
issued and outstanding shares of its capital stock as of the date hereof are
accurately set forth in the Recitals of this Agreement. All outstanding shares
of its common stock are duly authorized, validly issued, fully paid,
nonassessible and free of preemptive rights. Except (i) as set forth in Section
2.2 of its Disclosure Schedule or (ii) with respect to the Sturgis Option Plans
as set forth in Section 1.11 of its Disclosure Schedule, as of the date of this
Agreement, there are no options, convertible securities or warrants or other
rights to purchase or acquire any of its capital stock from it and no oral or
written agreement, contract, arrangement, understanding, plan or instrument of
any kind to which it is subject with respect to the issuance, voting or sale of
issued or unissued shares of its capital stock. A true and complete copy of each
plan and agreement pursuant to which such options, convertible securities,
warrants or other rights have been granted or issued, as in effect as of the
date of this Agreement, is included in Section 2.2 of its Disclosure Schedule.
2.3 OWNERSHIP OF SUBSIDIARIES. All outstanding shares or ownership
interests of its Subsidiaries are validly issued, fully paid, nonassessible and
owned beneficially and of record by it or one of its Subsidiaries free and clear
of any lien, claim, charge, restriction, rights of third parties, or encumbrance
(collectively "Encumbrance"), except as set forth in Section 2.3 of its
Disclosure Schedule. There are no options, convertible securities, warrants or
other rights (preemptive or otherwise) to purchase or acquire any capital stock
or ownership interests of any of its Subsidiaries and no contracts to which it
or any of its Subsidiaries is subject with respect to the issuance, voting or
sale of issued or unissued shares of the capital stock or ownership interests of
any of its Subsidiaries. It does not own more than 2% of the capital stock or
other equity securities (including securities convertible or exchangeable into
such securities) of or more than 2% of the aggregate profit participations in
any entity other than a Subsidiary or as otherwise set forth in Section 2.3 of
its Disclosure Schedule.
2.4 FINANCIAL STATEMENTS AND REPORTS. No registration statement,
offering circular, proxy statement, schedule or report filed by it or any of its
Subsidiaries under various securities and financial institution laws and
regulations ("Regulatory Reports"), on the date of its effectiveness in the case
of registration statements, or on the date of filing in the case of reports or
schedules, or on the date of mailing in the case of proxy statements, contain
any untrue statement of material fact or omit to state a material fact required
to be stated therein or necessary to make the statements therein, in light of
the circumstances in which they were made, not misleading. For the past three
years, it has timely filed all Regulatory Reports required to be filed by it
under various securities and financial institution laws and regulations except
to the extent that any failure to do so, in the aggregate, would not have a
material effect; and all such documents, as finally amended, complied in all
material respects with applicable requirements of law and, as of the respective
date or the date as amended, did not contain any untrue statements of material
fact or omit to state a material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which they
were made, not misleading. Except to the extent stated therein, all financial
statements and schedules included in the
<PAGE> 10
Regulatory Reports (or to be included in Regulatory Reports) to be filed after
the date hereof (i) were or will be (with respect to financial statements in
respect of periods ending after December 31, 1999), prepared in accordance with
its books and records, and (ii) present (and in the case of financial statements
and respective periods ending after December 31, 1999, will present) fairly the
consolidated financial position and the consolidated results of operations or
income, changes in shareholders' equity and cash flows of it as of the dates and
for the periods indicated in accordance with generally accepted accounting
principles applied on a consistent basis with prior periods. Its audited
financial statements after December 31, 1998 and for all periods thereafter up
to the Closing reflect or will reflect, as the case may be, all liabilities
(whether accrued, absolute, contingent, unliquidated or otherwise, whether due
or to become due and regardless of when asserted) as of such date required to be
reflected in such financial statements in accordance with generally accepted
accounting principles and contain or will contain, as the case may be, adequate
reserves for losses on loans and properties acquired in settlement of loans,
taxes and all other material accrued liabilities and for all reasonably
anticipated material losses, if any, as of such date in accordance with
generally accepted accounting principles. Except as disclosed in its financial
statements at December 31, 1999, there exists no set of circumstances that could
reasonably be expected to result in any liability or obligation, taken as a
whole, material to it and its Subsidiaries except for transactions effected or
actions occurring or taken after December 31, 1999 (i) in the ordinary course of
business, (ii) as permitted by this Agreement, or (iii) as disclosed in its
Regulatory Reports filed after December 31, 1999 and before the date of this
Agreement. A true and complete copy of such December 31, 1999 financial
statements have been delivered by it. The books and records of it have been, and
are being, maintained in all material respects in accordance with generally
accepted accounting principles and any other applicable legal and accounting
requirements.
2.5 ABSENCE OF CHANGES.
(a) Since December 31, 1999, there has been no material adverse change
affecting it and there is no occurrence, event or development of any nature
existing or, to its best knowledge, threatened which may reasonably be expected
to have a material adverse effect upon it.
(b) Except as set forth in Section 2.5 of its Disclosure Schedule or in
its Regulatory Reports filed after December 31, 1999 and before the date of this
Agreement, since December 31, 1999, it has owned and operated its assets,
properties and businesses in the ordinary course and consistent with past
practice.
2.6 PROSPECTUS AND PROXY STATEMENT. At the time the prospectus and
proxy statements are mailed to its shareholders for the solicitation of proxies
for the approvals referred to in SECTION 1.10 hereof and at all times after such
mailing up to and including the time that such approvals, such prospectus and
proxy statement (including any supplements thereto), with respect to all
information set forth therein relating to it and its shareholders, its common
stock, this Agreement, the Consolidation and other transactions contemplated
hereby, will:
(a) Comply in all material respects with applicable provisions of the
Securities Act, the Exchange Act and the rules and regulations under such Acts;
and
(b) Not contain any untrue statement of material fact or omit to state
any material fact required to be stated therein or necessary in order to make
the statements contained therein, in light of the circumstances under which it
is made, not misleading.
2.7 BROKER'S OR FINDER'S FEES. It has not incurred or will not incur
any liability for brokerage, finders', agents' or investment bankers' fees or
commissions in connection with this Agreement or the transactions contemplated
hereby, except for fees payable to Raymond James Financial, Inc. by Sturgis
pursuant to an engagement agreement which has been fully disclosed to Bancorp
and fees payable to Austin Associates, Inc. by Bancorp pursuant to an engagement
letter which has been fully disclosed to Sturgis.
<PAGE> 11
2.8 LITIGATION AND OTHER PROCEEDINGS. Except as set forth in Section
2.8 of its Disclosure Schedule, there is no litigation, action, suit,
investigation or proceeding pending or, to the best of its knowledge, overtly
threatened, against or affecting it or involving any of its properties or
assets, at law or in equity before any federal, state, municipal, local or other
governmental authority which individually or in the aggregate involve: (i) a
claim for damages or other monetary relief being one percent (1%) or more of its
combined capital stock, surplus and undivided profits, including reserves, or
(ii) matters which, if resolved adversely to the interest of it, would
presently, or in the future, materially and adversely effect the operations of
it or its ability to perform under this Agreement, and to the best of its
knowledge, no one has asserted and no one has reasonable or valid grounds on
which it reasonably can be expected that anyone will assert any such claims,
litigation, suits, actions and/or proceedings against it based upon the wrongful
action or inaction of it or its officers, directors or employees.
2.9 COMPLIANCE WITH LAW. Except as set forth in Section 2.9 of its
Disclosure Schedule:
(a) It is in compliance in all material respects with all laws,
regulations, ordinances, rules, judgments, orders or decrees applicable to its
operation or business, including without limitation the Equal Credit Opportunity
Act, The Fair Housing Act, The Community Reinvestment Act, The Homeowners'
Disclosure Act, and all other applicable fair lending laws or other laws
relating to discrimination. It has received no notice from any federal, state,
local government or governmental or regulatory agency or body of any material
violation of, and does not know of any material violations of this SECTION
2.9(A).
(b) It has all permits, licenses, certificates of authority,
franchises, orders and approvals of, and have made all filings, applications and
registrations with, all federal, state, local government or governmental or
regulatory agency or body that are required in order to permit it to carry on
its business as it is presently being conducted.
(c) It has not received since January 1, 1997 notification or
communication from any government or governmental or regulatory agency or body
or the staff thereof: (i) asserting that it is not in compliance with any of the
statutes, regulations or ordinances that any such government or governmental or
regulatory agency or body administers or enforces, (ii) threatening to revoke
any license, franchise, permit or application, or (iii) threatening or
contemplating any enforcement action by or supervisory or any other written
agreement with a state or federal banking regulator or any revocation or
limitation of, or action which would have the effect of revoking or limiting,
FDIC deposit insurance.
2.10 CORPORATE ACTIONS. Its Board of Directors (at a meeting duly
called and held) has by the requisite vote (i) determined that the Consolidation
is advisable and in the best interests of it and its shareholders, (ii) duly
approve the Consolidation and this Agreement and authorized its officers to
execute and deliver this Agreement and to take all action necessary to
consummate the Consolidation and the other transactions contemplated hereby, and
(iii) in the case of Sturgis, authorized and directed the submission for
shareholders' approval of adoption of this Agreement. In the case of Bancorp, it
is not required to submit this Agreement to its shareholders for approval.
2.11 AUTHORITY. Except as set forth in Section 2.11 of its Disclosure
Schedule, neither the execution and delivery of and performance of its
obligations under this Agreement by it nor the consummation of the Consolidation
will violate any of the provisions of, or constitute a breach of default, under
or give any person the right to terminate or accelerate payment or performance
under (i) its Articles of Incorporation or Bylaws, (ii) any regulatory restraint
on the acquisition of it or control thereof, (iii) any law, rule, ordinance or
regulation or judgment, order, decree, award or governmental permit or license
to which it is subject, or (iv) any agreement, lease, contract, note, mortgage,
indenture, arrangement or other obligation or instrument ("Contract") to which
it is a party or is subject or by which its properties or assets is bound and
which provides for payment by, on behalf of, or to it in excess of $50,000.00 in
the aggregate over the term of such Contract. It acknowledges that
<PAGE> 12
the consummation of the Consolidation and the other transactions contemplated
hereby is subject to shareholder approval in the case of Sturgis and to various
governmental or regulatory approvals. It has all requisite corporate power and
authority to enter into this Agreement and to perform its obligations hereunder
and thereunder, subject, to the approval or adoption of this Agreement by its
shareholders where required under applicable law. Other than the receipt of
Governmental Approvals (as defined in SECTION 4.1(C) hereof), the approval or
adoption of this Agreement by its shareholders if required by applicable law,
and except as set forth in Section 2.11 of its Disclosure Schedule with respect
to any Contract, no consents or approvals are required on its behalf in
connection with the consummation of the transactions contemplated by this
Agreement. This Agreement has been duly executed and delivered on behalf of it
and assuming due authorization, execution and delivery by every other party to
this Agreement, constitutes the valid and binding obligation of it, enforceable
against it in accordance with its terms, except as enforceability may be limited
by applicable laws relating to bankruptcy, insolvency, or creditors' rights
generally and general principles of equity.
2.12 EMPLOYMENT ARRANGEMENTS.
(a) Except as set forth in Section 2.12 of its Disclosure Schedule:
(i) All employees of it are employees-at-will, may be terminated
at any time for any lawful reason or for no reason and have no
entitlement to employment by virtue of any oral or written contract,
employer policy or otherwise;
(ii) There are no agreements, plans or other arrangements with
respect to employment, severance or other benefits with any current or
former directors, officers or employees of it which may not be
terminated without penalty or expense on thirty (30) days' or less
notice to any such person;
(iii) No Payments and benefits to current or former directors,
officers and employees of it resulting from the transactions
contemplated hereby or the termination of such persons' service or
employment within two years after completion of the Consolidation will
cause the imposition of excise taxes under Section 4999 of the Internal
Revenue Code or the disallowance of a deduction to it pursuant to
Section 162, 280G or any other Section of the Internal Revenue Code;
and
(iv) Neither the execution and delivery of this Agreement, nor
the consummation of the transactions contemplated hereby will (A)
constitute a stated "Triggering Event" under any "Employee Plans" (as
defined in SECTION 2.13(A) hereof) or "Benefit Arrangements" (as
defined in SECTION 2.13(A) hereof) of it that will result in any
material payment (including, without limitation, severance,
unemployment compensation, golden parachute or otherwise) becoming due
to any director, officer, stockholder or employee of it, (B) materially
increase any benefits otherwise payable under any Employee Plans or
Benefit Arrangements of it, or (C) result in any acceleration of the
time of payment or vesting of any such benefits to any material extent.
(b) It is not a party to any collective bargaining agreement or labor
union contract. To the best of its knowledge, (i) no grievance procedure,
arbitration proceeding or other labor controversy is pending against it under
any collective bargaining agreement that would result in a material liability,
(ii) it has complied in all material respects with all laws relating to the
employment of labor, including, without limitation, provisions thereof relating
to wages, hours, equal employment, safety, collective bargaining and the payment
of social security and similar taxes and it is not liable for any arrears of
wages or any taxes or penalties for failure to comply with any of the foregoing,
except, in each case, any of the foregoing which, individually or in the
aggregate would not have a material adverse effect on it, and (iii) there is no
unfair labor practice or similar complaint against it pending before the
National Labor Relations Board or similar authority or strike, dispute, slow
down, work stoppage or lockout pending or threatened against it or any complaint
pending before the Equal Employment Opportunity Commission or any comparable
federal, state or local fair employment
<PAGE> 13
practices agency and none has existed during the past three years that was not
dismissed without liability on the part of it.
2.13 EMPLOYEE BENEFITS. It maintains only the employee benefit plans
("Employee Plans") set forth in Section 2.13 of its Disclosure Schedule (true
and correct copies of which have been delivered to the other party). None of the
Employee Plans of it is and it has not participated in, or contributed to, a
"Multi-Employee Plan" as defined in Section 3(37) of the Employment Retirement
Income Security Act of 1974 ("ERISA") or a "Multiple Employer Plan" as covered
in Section 413(c) of the Internal Revenue Code or any plan which is subject to
Title IV of ERISA or Section 412 of the Internal Revenue Code. It has not
incurred nor does it reasonably expect to incur any liability to the Pension
Benefit Guaranty Corporation except for required premium payments which, to the
extent due and payable, have been paid. The Employee Plans intended to be
qualified under Section 401(a) and 401k of the Internal Revenue Code are
qualified, and it is not aware of any fact which would adversely effect the
qualified status of such plans. The Internal Revenue Service has issued a
current favorable determination letter with respect to the qualified status of
the Employee Plans and has not taken any action to revoke such letter. Except as
set forth in Section 2.13 of the Disclosure Schedule: (a) it does not provide
health, medical, death or survivor benefits to any former employee, retiree or
beneficiary thereof or (b) it does not maintain any form of current (exclusive
of base salary and base wages) or deferred compensation, bonus, stock option,
stock appreciation right, benefit, severance pay, retirement, employee stock
ownership, incentive, group or individual health insurance, welfare or similar
plan or arrangement for the benefit of any single, or class of Directors,
officers or employees (whether active or retired) (collectively "Benefit
Arrangements"). There are no restrictions on the rights of it to amend or
terminate any Employee Plans or Benefit Arrangements without incurring any
liability thereunder.
Except as disclosed in Section 2.13 of its Disclosure Schedule: (a) all
Employee Plans and Benefit Plans which are in effect were in effect for
substantially all of calendar year 1999 and there has been no material amendment
thereof, (other than amendments required to comply with applicable law) or
increase of the cost thereof or benefits payable thereunder on or after January
1, 2000, (b) to its best knowledge, with respect to all Employee Plans and
Benefit Arrangements, it is in substantial compliance with the requirements
prescribed by any and all statutes, governmental or court orders or rules or
regulations currently in effect, including but not limited to ERISA and the
Internal Revenue Code, applicable to such Employee Plans or Benefit
Arrangements, (c) it has performed all obligations required to be performed by
it under the Employee Plans (including, but not limited to, the making of all
contributions) and is not in default under and has no knowledge of any default
by any other party to the Employee Plans, (d) to its best knowledge, neither it
nor any party in interest, within the meaning of Section 4975 of the Internal
Revenue Code or Section 3(14) of ERISA, has engaged in any prohibited
transaction, as this term is defined in Section 4975 of the Internal Revenue
Code or Section 406 of ERISA, that could subject the Employee Plans to any tax
or penalty, (e) there are no actions or claims pending (other than routine
claims for benefits) or, to its best knowledge, threatened against the Employee
Plans, (f) no proceeding has been initiated to terminate the Employee Plans, and
(g) to its best knowledge, no condition exists that could constitute grounds for
the termination of any Employee Plan under ERISA; no "Prohibitive Transaction"
as defined in ERISA and the Internal Revenue Code, has occurred with respect to
any Employee Plan.
2.14 INFORMATION FURNISHED. No statement contained in any schedule,
certificate or other document furnished (whether before, on or after the date of
this Agreement) or to be furnished in writing by or on behalf pursuant to this
Agreement contains or will contain any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary in
order to make the statement contained therein, in light of the circumstances
under which it is made, not misleading.
<PAGE> 14
2.15 PROPERTY AND ASSETS. It is the sole and absolute owner of the
assets (real and personal, tangible and intangible) reflected in the financial
statements at December 31, 1999 referred to in SECTION 2.4 hereof or acquired
subsequent thereto (other than assets which are under Leases in accordance with
generally accepted accounting principles and assets which have been disposed of
since the date of such financial statements in the ordinary course of business).
It has good and marketable title to all such assets free and clear of any and
all Encumbrances, except for (a) the Encumbrances, if any, listed in Section
2.15 of its Disclosure Schedule, (b) in each case for any assets the failure to
have good and marketable title or the existence of such Encumbrance which,
individually or in the aggregate, would not have a material adverse effect on
it, and (c) in the case of real property: (i) such items are shown in such
financial statements or the notes thereto, (ii) liens for current real estate
taxes not yet delinquent, (iii) easements, restrictions of record and title
exceptions that are not material to the value or use of such property, (iv)
property sold or otherwise transferred in the ordinary course of business since
the date of such financial statements, and (v) as otherwise specifically
indicated in its Regulatory Reports filed after December 31, 1999 and before the
date of this Agreement. No one has any written or oral agreement, option,
understanding, or commitment, or any right or privilege capable of becoming an
agreement for the purchase from it of any of the material assets owned or leased
by it. It enjoys peaceful and undisturbed possession under all material leases
for the use of real property or personal property under which they are lessee;
all of such leases are valid and binding and in full force and effect, and it is
not in default in material respect under any such lease. No default will arise
under any material real property, material personal property lease or material
intellectual property license by reason of the consummation of the Consolidation
without the lessor's or licensor's consent except as set forth in Section 2.15
of its Disclosure Schedule. Except as set forth in Section 2.15 of its
Disclosure Schedule: (a) there has been no material physical loss, damage or
destruction, whether or not covered by insurance, affecting any of the real
properties or material personal property of it since December 31, 1999, and (b)
all fixed assets material to its business and currently used by it are, in all
material respects, in good operating condition and repair.
2.16 AGREEMENTS AND INSTRUMENTS. Except as set forth in its Regulatory
Reports filed after December 31, 1999 and before the date of this Agreement or
in Section 2.16 of its Disclosure Schedule, it is not a party to (a) any
material agreement or commitment not made in the ordinary course of business,
(b) any agreement, indenture or other instrument relating to the borrowing of
money by it, (c) any agreements to make any loans or for the provision, purchase
or sale of goods, services or property between it and any Director or officer of
it, (d) any agreements with or concerning any labor or employee organization to
which it is a party, (e) any agreements between it and any five percent (5%) or
more stockholder of it, and (f) any agreements, directives, orders or similar
arrangements between or involving it, any state or regulatory authority.
2.17 MATERIAL CONTRACT DEFAULTS. It is not in default under any respect
under any contract, agreement, commitment, arrangement, lease, insurance policy
other instrument to which it is a party or by which its assets, business or
operation may be bound or affected or under which its assets, business or
operations receive benefits, which default is reasonably expected to have,
either individually or in the aggregate, a material adverse effect on it, and
there has not occurred any event that, with the lapse of time or the giving of
notice or both, would constitute such a default.
2.18 TAX MATTERS.
(a) It has duly and properly filed all federal, state and other tax
returns and reports required to be filed and has timely made payments on all
taxes showing thereon to be due and payable, whether disputed or not; the
current status of audits of such returns and reports by the Internal Revenue
Service and other applicable tax authorities is as set forth in Section 2.18 of
its Disclosure Schedule; and, except as set forth in Section 2.18 of the
Disclosure Schedule, there is no agreement by it for the extension of time for
the assessment or payment of any taxes payable. Except as set forth in Section
2.18 of the Disclosure Schedule, neither the Internal Revenue Service nor any
other taxing authority is now asserting or, to its best knowledge, is
threatening to assert any deficiency or claim for additional taxes (or interest
thereon or penalties in connection therewith) nor
<PAGE> 15
is it aware of any basis for any such assertion or claim. It has complied in all
material respects with applicable Internal Revenue Service backup withholding
requirements. It has complied with all applicable state law tax collection and
reporting requirements.
(b) Adequate provision for any unpaid federal, state or local taxes
due or to become due for all periods through and including December 31, 1999 has
been made and is reflected in its December 31, 1999 financial statements
referred to in SECTION 2.4 hereof and has been or will be made with respect to
periods ending after December 31, 1999.
2.19 ENVIRONMENTAL MATTERS.
(a) Except as set forth in Section 2.19 of its Disclosure Schedule and
to its knowledge, it does not own, lease or otherwise control any property
affected by toxic waste, radon gas or other hazardous conditions or constructed
in part with the use of asbestos which requires removal or encapsulation. It has
no knowledge of, and has not received written notice from any governmental or
regulatory body of, any past, present or future conditions, activities,
practices or incidents which may interfere with or prevent compliance or
continued compliance with hazardous substance or other environmental laws or
regulations, orders, decrees, judgments or injunctions, issued, entered,
promulgated or approved thereunder or which may give rise to any common law or
legal liability or otherwise form the basis of any claim, action, suit,
proceeding, hearing, investigation or remediation activity based on or related
to the manufacture, processing, distribution, treatment, storage, disposal,
transport or handling, discharge, release, generation or threatened release into
the environment, of any pollutant, contaminant, chemical or industrial, toxic or
hazardous substance or waste. There is no civil, criminal or administrative
claim, action, suit, proceeding, hearing or investigation pending or, to its
knowledge, threatened against it relating in any way to such hazardous substance
laws or any regulation, order, decree, judgment or injunction issued, entered,
promulgated or approved thereunder. To its knowledge, there is no reasonable
basis for any such claim, action, suit, proceeding, hearing, investigation or
remediation activity that would impose any material liability or that could
reasonably be expected to have a material adverse effect on it.
(b) None of its "Loan Portfolio Properties, Trust Properties and Other
Properties" as defined in this SECTION 2.19(B) is in violation of or has any
liability absolute or contingent under any environmental laws or regulations,
except any such violations or liabilities which, individually or in the
aggregate would not have a material adverse effect on it. There are no actions,
suits, demands, notices, claims, investigations or proceedings threatened or
relating to any of its Loan Portfolio Properties, Trust Properties and Other
Properties including, without limitation, any notices, demand letters or
requests for information (from any federal or state environmental agency
relating to any such liability under or violation of any environmental laws or
regulation), which would impose liability upon it pursuant to any environmental
law or regulation, except such as would not, individually or in the aggregate
have a material adverse effect on it. "Loan Portfolio Properties, Trust
Properties and Other Properties" means, any real property, interest in real
property, improvements, appurtenances, rights and personal property attendant
thereto, which is owned, leased as a landlord or tenant, licensed as a licensor
or licensee, managed or operated or upon which is held a mortgage, deed to
secure debt or other security interest by it whether directly, as an agent, as a
trustee or other fiduciary or otherwise.
2.20 LOAN PORTFOLIO AND PORTFOLIO MANAGEMENT.
(a) All evidences of indebtedness reflected as assets on its financial
statement at December 31, 1999 referred to in SECTION 2.4 hereof, or originated
or acquired since such date, are (except with respect to those assets which are
no longer assets of it) binding obligations except as enforcement may be limited
by bankruptcy, insolvency, or other similar laws affecting the enforcement of
creditors' rights generally and except as to the availability of equitable
remedies, including specific performance, which are subject to the discretion of
the court before which a proceeding is brought, and the payment of no material
amount thereof (individually or in the aggregate with other evidences of
indebtedness) is subject to any defenses or offsets which have been
<PAGE> 16
threatened or asserted against it. All such indebtedness which is secured by an
interest in real property is secured by a valid and perfected mortgage lien
having the priorities specified in the loan documents. All such indebtedness
which is secured by an interest in personal property is secured by a valid and
perfected security interest having the priorities specified in the loan
agreement, except in each case in which individually or in the aggregate, the
failure to have such a security interest would not have a material adverse
effect on it. All loans originated, directly or indirectly or purchased by it at
the time entered into and at times owned by it in compliance with all material
respects with all applicable laws and regulations (including, without
limitation, all consumer protection laws and regulations). It administers loans
and investment portfolios in accordance with all applicable laws and regulations
and the terms of all applicable instruments. The records of it regarding all
loans outstanding on its books are accurate in all material respects.
(b) Section 2.20 of its Disclosure Schedule sets forth a list, of
aggregate amount of loans, extensions of credit and other assets of it that have
been adversely designated, criticized or classified by it as of January 31,
2000, separated by category or classifications or criticism (the "Asset
Classification"); and no amounts of loans, extensions of credit or other assets
that have been adversely designated, classified or criticized as of the date
hereof by any representative of any representative of any governmental or
regulatory authority as "Special Mention" "Substandard," "Doubtful," "Loss", or
words of similar import are excluded from amounts disclosed in the Asset
Classification other than amounts of loans, extensions of credit or other assets
that were charged off by it or before the date hereof.
2.21 REAL ESTATE LOANS; INVESTMENTS.
(a) Except for properties acquired in settlement of loans, there are
no facts, circumstances or contingencies known to it which exist and would
require a material reduction under generally accepted accounting principles of
the present carrying value of any of the real estate investments, joint
ventures, construction loans or other investments or other loans of it.
(b) It has good and marketable title to all securities held by it free
and clear of any Encumbrance, except to the extent such securities are pledged
in the ordinary course of business consistent with prudent banking practices to
secure obligations of it. Such securities are valued on its books in accordance
with generally accepted accounting principles. No material investment is subject
to any restrictions, contractual, statutory or other that would materially
impair the ability of it to dispose freely of any such investment at any time,
except restrictions on the public distribution or transfer of any such
investments under the Securities Act and the regulations thereunder or state
securities laws and pledges for security interest given to secure public funds
on deposit.
2.22 DERIVATIVE CONTRACTS. It is not a party to, nor has it agreed to
enter into, an exchange-traded or over-the-counter-swap, forward, future,
option, cap, floor or collar financial contract or other contract not included
in its financial statement as of December 31, 1999 which is a derivative
contract (including various combination thereof) (each, a "Derivative
Contract"), except for those Derivative Contracts set forth in Section 2.22 of
its Disclosure Schedule including a list, as applicable, of any of its assets
pledged as security for a Derivative Contract.
2.23 INTELLECTUAL PROPERTY.
(a) It owns or has the right to use pursuant to license, sub-license,
agreement or permission, all intellectual property necessary for the operation
of its businesses presently conducted and as presently proposed to be conducted.
The term "Intellectual Property" means all trademarks, service marks, logos,
trade names and corporate names and registrations and applications for
registration thereof, copyrights and registrations and applications for
registration thereof, computer software, data and documentation, trade secrets
and confidential
<PAGE> 17
business information (including financial, marketing and business data, pricing
and cost information, business and marketing plans, and customer and supplier
lists and information), other proprietary rights, and copies of tangible
embodiments thereof (in whatever form or medium).
(b) To the best of its knowledge, it has not interfered with,
infringed upon, misappropriated or otherwise come into conflict with any
intellectual property rights of third parties and it has not received any
charge, compliant, claim or notice alleging any such infringement, interference,
misappropriation or violation. To its knowledge, no third party has interfered
with, infringed upon, misappropriated or otherwise come into conflict with
intellectual property rights of it.
(c) Each item of intellectual property that any third party owns and
that it uses pursuant to license, sublicense, agreement or permission (i) the
license, sublicense, agreement or permission covering the item is legal, valid,
binding, enforceable and in full force and effect, (ii) the license, sublicense,
agreement or permission will continue to be legal, valid, binding and
enforceable and in full force and effect on identical terms on or after the
Closing, (iii) no party to the license, sublicense, agreement or permission is
in breach or default and no event of default has occurred which with notice or
lapse of time, or both, would constitute a breach or default or permit
termination, modification or acceleration thereunder, (iv) no party to the
license, sublicense, agreement or permission has repudiated any provision
thereof, and (v) it has not granted any sublicense or similar right with respect
to the license, sublicense, agreement or permission.
2.24 NO INVESTMENT COMPANY. It is not an "Investment Company" or a
company "controlled by" an "Investment Company" within the meaning of the
Investment Company Act of 1940, as amended.
2.25 TAX TREATMENT; POOLING OF INTEREST. It knows of no reason why the
Consolidation will fail to qualify as a reorganization under Section 368 of the
Internal Revenue Code. Except as set forth in Section 2.25 of its Disclosure
Schedule, all share repurchase programs previously authorized by its Board of
Directors, except to the extent that it is advised by the SEC that such
purchases would not adversely affect the ability of the parties to account for
the Consolidation as a "pooling of interest" for accounting purposes, have been
revoked by resolution duly adopted on or prior to the date hereof.
2.26 YEAR 2000 WARRANTY. Except as set forth in Section 2.26 of its
Disclosure Schedule, the computer systems and software programs of it (including
equipment and devices which are computer controlled or include imbedded
microprocessors) are Year 2000 Compliant (as defined below); provided, however,
that it makes no representations or warranties as to whether the computer
systems or software programs of any supplier, vender, customer or other third
party are Year 2000 Compliant and this SECTION 2.26 shall not apply if a
computer system or software program of any supplier, vender, customer or other
third party directly or indirectly causes its computer systems or software
programs to be non-year 2000 Compliant. The term "Year 2000 Compliant", with
respect to a computer system or software program, means that such computer
system or program, as applicable: (i) is capable of recognizing, processing,
managing, representing, interpreting, and manipulating correctly date related
data for dates earlier and later than January 1, 2000, (ii) has the ability to
provide date recognition for any data element without limitation, (iii) has the
ability to recognize all "leap years" including February 29, 2000.
2.27 INSIDER TRADING. It has reviewed its stock transfer records since
July 26, 1999 and has questioned its directors and executive officers concerning
known stock transfers since that date. Based upon that investigation, it has
not, and to its knowledge (a) no director or officer of it, (b) no person
related to any such director or officer by blood or marriage and residing in the
same household, and (c) no person knowingly provided material nonpublic
information by any one or more of these persons; has purchased or sold, or
caused to be purchased or sold, any shares of it during any period when it was
in possession of material nonpublic information or in violation of any
applicable provisions of the Exchange Act.
<PAGE> 18
2.28 INSURANCE. It maintains insurance in full force and effect on
its assets, properties, premises, operations, and personnel in such amounts and
against such risks and losses as are customary and adequate for comparable
entities engaged in the same business and industry. There is no unsatisfied
claim of $25,000.00 or more under such insurance as to which the insurance
carrier has denied liability. During the last five years, no insurance company
has cancelled or refused to renew a policy of insurance covering its assets,
properties, premises, operations, or personnel. It has given adequate and timely
notice to each carrier, and has complied with all policy provisions, with
respect to any known claim for which a defense and/or indemnification may be
available to it.
2.29 EXCEPTIONS TO REPRESENTATIONS AND WARRANTIES.
(a) Within fourteen (14) days of the date hereof, Bancorp shall
deliver to Sturgis and Sturgis shall deliver to Bancorp each party's respective
Disclosure Schedule setting forth exceptions to its and its Subsidiaries'
representations and warranties in this ARTICLE TWO, provided that each exception
set forth in a Disclosure Schedule shall be deemed disclosed for purposes of all
representations and warranties if such exception is contained in a section of
the Disclosure Schedule corresponding to a Section in ARTICLE TWO and provided
further that no such exception is required to be set forth in a Disclosure
Schedule if its absence would not result in the related representation or
warranty being deemed untrue or incorrect under the standard established by
SECTION 2.29(B).
(b) If the Disclosure Schedule of either party reveals the
existence of any fact, circumstance or event, individually or taken together
with all other facts, circumstances or events, which would constitute a material
adverse effect or material adverse change (as defined in SECTION 2.29(C)), then
either party, in writing, may terminate this Agreement within five (5) business
days after receipt of such Disclosure Schedule and (i) this Agreement shall
become void and have no effect except the provisions of SECTIONS 2.7, 3.6, 8.2
AND 8.12 shall survive; and (ii) each party shall bear and pay all costs and
expenses incurred by it in connection with this Agreement and the transactions
contemplated herein.
(c) None of the representations or warranties of Bancorp or
Sturgis contained in ARTICLE TWO shall be deemed untrue or incorrect, and no
party shall be deemed to have breached its representations or warranties
contained herein, as a consequence of the existence of any fact, circumstance or
event if such fact, circumstance or event, individually or taken together with
all other facts, circumstances or events, would not have a material adverse
effect or material adverse change on such party. As used in this Agreement, the
term "material adverse effect" or "material adverse change" means an effect or
change which (i) is materially adverse to the financial condition of a party and
its respective Subsidiaries taken as a whole, (ii) significantly and adversely
affects the ability of Bancorp or Sturgis to consummate the transactions
contemplated hereby or to perform its material obligations hereunder or (iii)
enables any person to prevent the consummation of the transactions contemplated
hereby, provided however that any effect or change resulting from (A) actions or
omissions of Bancorp or Sturgis contemplated by this Agreement or taken with the
prior consent of the other party in contemplation of the transactions provided
for herein, or (B) circumstances affecting the financial institutions industry
generally (including changes in laws or regulations, accounting principles or
general levels of interest rates) which do not adversely affect a party and its
Subsidiaries, taken as a whole, in a manner significantly different than the
other party hereto, shall be deemed not to be or have a material adverse effect
or result in a material adverse change.
ARTICLE THREE
COVENANTS
3.1 INVESTIGATION; ACCESS AND COPIES. Between the date of this
Agreement and the Effective Time, each party agrees to give the other party and
its respective representatives and agents full access (to the extent lawful) to
all of the premises, books, records and employees of it and its Subsidiaries at
all reasonable times and to furnish and cause its Subsidiaries to furnish to the
other party and its respective agents or representatives
<PAGE> 19
access to and true and complete copies of such financial and operating data, all
documents with respect to matters to which reference is made in ARTICLE TWO of
this Agreement or any list, schedule or certificate delivered or to be delivered
in connection herewith and such other documents, records or information with
respect to the businesses and properties of it as the other party or its
respective agents or representatives shall from time to time reasonably request;
provided however, that any such inspection: (a) shall be conducted in such
manner as not to interfere unreasonably with the operation of the business of
the entity inspected, and (b) shall not affect any of the representations and
warranties hereunder. Each party will give prompt written notice to the other
party of any event or development which (i) had it existed or been known on the
date of this Agreement, would have been required to be disclosed under this
Agreement, (ii) would cause any of its representations and warranties contained
herein to be inaccurate or otherwise materially misleading, or (iii) materially
relates to the satisfaction of the conditions set forth in ARTICLE FOUR of this
Agreement. Notwithstanding anything to the contrary herein, no party hereto
shall be required to provide access to or to disclose information where such
access or disclosure would have jeopardized the attorney-client privilege of the
entity in possession or control of such information or contravene any law, rule,
regulation, order, judgment, decree, fiduciary duty or binding agreement entered
into prior to the date of this Agreement or, in the event of any litigation or
threatened litigation between the parties or the terms of this Agreement, where
access to information may be adverse to the interest of such party. To the
extent reasonably practical, the parties hereto will make appropriate substitute
disclosure arrangements where the restrictions of the preceding sentence apply.
3.2 CONDUCT OF BUSINESS. Between the date of this Agreement and
the Effective Time or the termination of this Agreement, each party agrees, on
behalf of itself and its respective Subsidiaries, except insofar as the
President of Sturgis or the President of Bancorp shall otherwise consent in
writing (which consent shall not be unreasonably withheld):
(a) That it and its Subsidiaries shall (i) except as contemplated
in this Agreement conduct their businesses only in the ordinary course
consistent with past practices, (ii) maintain their books and records in
accordance with past practices, and (iii) use all reasonable efforts to preserve
intact their business organization and assets, to maintain their rights,
franchises and existing relations with customers, suppliers, employees and
business associates and take no action that would (A) adversely affect the
ability of any of them to obtain any Governmental Approvals (as defined in
SECTION 4.1(C) hereof) or which would reasonably be expected to hinder or delay
receipt of Governmental Approvals or (B) adversely affect its ability to perform
its obligations under this Agreement;
(b) That, except as expressly permitted in this SECTION 3.2(B),
it and its Subsidiaries shall not: (i) declare, set aside or pay any dividend or
make any other distribution with respect to its capital stock, except for
dividends in accordance with past practice, (ii) reacquire or buy any of its
outstanding shares, (iii) issue or sell any shares of capital stock of it except
shares of it issued pursuant to exercise of stock options previously issued and
identified in SCHEDULE 1.11, (iv) effect any stock split, stock dividend,
reverse stock split or other reclassification or recapitalization of its common
stocks, or (v) issue any options or other rights to purchase its capital stock.
Notwithstanding the foregoing, Bancorp may adopt a stock option plan after the
date of this Agreement and prior to the Effective Date as contemplated by
SECTION 1.11(C) above.
(c) That, except as expressly permitted in this SECTION 3.2(C),
it and its Subsidiaries shall not: (i) sell, dispose of or pledge any
significant assets of it other than in the ordinary course of business
consistent with past practices or to borrow funds consistent with the provisions
hereinafter contained, (ii) merge or consolidate it into another entity or
acquire any other entity or except in accordance with its written business plan
in effect on the date hereof, acquire any significant assets, (iii) sell or
pledge or agree to sell or pledge or permit any lien to exist on any stock of
any of its Subsidiaries owned by it, (iv) change the Articles of Incorporation
or, charter, Bylaws or other governing instruments of it, except as contemplated
by this Agreement, (v) engage in any lending activities other than in the
ordinary course of business consistent with past practices, (vi) form any new
Subsidiary (except as contemplated by this Agreement with respect to Newbank and
Sturgis and Southern each
<PAGE> 20
creating their own limited liability company for single business tax purposes)
or cause or permit a material change in the activities presently conducted by
any Subsidiary or make any additional investment in Subsidiaries in excess of
$50,000.00, (vii) engage in any off balance sheet interest rate swap agreement,
except to hedge interest rate risk on certificates of deposit or mortgage
servicing rights, or to hedge interest rate risk and/or credit risk on
commitments to extend consumer credit secured by residential mortgage loans,
(viii) engage in any material activity not contemplated by its written business
plan in effect on the date hereof, (ix) purchase any equity securities other
than Federal Home Loan Bank Stock or incur or assume any indebtedness except in
the ordinary course of business, (x) authorize capital expenditures other than
in the ordinary course of business, (xi) implement or adopt any change in its
accounting principles, practices, or methods other than as may be required by
generally accepted accounting principles, or (xii) make any change to or take
any action to amend, modify or terminate its Contracts. The limitations
contained in this SECTION 3.2 shall also be deemed to constitute limitations as
to the making of any commitment with respect to any matters set forth in this
SECTION 3.2.
(d) That, except as expressly permitted in this SECTION 3.2(C),
it and its Subsidiaries shall not: (i) grant any general increase in
compensation or benefits to its employees or officers or pay any bonus to its
employees or officers except in accordance with policies in effect on the date
hereof, (ii) enter into, extend, renew, modify, amend or otherwise change any
employment or severance agreement with any of its directors, officers or
employees (except as provided in SECTION 4.1(I) below), (iii) grant any increase
in fees or other increases in compensation or benefits to any of its present or
former directors in such capacity, and (iv) establish or sponsor any new
Employee Plan or Benefit Arrangement or effect any material change in its
Employee Plans or Benefit Arrangements (unless such change is contemplated by
this Agreement or is required by applicable law or, in the opinion of its
counsel, is necessary to maintain continued qualification of tax-qualified plan
that provides for retirement benefits).
3.3 NO SOLICITATION. Each party agrees on behalf of itself and
each of its Subsidiaries that it will not authorize or permit any director,
officer, employee, investment banker, financial consultant, attorney, accountant
or other representative of it, directly or indirectly to initiate contact with
any person or entity in an effort to solicit, initiate or encourage any "Take
Over Proposal" (as defined in this SECTION 3.3). Except as the fiduciary duties
of its Board of Directors may otherwise require (as determined in good faith
after consultation with its legal counsel), each party agrees that it will not
authorize or permit any officer, director, employee, investment banker,
financial consultant, attorney, accountant or other representative of it,
directly or indirectly: (i) to cooperate with, or furnish or cause to be
furnished any non-public information concerning its business, properties or
assets, to any person or entity in connection with any Take Over Proposal, (ii)
to negotiate any Take Over Proposal with any person or entity, or (iii) to enter
into any agreement, letter of intent or agreement in principle as to any Take
Over Proposal. Each party agrees that it shall promptly give notice to the other
upon becoming aware of any Take Over Proposal, such notice to contain, at a
minimum, the identity of the person submitting the Take Over Proposal, a copy of
any written inquiry or other communication, the terms of any Take Over Proposal,
any information requested or discussion sought to be initiated and the status of
any request, negotiations or expression of interest. As used in this Agreement
"Take Over Proposal" shall mean any proposal other than as contemplated by this
Agreement for a consolidation or other business combination involving either
party or for the acquisition of a ten percent or a greater equity interest in
either party or any of their respective Subsidiaries or for the acquisition of a
substantial portion of the assets of either party or any of their respective
Subsidiaries.
3.4 SHAREHOLDER APPROVAL. Sturgis shall call the meeting(s) of
its shareholders for the purpose of voting upon this Agreement and related
matters, as referred to in SECTION 1.10 and, if necessary, SECTION 1.12(E)(IV)
hereof, as soon as practicable. In connection with the Sturgis Shareholders
Meeting, the Board of Directors shall recommend approval of this Agreement and
any other matters requiring shareholder action relating to the transactions
contemplated herein unless as a result of an unsolicited Take Over Proposal
received by a party after the date hereof, the Board of Directors of Sturgis
determines in good faith after consultation
<PAGE> 21
with its legal counsel and investment banking firm that to do so would
constitute a breach of the fiduciary duties of such Board of Directors to the
shareholders of Sturgis. Sturgis shall use its best effort to solicit from its
shareholders proxies in favor of approval, and to take all other action
necessary or helpful to secure a vote of the holders of the outstanding shares
of its common stock in favor of this Agreement, except as the fiduciary duties
of the Board of Directors may otherwise require.
3.5 COMPLIANCE WITH ACCOUNTING AND SECURITIES RULES.
(a) After execution of this Agreement, (i) Sturgis shall use its
best efforts to cause to be delivered to Bancorp from each person who may be
deemed to be an "affiliate" of Sturgis within the meaning of Rule 145 of the
Securities Act, a written letter agreement as of a date prior to the date of the
Sturgis Shareholders Meeting in form reasonably satisfactory to Bancorp,
regarding restrictions on resale of shares of Bancorp Common Stock, to ensure
compliance with applicable restrictions imposed under the federal securities
laws and, prior to the Effective Time, Sturgis shall use its best efforts to
secure such written letter agreement from persons who become an affiliate of it
subsequent to the date hereof, and (ii) neither party shall take any action
which would prevent the Consolidation and the other transactions contemplated
hereby from qualifying as a reorganization within the meaning of Section 368 of
the Internal Revenue Code, or, except as provided in SECTION 1.12(E) above,
which would disqualify the Consolidation as a "pooling of interests" for
accounting purposes.
(b) Because the Consolidation is intended to qualify for pooling
of interests accounting treatment, the shares of Bancorp Common Stock received
by Sturgis affiliates in the Consolidation shall not be transferable until such
time as financial results covering at least 30 days of post-Consolidation
operations have been published, and the certificates representing such shares
will bear an appropriate restrictive legend. Bancorp shall use its best efforts
to publish as promptly as reasonably practical but in no event later than
forty-five (45) days after the end of the first full month after the Effective
Time in which there are at least thirty (30) days of post-consolidation combined
operations (which month may be the month in which the Effective Time occurs),
combined net interest income and net income figures as contemplated by and in
accordance with the terms of SEC Accounting Series Release No. 135. In the event
the Consolidation is to be treated as a "purchase" pursuant to SECTION 1.12(E)
above, this SECTION 3.5(B) shall be null and void.
3.6 PUBLICITY. Between the date of this Agreement and the
Effective Time, neither party nor any of its Subsidiaries shall, without the
prior approval of the other party (which approval shall not be unreasonably
withheld) issue or make, or permit any of its directors, employees, officers or
agents to issue or make, any press release, disclosure or statement to the press
or third party with respect to the Consolidation or the other transactions
contemplated hereby, except as required by applicable law or applicable rules of
the National Association of Security Dealers, Inc. The parties shall cooperate
when issuing or making any press release, disclosure statement with respect to
the Consolidation or any other transactions contemplated hereby.
3.7 COOPERATION. Between the date of this Agreement and the
Effective Time, the parties and their respective Subsidiaries shall, in
conformance with provisions of this Agreement, use their best efforts, and take
all actions necessary or appropriate to consummate the Consolidation and the
other transactions contemplated hereby at the earliest practicable date.
3.8 ADDITIONAL FINANCIAL STATEMENTS AND REPORTS. As soon as
reasonably practical after they become publicly available, each party shall
furnish to the other its statements of financial condition, statements of
operation or statements of income, statements of cash flow and statements of
changes in shareholders' equity at all dates and for all periods before the
Closing. Such financial statements will be prepared in conformity with generally
accepted accounting principles applied on a consistent basis and fairly present
the financial condition, results of operation and cash flow of the respective
parties (subject, in the case of unaudited financial statements to (a) normal
year-end audit adjustments, (b) any other adjustments described therein, and (c)
the absence of notes which, if presented, would not differ materially from those
included in the most recent audited financial
<PAGE> 22
statements), and all such financial statements will be prepared in conformity
with the requirements of Form 10-Q or 10-K under the Exchange Act. As soon as
reasonably practical after they are filed, each party shall, to the extent
permitted under applicable law, furnish to the other its Regulatory Reports.
3.9 STOCK EXCHANGE LISTING. After the Closing, Bancorp agrees to
use all commercially reasonable efforts to cause Bancorp Common Stock to be
listed in the NASDAQ National Market.
3.10 EMPLOYEE BENEFITS AND AGREEMENTS. The Employee Plans shall
not be terminated by reason of the Consolidation, but shall continue thereafter
as plans of Sturgis and Bancorp until such time as the Employee Plans are
integrated, subject to the terms and conditions specified in such plans and to
such changes therein as may be necessary to reflect the consummation of the
Consolidation.
3.11 SECTION 3.11 has been intentionally omitted.
3.12 FORBEARANCES. During the period from the date of this
Agreement to the Effective Time, except as set forth in its Disclosure Schedule
and, except as expressly contemplated or permitted by this Agreement neither
party shall, without the prior written consent of the other party: (a) take any
action that would prevent or impede the Consolidation from qualifying (i) for
"pooling of interest" accounting treatment or (ii) as a reorganization within
the meaning of Section 368 of the Internal Revenue Code.
3.13 LEGAL CONDITIONS TO CONSOLIDATION. Each party shall, and
shall cause its Subsidiaries to, use their best efforts (a) to take, or cause to
be taken, all actions necessary, proper or advisable to comply promptly with all
legal requirements which may be imposed on such party with respect to the
Consolidation and, subject to the conditions set forth in ARTICLE FOUR hereof,
to consummate the transactions contemplated by this Agreement and (b) to obtain
(and to cooperate with the other party to obtain) any consent, authorization,
order or approval of, or any exemption by, any governmental entity or authority
and any other third party which is required to be obtained by it or any of its
Subsidiaries in connection with the Consolidation and the other transactions
contemplated by this Agreement.
3.14 COMPLIANCE. Each party shall comply, and shall cause each of
its Subsidiaries to comply, in all material respects with all laws, regulations,
agreements, court orders, and administrative orders applicable to the conduct of
its business unless the application of such laws, regulations, or orders is
being contested in good faith and the other party has been notified of such
contest.
3.15 MAINTENANCE. Each party will use all reasonable efforts to
maintain its and its Subsidiaries' property and assets in their present state of
repair, order and condition, reasonable wear and tear and damage by fire or
other casualty excepted.
3.16 PRESERVATION OF GOODWILL. Each party will use all reasonable
efforts to preserve its and its Subsidiaries' business organizations intact, to
keep available the services of its and its Subsidiaries' present officers and
employees, and to preserve the goodwill of its and its Subsidiaries' customers
and others having business relations with it or its Subsidiaries.
3.17 INSURANCE POLICIES. Each party shall use all reasonable
efforts to maintain and keep in full force and effect insurance coverage, so
long as such insurance is reasonably available, on its and its Subsidiaries'
assets, properties, premises, operations, and personnel in such amounts against
such risk and loss as are presently in force.
3.18 CHARGE-OFFS. Each party shall maintain its and its
Subsidiaries' reserve for loan and lease losses in a manner in conformity with
its prior practice and applicable industry, regulatory and accounting standards.
<PAGE> 23
3.19 DATA PROCESSING CONTRACTS. Each party shall maintain all
material data processing contracts of it and its Subsidiaries.
ARTICLE FOUR
CONDITIONS OF CONSOLIDATION
4.1 GENERAL CONDITIONS. The obligations of each party to effect
the Consolidation shall be subject to the satisfaction (or written waiver by
such party, to the extent such condition is waivable) of the following
conditions before the Effective Time:
(a) SHAREHOLDER APPROVAL. The holders of the outstanding shares
of Sturgis Common Stock shall have approved or adopted this Agreement as
specified in SECTION 1.10 and SECTION 1.12(E)(IV) hereof or as otherwise
required by applicable law.
(b) NO PROCEEDINGS. No order shall have been entered and remain
in force restraining or prohibiting the Consolidation and any legal,
administrative, arbitration, investigatory or other proceedings by any
governmental or judicial or other authority. No statute, rule, regulation,
order, injunction or decree shall have been enacted, entered, promulgated or
enforced by any governmental or regulatory authority which prohibits, materially
restricts or makes illegal the consummation of the Consolidation.
(c) GOVERNMENTAL APPROVALS. To the extent required by applicable
law or regulation, all approvals of or filings with any governmental or
regulatory authority (collectively "Governmental Approvals") shall have been
obtained or made, and any waiting period shall have expired in connection with
the consummation of the Consolidation; provided, however, that none of the
proceedings shall be deemed obtained or made if it shall be conditioned or
restricted in a manner that would have or result in a material adverse effect on
the parties hereto. All other statutory or regulatory requirements for the valid
consummation of the Consolidation shall have been satisfied.
(d) REGISTRATION STATEMENT. The Registration Statement shall have
been declared effective and shall not be subject to a stop order of the SEC (and
no proceedings for that purpose shall have been initiated or threatened by the
SEC) and, if the offer and sale is subject to the securities laws of any state,
shall not be subject to a stop order of any state's securities authority.
(e) FEDERAL TAX OPINION. Each party shall have received an
opinion of its independent accountants, dated as of the Effective Time, to the
effect that for federal income tax purposes (i) the Consolidation will qualify
as a reorganization under Section 368 of the Internal Revenue Code, (ii) no gain
or loss will be recognized by Sturgis or Bancorp by reason of the Consolidation,
(iii) no gain or loss will be recognized by any shareholder of Sturgis upon the
exchange of Sturgis Common Stock solely for Bancorp Common Stock in the
Consolidation, (iv) the basis of the Bancorp Common Stock received by each
shareholder of Sturgis who exchanges Sturgis Common Stock for Bancorp Common
Stock in the Consolidation will be the same as the basis of Sturgis Common Stock
surrendered and exchanged therefor (subject to any adjustments required as a
result of receipt of cash in lieu of a fractional share), (v) the holding period
of the Bancorp Common Stock received by a shareholder of Sturgis in the
Consolidation will include the holding period of the Sturgis Common Stock
surrendered in exchange therefor, provided that such shares of Sturgis Common
Stock were held as a capital asset by such shareholders at the Effective Time,
and (vi) cash received by a Sturgis shareholder in lieu of a fractional share
interest of Bancorp Common Stock as part of the Consolidation will be treated as
having been received as a distribution in full payment in exchange for the
fractional share interest which such shareholder would otherwise be entitled to
receive and will qualify as capital gain or loss (assuming the Sturgis stock was
a capital asset in such shareholders' hands at the Effective Time).
<PAGE> 24
(f) THIRD PARTY CONSENTS. All consents or approvals of all
persons (other than Governmental Approvals referred to in SECTION 4.1(C) hereof)
required for the execution, delivery and performance of this Agreement and the
consummation of the Consolidation shall have been obtained and shall be in full
force and effect unless the failure to obtain such consent or approval is not
reasonably likely to have, individually or in the aggregate a material adverse
effect on the parties or transaction hereto.
(g) POOLING OF INTEREST. Each party shall have received a letter,
effective as of the Effective Time, from its independent accountants addressed
to it to the effect that the Consolidation will qualify for "pooling of
interest" accounting treatment.
(h) FAIRNESS OPINION. Each party shall have received its written
fairness opinion from its financial consultant.
(i) EMPLOYMENT AGREEMENTS. Bancorp shall have entered into
Employment Agreements in form and substance reasonably acceptable to Bancorp and
Sturgis with: (i) Leonard L. Eishen, (ii) James T. Grohalski and (iii) such
other individuals, if any, as shall be mutually agreed upon by Bancorp and
Sturgis.
(j) STOCK OPTION PLAN. The holders of the outstanding shares of
Bancorp Common Stock shall have approved a Stock Option Plan at the 2000 annual
meeting of Bancorp's shareholders whereby Bancorp shall be authorized to issue
qualified and non-qualified stock options in sufficient amounts to convert the
options for Sturgis Common Stock specified in SCHEDULE 1.11 to options for
Bancorp Common Stock as provided in SECTION 1.11 above.
(k) DISSENTER RIGHTS. The independent accounting firms regularly
retained by Bancorp and Sturgis shall have mutually determined that the
Consolidation would qualify as a "pooling of interest" for accounting purposes
if all the holders of Potentially Dissenting Shares (as defined below) perfect
their dissenters' rights under MSBA. As used herein, "Potentially Dissenting
Shares" shall mean all shares held by any holder of Sturgis Common Stock where
such holder shall have taken one or both of the following actions: (i) given
notice in writing to Sturgis at or prior to the Sturgis Shareholders Meeting
that such holder dissents from the Consolidation, or (ii) voted against the
Consolidation at the Sturgis Shareholders Meeting.
(1) BANCORP NAME. Bancorp shall have adopted an assumed name by
the procedure specified in SECTION 1.14 hereof.
4.2 CONDITIONS TO OBLIGATIONS OF STURGIS. The obligations of
Sturgis to effect the Consolidation and the other transactions contemplated
hereby shall be subject to the satisfaction or written waiver of Sturgis of the
following conditions before the Effective Time:
(a) NO MATERIAL ADVERSE EFFECT. Between the date of this
Agreement and the Closing, Bancorp shall not have been affected by any event or
change which has had or caused a material adverse effect or material adverse
change on it.
(b) REPRESENTATIONS, WARRANTIES AND CONDITIONS. The
representations and warranties of Bancorp (i) shall be true and correct as of
the date hereof and at the Effective Time with the same effect as though made at
the Effective Time (or on the date when made in the case of any representation
or warranty which specifically relates to an earlier date) except where the
failure to be true and correct would not have, or would not reasonably be
expected to have, a material adverse effect on Bancorp, (ii) Bancorp and its
Subsidiaries shall have performed all obligations and complied with each
covenant, in all material respects, and satisfied all conditions under this
Agreement on its part to be satisfied at or before the Effective Time, and (iii)
Bancorp shall have delivered to Sturgis a certificate, dated the Effective Time
and signed by its chief executive officer and chief financial officer,
certifying as to the satisfaction of clauses (i) and (ii) hereof.
<PAGE> 25
(c) NO LITIGATION. Neither Bancorp nor any Bancorp Subsidiary
shall be subject to any pending litigation which, if determined adversely to
Bancorp or to any Bancorp Subsidiary, would have a material adverse effect on
Bancorp.
(d) AUDITED FINANCIALS. Bancorp shall have delivered to Sturgis
audited consolidated financial statements at and for the year ended December 31,
1999, including an unqualified opinion of Bancorp's independent auditors related
thereto.
(e) OTHER CERTIFICATES. Bancorp shall have delivered to Sturgis
such other certificates and instruments as Sturgis and its counsel may
reasonably request. The form and substance of all certificates, instruments and
other documentation delivered to Sturgis under this Agreement shall be
reasonably satisfactory to Sturgis and its counsel.
(f) OPINION OF LEGAL COUNSEL. Bancorp shall have delivered to
Sturgis an opinion of Miller, Canfield, Paddock & Stone, P.L.C., counsel for
Bancorp, dated as of the date of the Closing and in form reasonably satisfactory
to counsel for Sturgis.
4.3 CONDITIONS TO OBLIGATIONS OF BANCORP. The obligations of
Bancorp to effect the Consolidation and the other transactions contemplated
hereby shall be subject to the satisfaction or written waiver by Bancorp of the
following additional conditions before the Effective Time:
(a) NO MATERIAL ADVERSE EFFECT. Between the date of this
Agreement and Closing, Sturgis shall have not been affected by any event or
change which has had or caused a material adverse effect or material adverse
change on Sturgis.
(b) REPRESENTATIONS, WARRANTIES AND CONDITIONS. The
representations and warranties of Sturgis shall (i) be true and correct as of
the date hereof and at the Effective Time with the same effect as though made at
the Effective Time (or on the date when made in the case of any representation
or warranty which specifically relates to an earlier date) except where the
failure to be true and correct would not have, or would not reasonably be
expected to have, a material adverse effect on Sturgis, (ii) Sturgis and its
Subsidiaries shall have performed all obligations and complied with each
covenant, in all material respects and satisfied all conditions under this
Agreement on its part to be satisfied at or before the Effective Time, and (iii)
Sturgis shall have delivered to Bancorp a certificate, dated the Effective Time
and signed by its President and chief financial officer, certifying as to the
satisfaction of clauses (i) and (ii) hereof.
(c) NO LITIGATION. Neither Sturgis nor any Sturgis Subsidiary
shall be subject to any pending litigation which, if determined adversely to
Sturgis or to any Sturgis Subsidiary, would have a material adverse effect on
Sturgis.
(d) AUDITED FINANCIALS. Sturgis shall have delivered to Bancorp
audited financial statements at and for the year ended December 31, 1999,
including an unqualified opinion of Sturgis' independent auditors related
thereto.
(e) OTHER CERTIFICATES. Sturgis shall have delivered to Bancorp
such other certificates and instruments as Bancorp and its counsel may
reasonably request. The form and substance of all certificates, instruments and
other documentation delivered to Bancorp under this Agreement shall be
reasonably satisfactory to Bancorp and its counsel.
(f) OPINION OF LEGAL COUNSEL. Sturgis shall have delivered to
Bancorp an opinion of Dresser, Dresser, Gilbert & Haas, P.C., counsel for
Sturgis, dated as of the date of Closing and in form reasonably satisfactory to
counsel for Bancorp.
<PAGE> 26
ARTICLE FIVE
CORPORATE GOVERNANCE
5.1 STURGIS AND SOUTHERN OFFICERS AND EMPLOYEES. After the
Effective Time, Sturgis as the Surviving Corporation and Southern shall continue
to have the same officers and employees as immediately before the Effective Time
subject to the discretion of the continuing Board of Directors of Sturgis and
Southern.
5.2 STURGIS AND SOUTHERN BOARD OF DIRECTORS. The present Boards
of Directors of Sturgis and Southern shall continue to serve as the Board of
Directors of Sturgis and Southern after the Consolidation except that Sturgis
shall cause James T. Grohalski to be added to the Board of Directors of Sturgis
and Bancorp shall cause Leonard L. Eishen to be added to the Board of Directors
of Southern. The Bylaws of Sturgis and Southern shall be amended as necessary to
accommodate such additions.
5.3 BANCORP BOARD OF DIRECTORS. Bancorp shall cause all of the
Directors of Bancorp except James T. Grohalski or another Director designated by
the Board of Directors of Bancorp (the "Designated Director") to resign as of
the Effective Time. Immediately after the Effective Time, the Designated
Director, as the sole remaining Director of Bancorp, shall elect the individuals
identified in Section 5.3 of each party's Disclosure Schedule to the Board of
Directors of Bancorp for the terms indicated: (i) two (2) individuals designated
by Bancorp and one (1) individual designated by Sturgis for a one (1) year term,
(ii) two (2) individuals designated by Bancorp and one (1) individual designated
by Sturgis for a two (2) year term, and (iii) two (2) individuals designated by
Sturgis and one (1) individual designated by Bancorp for a three (3) year term;
provided that the Designated Director shall continue to serve the balance of his
or her elected term and shall, for purposes of the foregoing, be deemed an
individual designated by Bancorp for that particular term.
5.4 BANCORP OFFICERS AND COMMITTEES. Bancorp shall cause all of
the officers of Bancorp to resign as of the Effective Time. It is the intention
of the parties that immediately after the Board of Directors of Bancorp is
formed under SECTION 5.3 above, the Board of Directors will take action to
elect: Leonard L. Eishen as President and Chief Executive Officer ("CEO") of
Bancorp; James T. Grohalski as Vice-Chairman, Chief Operating Officer and Chief
Financial Officer of Bancorp; James Morrison as Chairman of Bancorp; James
Goethals as Vice Chairman of Bancorp; and all members of all committees of the
Bancorp Board of Directors with equal representation from both the Sturgis and
Bancorp designated board members. It is intended by the parties that at age
sixty-five (65) years, Leonard L. Eishen will be succeeded by James T. Grohalski
as President and CEO of Bancorp and Leonard L. Eishen will become Chairman of
the Board of Directors of Bancorp.
5.5 BYLAWS. At the Effective Time, the Bylaws of Bancorp shall be
amended and restated to provide as follows (the "Amended and Restated Bylaws"):
(a) The Board of Directors of Bancorp shall have nine (9) members
with staggered three (3) year terms and no Director may stand for election after
age seventy (70) years.
(b) Bancorp shall not take any of the following actions unless
such action is authorized by a vote of seventy five percent (75%) of the members
of the Board of Directors of Bancorp:
(i) amendments to Bancorp's Articles of Incorporation or
the Amended and Restated Bylaws;
(ii) approval of any merger, share exchange or dissolution
involving Bancorp or any of its subsidiaries;
(iii) sale or transfer of substantially all of the corporate
assets of Bancorp or any of its subsidiaries;
<PAGE> 27
(iv) issuance and/or sale of any stock of Bancorp including
the establishment of the consideration to be accepted by Bancorp for
the sale of any shares of its stock;
(v) acquisition by Bancorp of another business or
operation by way of merger, share exchange, purchase of stock, purchase
of assets or otherwise wherein the consideration paid or delivered
exceeds either 10% of the book value of assets of Bancorp and its
subsidiaries or 10% of the fair market value of outstanding capital
stock of Bancorp, as applicable;
(vi) any action taken by Bancorp as a shareholder of any
subsidiary including, without limitation, Sturgis and Southern; and
(vii) election of officers, nomination of directors and
appointment of Board of Directors committee members.
ARTICLE SIX
TERMINATION OF OBLIGATIONS
6.1 TERMINATION OF AGREEMENT AND ABANDONMENT OF CONSOLIDATION.
This Agreement may be terminated at any time before the Effective Time, whether
before or after approval thereof by the shareholders of Sturgis or Bancorp, as
provided below:
(a) MUTUAL CONSENT. By mutual consent of the parties as
evidenced by their written agreement.
(b) CLOSING DELAY. At the election of either party, as evidenced
by written notice, if the Closing shall not have occurred on or before December
31, 2000, or such later date as shall have been agreed to in writing by the
parties, provided, however, that the right to terminate under this SECTION
6.1(B) shall not be available to any party whose failure to perform an
obligation hereunder has been the cause of, or has resulted in, the failure of
the Closing to occur on or before such date.
(c) CONDITIONS TO STURGIS' PERFORMANCE NOT MET. By Sturgis
(provided it has not breached this Agreement to any material extent) upon
delivery of written notice of termination to Bancorp if any event occurs
(through no fault of Sturgis) which renders impossible the satisfaction in any
material respect one or more of the conditions to the obligations of Sturgis to
effect the Consolidation set forth in SECTIONS 4.1 and 4.2 hereof and
non-compliance is not waived in writing by Sturgis.
(d) CONDITIONS TO BANCORP'S PERFORMANCE NOT MET. By Bancorp
(provided it has not breached this Agreement to any material extent) upon
delivery of written notice of termination to Sturgis if any event occurs
(through no fault of Bancorp) which renders impossible the satisfaction in any
material respect one or more of the conditions to the obligations of Bancorp to
effect the Consolidation set forth in SECTIONS 4.1 and 4.3 hereof and
non-compliance is not waived in writing by Bancorp.
(e) BREACH. By either Sturgis or Bancorp if there has been a
material breach of the other party's representations and warranties (as
contemplated in this Agreement), covenants or agreements set forth in this
Agreement of which written notice has been given to such breaching party and
which has not been fully cured or cannot be fully cured within the earlier of
(i) thirty (30) days after receipt of such notice or (ii) five (5) days prior to
the Closing and which breach would, in the reasonable opinion of the
non-breaching party, individually or in the aggregate, have, or be reasonably
likely to have, a material adverse effect on the non-breaching party.
(f) STURGIS ELECTION. By Sturgis if the Board of Directors of
Bancorp shall have authorized Bancorp to enter into any agreement, letter of
intent or agreement in principle with the intent to pursue or effect a Take Over
Proposal.
<PAGE> 28
(g) BANCORP ELECTION. By Bancorp if: (i) the Board of Directors
of Sturgis shall not have publicly recommended in the prospectus and proxy
statement that its shareholders approve and adopt this Agreement or shall have
withdrawn, modified or changed in any manner adverse to Bancorp its approval or
recommendation of this Agreement, or (ii) the Board of Directors of Sturgis
shall have authorized Sturgis to enter into any agreement, letter of intent or
agreement in principle with the intent to pursue or effect a Take Over Proposal.
6.2 TERMINATION; LACK OF SURVIVAL OF REPRESENTATIONS AND
WARRANTIES. In the event of termination of this Agreement pursuant to SECTION
6.1 hereof:
(a) This Agreement shall become void and have no effect, except
(i) the provisions of SECTIONS 2.7, 3.6, 8.2 and 8.12 shall survive; (ii) a
termination pursuant to SECTION 6.1(E) hereof shall not relieve the breaching
party from any liability for any uncured intentional breach of a representation,
warranty, covenant or agreement giving rise to such termination and the party
whose representations and warranties were incorrect or who breached such
covenant or agreement shall be liable to the other party for all costs and
expenses of the other party in connection with the preparation, negotiation,
execution and performance of this Agreement (including reasonable legal and
accounting fees), in addition to all rights and remedies to which such
non-breaching party may otherwise be entitled; (iii) in the event of a
termination pursuant to SECTION 6.1(F) by Sturgis, Bancorp shall pay Sturgis
Five Hundred Thousand and 00/100 Dollars ($500,000.00) as a break-up fee plus
all costs, fees and expenses incurred by Sturgis in connection with the
preparation, negotiation, execution and performance of this Agreement (including
reasonable legal and accounting fees) which shall be the sole and exclusive
remedy of Sturgis in connection with such termination of this Agreement; and
(iv) in the event of a termination pursuant to SECTION 6.1(G) by Bancorp,
Sturgis shall pay Bancorp Five Hundred Thousand and 00/100 Dollars ($500,00.00)
as a break-up fee plus all costs, fees and expenses incurred by Bancorp in
connection with the preparation, negotiation, execution and performance of this
Agreement (including reasonable legal and accounting fees) which shall be the
sole and exclusive remedy of Bancorp in connection with such termination of this
Agreement.
(b) The representations, warranties and agreements set forth in
this Agreement shall not survive the Effective Time and shall be terminated and
extinguished at the Effective Time, and from and after the Effective Time, no
party shall have any liability to the other on account of any breach or failure
of any of those representations, warranties, covenants and agreements, provided,
however that the foregoing clause (i) shall not apply to agreements of the
parties which by their terms are intended to be performed after the Effective
Time and (ii) shall not relieve any party or person for liability for fraud or
intentional misrepresentation.
(c) At any time prior to the Effective Time, the parties hereto,
by action taken or authorized by their respective Board of Directors, may, to
the extent legally allowed, (i) extend the time for the performance of any of
the obligations or other acts of the other parties hereto, (ii) waive any
inaccuracies in the representations and warranties contained herein or in any
document delivered pursuant hereto, and (iii) waive compliance with any of the
agreements or conditions contained herein; provided, however, that after any
approval of the transactions contemplated by Sturgis' shareholders, there may
not be, without further approval of such shareholders, any extension or waiver
or this Agreement or any portion hereof which reduces the amount or changes the
form of consideration to be delivered to the holders of Sturgis Common Stock.
Any agreement on the part of a party hereto to any such extension or waiver
shall be valid only if set forth in a written instrument signed on behalf of
such party, but such extension or waiver or failure to insist on strict
compliance with an obligation, covenant, agreement or condition shall not
operate as a waiver of, or a estoppel with respect to, any subsequent waiver or
extension.
6.3 PAYMENT OF EXPENSES. Except as otherwise provided herein,
each party shall bear and pay all costs and expenses incurred by it in
connection with the transactions contemplated hereby; provided, however, that
the costs and expenses of printing and mailing the Proxy Statement/Prospectus,
and all filing and other fees paid to the SEC in connection with the
Consolidation, shall be borne equally by Sturgis and Bancorp.
<PAGE> 29
ARTICLE SEVEN
OTHER AGREEMENTS
7.1 ADDITIONAL AGREEMENTS.
(a) If at any time after the Effective Time any further action is
necessary or desirable to carry out the purposes of this Agreement, the proper
officers and directors of each party to this Agreement and their respective
Subsidiaries shall take all necessary action as may be reasonably requested by,
and at the sole expense of, Bancorp.
(b) Except as provided in SECTION 1.12(E) above, each party shall
use all commercially reasonable efforts to cause to be delivered to the other
the independent accountants letter, dated as of the Closing, stating that
accounting for the Consolidation is as a "pooling of interest" under opinion 16
of the Accounting Principles Board and applicable SEC rules and regulations.
7.2 ADVICE OF CHANGES. Each party shall promptly advise the other
party of any change or event having a material adverse effect on it or which it
believes would or would reasonably be likely to cause or constitute a material
breach of any of its representations, warranties or covenants contained herein.
ARTICLE EIGHT
GENERAL
8.1 AMENDMENTS. Subject to applicable law, this Agreement may be
amended, whether before or after any shareholder approval hereof, by an
agreement in writing executed in the same manner as this Agreement and
authorized or ratified by the Boards of Directors of the parties hereto,
provided that after the approval of this Agreement by the shareholders of
Sturgis, no such amendment may change the amount or form of the consideration to
be delivered hereunder without such shareholders' approval. This Agreement may
not be amended except by a written instrument executed on behalf of each of the
parties.
8.2 CONFIDENTIALITY. All information disclosed by any party to
any other party, whether prior or subsequent to the date of this Agreement,
including without limitation, any information obtained pursuant to SECTION 3.1
hereof, shall be kept confidential by such other party and shall not be used by
such other party otherwise than herein contemplated, all in accordance with the
terms of the Confidentiality Agreement between the parties dated September 9,
1999 (the "Confidentiality Agreement"). In the event of the termination of this
Agreement, each party shall upon request use all reasonable efforts to promptly
return to the other party all documents (and reproductions thereof) received
from such other party (and, in the case of reproductions, all such reproduction)
that include information subject to the confidentiality requirements set forth
above.
8.3 GOVERNING LAW. This Agreement and the legal relations between
the parties shall be governed by and construed in accordance with the laws of
the State of Michigan except to the extent certain matters may be governed by
federal law.
8.4 NOTICES. All notice and other communication required or
permitted hereunder shall be in writing and shall be deemed given if mailed by
registered or certified mail (postage prepaid and return receipt requested)
addressed as follows:
If to Sturgis: Sturgis Bank & Trust Company
P.O. Box 600
Sturgis, Michigan 49091
Attn: Leonard L. Eishen
Fax: (616) 651-5512
<PAGE> 30
With a copy to: Dresser, Dresser, Gilbert & Haas, P.C.
112 South Monroe Street
Sturgis, Michigan 49091
Attn: John R. Dresser, Esq.
Fax: (616) 651-2361
If to Bancorp: Southern Michigan Bancorp, Inc.
51 West Pearl
Coldwater, Michigan 49036
Attn: James T. Grohalski
Fax: (517) 278-8469
With a copy to: Miller, Canfield, Paddock & Stone, P.L.C.
444 West Michigan Avenue
Kalamazoo, Michigan 49007-3714
Attn: John R. Cook, Esq.
Fax: (616) 382-0244
(or such other address as shall be furnished in writing by either party to the
other), and any such notice or communication shall be deemed to have been given
two business days after the date of such mailing (except that the notice of
change of address shall not be deemed to have been given until received by the
addressee). Notices may also be sent by facsimile transmission, hand delivery or
overnight courier and in such event shall be deemed to have been given as of the
date received by the addressee.
8.5 NO ASSIGNMENT. This Agreement may not be assigned by any
party hereto, by operation of law or otherwise, except as contemplated hereby.
8.6 HEADINGS. The description of the Articles and Sections of
this Agreement are inserted for convenience only and are not a part of this
Agreement.
8.7 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
shall become effective when one or more counterparts have been signed by each
party and delivered to each other party.
8.8 CONSTRUCTION AND INTERPRETATION. It is expressly acknowledged
and agreed that all parties have been represented by counsel and have
participated in the negotiation and drafting of this Agreement, and there shall
be no presumption against any party on the ground that such party was
responsible for preparing this Agreement or any part of it. Each of the Exhibits
and Schedules referred to in, and/or attached to this Agreement, are an integral
part of this Agreement and are incorporated in this Agreement by reference. In
the event of a conflict between the terms of this Agreement and any Exhibit,
Schedule or other attachment hereto, the terms of this Agreement shall control,
unless prohibited by applicable law. No provision of this Agreement shall be
construed to require either party or their Subsidiaries to take any action which
would violate any applicable law, rule or regulation. Except as the context
otherwise requires, all references herein to any state or federal regulatory
agency shall also be deemed to refer to any predecessor or successor agency, and
all references to state and federal statutes or regulations shall be deemed to
refer to any successor statute or regulation. Whenever this Agreement refers to
a number of days, such number shall refer to calendar days unless business days
are specified. Whenever in this Agreement "or" is used, it is used in the
inclusive sense of "and/or" unless otherwise specified.
<PAGE> 31
8.9 ENTIRE AGREEMENT. This Agreement, together with the
Schedules, lists, Exhibits and certificates referred to herein or required to be
delivered hereunder, and any amendment hereafter executed and delivered in
accordance with SECTION 8.1 hereof, constitutes the entire agreement of the
parties and supersedes any prior written or oral agreement or understanding
among any parties pertaining to the Consolidation, except that the
Confidentiality Agreement shall remain in full force and effect as contemplated
in SECTION 8.2 hereof.
8.10 SEVERABILITY. Whenever possible, each provision of this
Agreement shall be interpreted in such manner as to be effective and valid under
applicable law, but if such provision in this Agreement is held to be prohibited
by or invalid under applicable law, then such provision will be ineffective only
to the extent of such prohibition or invalidity, without invalidating the
remainder of such provision or the remaining provisions of this Agreement.
8.11 NO THIRD PARTY BENEFICIARIES. Nothing in this Agreement shall
entitle any person (other than the parties hereto and their respective
successors and assigns) permitted hereby, to any claim, cause of action, remedy
or right of any kind.
8.12 NO EMPLOYMENT SOLICITATION. If this Agreement is terminated,
the parties hereto agree that for a period of twelve (12) months subsequent to
such termination (i) none of the parties shall, without first obtaining the
prior written consent of the other, directly or indirectly, solicit the
employment of any current Director, officer or employee of the other party or
any Subsidiary of such other party and (ii) none of the parties shall actively
solicit business relationships with clients of the other party or any Subsidiary
of such other party solely as the result of review of the information
contemplated in SECTION 8.2 hereof. This provision shall supercede in entirety
the second sentence of Section 6 of the Confidentiality Agreement.
8.13 CONSENT TO JURISDICTION. Each of the parties consent to the
exclusive personal jurisdiction and venue of the courts, state and federal, for
St. Joseph County, State of Michigan, for the purposes of any suit, action or
other proceeding arising out of this Agreement or the transactions contemplated
hereby.
8.14 FURTHER ASSURANCES. At the request of any party to this
Agreement, the other party shall execute, acknowledge and deliver such other
documents and/or instruments as may be reasonably required by the requesting
party to carry out the purposes of this Agreement. In the event any party to
this Agreement shall be involved in litigation, threatened litigation or
government inquiries with respect to a matter covered by this Agreement, every
other party to this Agreement shall also make available to such party, at
reasonable times and subject to reasonable requirements of its own businesses,
such of its personnel as may have information relevant to such matters, provided
that such party shall reimburse the providing party for its reasonable costs for
employee time incurred in connection therewith if more than one business day is
required. Following the Closing, the parties will cooperate with each other in
connection with tax audits and in the defense of any legal proceedings.
8.15 REMEDIES. Unless expressly made the exclusive remedy by the
terms of this Agreement, all remedies provided for in this Agreement are
cumulative and shall be in addition to any and all other rights and remedies
provided by law and by any other agreement between the parties.
<PAGE> 32
IN WITNESS WHEREOF, each party has caused this Agreement to be executed
on its behalf by its duly authorized officers as of the date first set forth
above.
STURGIS BANK & TRUST COMPANY
/s/ Leonard L. Eishen
----------------------------------------------
By: Leonard L. Eishen
Title: President and Chief Executive Officer
SOUTHERN MICHIGAN BANCORP, INC.
/s/ James T. Grohalski
----------------------------------------------
By: James T. Grohalski
Title: President and Chief Executive Officer
<PAGE> 1
EXHIBIT 10(b)
SOUTHERN MICHIGAN BANCORP, INC.
2000 STOCK OPTION PLAN
1. Purpose. The purpose of the Southern Michigan Bancorp, Inc. 2000
Stock Option Plan (this "Plan") is to advance the interests of Southern Michigan
Bancorp, Inc., a Michigan corporation (the "Corporation"), and its subsidiaries
by providing a larger personal and financial interest in the success of the
Company and its subsidiaries to employees and directors upon whose judgment,
interest and special efforts the Company and its subsidiaries are dependent for
the successful conduct of its and their operations and to enable the Company and
its subsidiaries to attract and retain key employees and directors.
2. Participants. Options may be granted under this Plan to any
employee or director of the Company and its subsidiaries. The employees and
directors of the Company and its subsidiaries to whom options are granted and
the terms of such options shall be determined by the Board of Directors. A
grantee may hold more than one option. Nothing contained in this Plan, nor in
any option granted pursuant to this Plan, shall confer upon any employee or
director any right to the continuation of his or her employment or directorship
nor limit in any way the right of the Company or its subsidiaries to terminate
such employment or directorship at any time. As used herein, the term
"subsidiary" shall mean any present or future entity that is controlled by the
Company, directly or through one or more intermediaries.
3. Effectiveness and Termination of Plan. This Plan shall become
effective upon approval thereof by the shareholders of the Company at a meeting
held, among other things, for such purpose. The adoption date of this Plan shall
be March 20, 2000, the date of its adoption by the Board of Directors of the
Company. This Plan shall terminate on the earliest of: (i) ten (10) years from
its adoption date; (ii) when all shares of Common Stock (as defined in Section 4
hereof) that may be issued under this Plan shall have been issued through
exercise of options granted under this Plan; or (iii) at any earlier time that
the Board of Directors may determine. Any option outstanding under this Plan at
the time of its termination shall remain in effect in accordance with its terms
and conditions and those of this Plan.
4. Common Stock. The aggregate number of shares of common stock,
$2.50 par value per share, of the Company (the "Common Stock") that may be
issued under this Plan shall consist of 110,000 shares, subject to further
adjustment as provided in Section 7 hereof. Such number of shares may be set
aside out of the authorized but unissued shares of Common Stock of the Company
not reserved for any other purpose or out of shares of Common Stock acquired by
the Company. All or any shares of Common Stock subjected under this Plan to an
option that, for any reason, is canceled, terminates, lapses or expires
unexercised as to such shares may again be subjected to an option under this
Plan.
5. Types of Options and Terms and Conditions.
(a) Options granted under this Plan shall be in the form of: (i)
incentive stock options ("Incentive Stock Options") as defined in Section 422 of
the Internal Revenue Code of 1986, as amended (the "Code"); or (ii) options not
qualifying under Section 422 of the Code ("Nonstatutory Stock Options"), all in
such amounts as determined by the Board of Directors.
(b) Options may be granted at any time and from time to time
prior to the termination of this Plan. Except as hereinafter provided, all
options granted pursuant to this Plan shall be subject to the following terms
and conditions:
<PAGE> 2
(i) Price. The purchase price of the shares of Common Stock
issuable upon exercise of options granted under this Plan shall be not
less than 100% of the fair market value of the Common Stock on the date
of the grant of the option. For purposes of this Plan, "fair market
value" of the Common Stock shall mean: (A) the mean between the closing
high bid and low asked prices as reported by the National Association
of Securities Dealers Automated Quotation System (or, if not so
reported, by the system then regarded as the most reliable source of
such quotation); or (B) if the Common Stock is quoted in the domestic
over-the-counter market, but there are not reported quotations on the
given date, the value determined pursuant to (A) above using the
reported quotations on the last previous date on which so reported; or
(C) if neither of the foregoing clauses apply, the price determined in
good faith by the Board of Directors.
The purchase price shall be paid in full at the time of such purchase,
in: (A) cash; (B) shares of Common Stock of the Company valued at the
fair market value of the Common Stock on the date of purchase; or (C)
any combination of cash and Common Stock. Notwithstanding the
foregoing, the Board of Directors may, in order to prevent any possible
violation of law, require the purchase price to be paid in cash and
further provide that the right to deliver Common Stock in payment of
the purchase price may be limited or denied in any Option Agreements
(as defined in Section 11 hereof). The purchase price shall be subject
to adjustment, but only as provided in Section 7 hereof.
(ii) Duration and Exercise of Options. Options may be granted for
terms of up to but not exceeding ten (10) years from the date the
particular option is granted. Options shall be exercisable as provided
by the Board of Directors at the time of grant thereof.
(iii) Termination of Employment or Service as a Director. Upon the
termination of the grantee's employment or service as a director, his
or her rights to exercise an option shall be only as follows:
(1) Death, Disability or Retirement. If the grantee's
employment or service as a director is terminated by reason of
death or disability (as described in Section 22(e)(3) of the
Code), the grantee or the grantee's estate may, within one (1)
year following such termination, exercise the option with respect
to only such number of shares of Common Stock as to which the
right of exercise had accrued on or before the last day on which
the grantee was either an employee or director of the Company or
any subsidiary. If the grantee's employment or service as a
director is terminated by reason of retirement, the grantee or the
grantee's estate (in the event of the grantee's death after such
termination) may, within three (3) months following such
termination, exercise the option with respect to only such number
of shares of Common Stock as to which the right of exercise had
accrued on or before the last day on which the grantee was either
an employee or director of the Company or any subsidiary. For
purposes of this Plan, "retirement" shall mean termination of
employment or service as a director with the Company and/or its
subsidiaries on or after the grantee's 65th birthday or the
grantee's 60th birthday if the grantee has completed ten (10)
years of service with the Company and/or its subsidiaries.
(2) Other Reasons. If the grantee ceases to be an employee
or director for any reason other than those provided above under
"Death, Disability or Retirement," the grantee or the grantee's
estate (in the event of the grantee's death after such
termination) may, within the one (1) month period following such
termination, exercise the option with respect to only such number
of shares of Common Stock as to which the right of exercise had
accrued on or before the last day on which the grantee was either
an employee or director of the Company or any subsidiary.
(3) General. Notwithstanding the foregoing, no option shall
be exercisable in whole or in part: (A) after the termination date
provided in the option; or (B) except as provided in the
<PAGE> 3
second paragraph of Section 10, for one (1) year following the
date the option was granted. A grantee's "estate" shall mean the
grantee's legal representatives upon the grantee's death or any
person who acquires the right under the laws of descent and
distribution to exercise an option by reason of the grantee's
death.
(iv) Transferability of Option. Except as otherwise provided
herein, options shall be transferable only by will or the laws of
descent and distribution and shall be exercisable during the grantee's
lifetime only by him or her. An option and all rights thereunder shall
terminate immediately if the holder attempts to or does sell, assign,
transfer, pledge, hypothecate or otherwise dispose of the option or any
rights thereunder to any person except as permitted herein.
(v) Other Terms and Conditions. Options may also contain such
other provisions, which shall not be inconsistent with any of the
foregoing terms, as the Board of Directors shall deem appropriate.
(c) Incentive Stock Options granted pursuant to this Plan shall
be subject to all the terms and conditions included in subsection (b) and to the
following terms and conditions:
(i) No Incentive Stock Option shall be granted to an individual
who is not an employee of the Company or a "subsidiary corporation" as
defined in Section 424(f) of the Code;
(ii) No Incentive Stock Option shall be granted to an employee
who owns stock possessing more than 10% of the total combined voting
power of all classes of stock of the Company unless the grant complies
with the requirements of Section 422(c)(5) of the Code;
(iii) The aggregate fair market value (determined as of the date
the option is granted) of the shares of Common Stock with respect to
which Incentive Stock Options are exercisable for the first time by any
grantee during any calendar year (under all plans of the Company) shall
not exceed $100,000 or such other amount as may subsequently be
specified by the Code; provided that, to the extent that such
limitation is exceeded, any excess options (as determined by the Code)
shall be deemed to be Nonstatutory Stock Options; and
(iv) No Incentive Stock Option may be granted under this Plan if
such grant, together with any applicable prior grants that are
Incentive Stock Options within the meaning of Section 422(b) of the
Code, would exceed any maximum established under the Code for incentive
stock options that may be granted to an individual employee.
6. Rights of a Shareholder. A recipient of an option shall have no
rights as a shareholder with respect to any shares issuable or transferable upon
exercise thereof until the date of issuance of a stock certificate for such
shares. Except as otherwise provided pursuant to Section 7 hereof, no adjustment
shall be made for dividends or other rights for which the record date is prior
to the date of such stock certificate.
7. Adjustment of and Changes in Common Stock. In the event that the
shares of Common Stock of the Company, as presently constituted, shall be
changed into or exchanged for a different number or kind of shares of stock or
other securities of the Company or of another corporation (whether by reason of
merger, consolidation, recapitalization, reclassification, split-up, combination
of shares, or otherwise) or if the number of such shares of Common Stock shall
be increased through the payment of a stock dividend or a dividend on the shares
of Common Stock of rights or warrants to purchase securities of the Company
shall be made, then there shall be substituted for or added to each share of
Common Stock theretofore appropriated or thereafter subject or that may become
subject to an option under this Plan, the number and kind of shares of stock or
other securities into which each outstanding share of Common Stock of the
Company shall be so changed, or for
<PAGE> 4
which each such share shall be exchanged, or to which each such share shall be
entitled, as the case may be, and references herein to the Common Stock shall be
deemed to be references to any such stock or other securities as appropriate.
Outstanding options shall also be appropriately amended as to price and other
terms as may be necessary to reflect the foregoing events. In the event there
shall be any other change in the number or kind of the outstanding shares of the
Common Stock of the Company, or of any stock or other securities into which such
Common Stock shall have been changed or for which it shall have been exchanged,
then if the Board of Directors shall, in its sole discretion, determine that
such change equitably requires an adjustment in any option theretofore granted
or that may be granted under this Plan, such adjustments shall be made in
accordance with such determination. Fractional shares resulting from any
adjustment in options pursuant to this Section 7 may be settled in cash or
otherwise as the Board of Directors shall determine. Notice of any adjustment
shall be given by the Company to each holder of an option that shall have been
so adjusted and such adjustment (whether or not such notice is given) shall be
effective and binding for all purposes of this Plan. Any options granted or
which may be granted pursuant to this Plan, and which such options are or are
intended to be Incentive Stock Options within the meaning of Section 422 of the
Code, shall, to the extent it is reasonably feasible to do so (determined in the
sole discretion of the Board of Directors), be adjusted or modified pursuant to
this Section 7 in a manner which will allow such options to continue to be
classified as Incentive Stock Options within the meaning of Section 422 of the
Code or successor legislation.
8. Securities Act Requirements. No option granted pursuant to this
Plan shall be exercisable in whole or in part, and the Company shall not be
obligated to sell any shares of Common Stock subject to any such option, if such
exercise and sale would, in the opinion of counsel for the Company, violate the
Securities Act of 1933 (or other Federal or State statutes having similar
requirements), as in effect at that time. Each option shall be subject to the
further requirement that, if at any time the Board of Directors shall determine
in its discretion that the listing or qualification of the shares of Common
Stock subject to such option under any securities exchange requirements or under
any applicable law, or the consent or approval of any governmental regulatory
body, is necessary or desirable as a condition of, or in connection with, the
issue of shares thereunder, such option may not be exercised in whole or in part
unless such listing, qualification, consent or approval shall have been effected
or obtained free of any conditions not acceptable to the Board of Directors.
9. Withholding. Appropriate provision (which may, in accordance with
rules determined by the Board of Directors, include the election by the grantee
to have the Company withhold from the Common Stock to be issued upon exercise of
an option a number of shares having an aggregate fair market value that would
satisfy the withholding amount due or to deliver to the Company shares of Common
Stock already owned having such aggregate fair market value to satisfy the
withholding amount) shall be made for all taxes required to be withheld from
shares of Common Stock issued under this Plan under the applicable laws or other
regulations of any governmental authority, whether federal, state or local, and
domestic or foreign. To that end, the Company may at any time take such steps as
it may deem necessary or appropriate (including sale or retention of shares) to
provide for payment of such taxes.
10. Administration and Amendment of Plan. The Board of Directors from
time to time may adopt rules and regulations for carrying out this Plan. The
interpretation and construction by the Board of Directors of any provision of
this Plan or any option granted pursuant hereto shall be final and conclusive.
No member of the Board of Directors shall be liable for any action or
determination made in good faith with respect to this Plan or any option granted
pursuant thereto. The Board of Directors may from time to time make such changes
in and additions to this Plan as it may deem proper and in the best interests of
the Company, without further action on the part of the shareholders of the
Company except as required by law, regulation or by the rules of the principal
trading market of the Company's Common Stock at that time; provided, however,
that, unless the shareholders of the Company shall have first approved thereof:
(i) except as provided in Section 7 hereof, the total number of shares of Common
Stock subject to this Plan shall not be increased and the minimum purchase price
shall not be changed; (ii) no option shall be exercisable more than ten (10)
years after the date it is granted; and (iii) the expiration date of this Plan
shall not be extended.
<PAGE> 5
The Board of Directors shall have the power, in the event of any
disposition of substantially all of the assets of the Company, its dissolution
or of any consolidation or merger of the Company with and into any other
corporation, to amend all outstanding options to permit the exercise of all such
options prior to the effectiveness of any such transaction and to terminate such
options as of such effectiveness. If the Board of Directors shall exercise such
power, all options then outstanding and subject to such requirement shall be
deemed to have been amended to permit the exercise thereof in whole or in part
by the grantee at any time or from time to time as determined by the Board of
Directors prior to the effectiveness of such transaction and such options shall
be deemed to terminate upon such effectiveness.
11. Miscellaneous.
(a) Separate Plan. This Plan is separate and independent from
any other stock option plan or similar plan of the Company.
(b) Option Agreements. Options granted hereunder shall be
evidenced by option agreements ("Option Agreements") containing such terms and
conditions as the Board of Directors shall establish from time to time
consistent with this Plan. Option Agreements need not be identical but each
Option Agreement shall contain, without limitation, language including the
substance of the following provisions:
(i) Number of Shares and Exercise Price. Each Option Agreement
shall state the number of shares to which it pertains and the exercise
price therefor.
(ii) Exercise of Options. Options may be exercised only in
accordance with the terms of each Option Agreement which shall include
the period of time during which the option may be exercised.
(iii) Method of Exercise and Payment of Purchase Price. An option
may be exercised, as to all or part of the shares covered by the
option, by the grantee delivering to the Board of Directors: (A) a
written notice identifying the option being exercised, stating the
number of shares being purchased and enclosing payment to the Company
of the purchase price for the number of shares being exercised; and (B)
such items as the Company may reasonably request. If the option is
being exercised by any person or persons other than the grantee, the
written notice exercising the option shall be accompanied by
appropriate proof of the right of such person or persons to exercise
the option.
(iv) Additional Terms and Conditions. The Board of Directors may
specify such additional terms and conditions as it deems appropriate.
(c) Loans. Subject to the sole discretion of the Board of
Directors, the Company may loan the grantee funds to finance the exercise of any
option.
(d) Governing Law. This Plan and the Option Agreements shall be
interpreted and enforced in accordance with the laws of the State of Michigan.
IN WITNESS WHEREOF, this Plan has been executed by the Company on the
20th day of March, 2000.
SOUTHERN MICHIGAN BANCORP, INC.
By: /s/ James T. Grohalski
----------------------------------------
James T. Grohalski
Its: President and Chief Executive Officer
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
State or County
Name of Subsidiary of Incorporation
------------------ ----------------
Southern Michigan Bank & Trust Michigan
SMB&T Financial Services, Inc. Michigan
Southern Michigan Bancorp, Inc. is the immediate parent and owns 100% of the
outstanding shares of Southern Michigan Bank & Trust. Southern Michigan Bank &
Trust is the immediate parent and owns 100% of the outstanding shares of SMB&T
Financial Services, Inc.
<PAGE> 1
EXHIBIT 23
[CROWE CHIZEK LOGO]
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements of
Southern Michigan Bancorp, Inc. on Form S-3 (Registration No. 33-24977 and
Registration No. 333-51417), of our report dated February 11, 2000 on the
consolidated financial statements of Southern Michigan Bancorp, Inc., which
report is included in the 1999 Annual Report on Form 10-K of Southern Michigan
Bancorp, Inc.
/s/ Crowe, Chizek and Company LLP
---------------------------------------
Crowe, Chizek and Company LLP
South Bend, Indiana
March 22, 2000
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME FILED AS PART OF
THE ANNUAL REPORT ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH ANNUAL REPORT ON FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 12,046
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 54,229
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 193,371
<ALLOWANCE> 2,132
<TOTAL-ASSETS> 275,825
<DEPOSITS> 223,303
<SHORT-TERM> 588
<LIABILITIES-OTHER> 6,944
<LONG-TERM> 15,000
0
0
<COMMON> 4,597
<OTHER-SE> 15,393
<TOTAL-LIABILITIES-AND-EQUITY> 275,825
<INTEREST-LOAN> 16,577
<INTEREST-INVEST> 3,367
<INTEREST-OTHER> 107
<INTEREST-TOTAL> 20,051
<INTEREST-DEPOSIT> 7,738
<INTEREST-EXPENSE> 8,435
<INTEREST-INCOME-NET> 11,616
<LOAN-LOSSES> 852
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 9,484
<INCOME-PRETAX> 4,305
<INCOME-PRE-EXTRAORDINARY> 4,305
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,300
<EPS-BASIC> 1.64
<EPS-DILUTED> 1.64
<YIELD-ACTUAL> 5.1
<LOANS-NON> 329
<LOANS-PAST> 600
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,683
<ALLOWANCE-OPEN> 2,026
<CHARGE-OFFS> 1,050
<RECOVERIES> 304
<ALLOWANCE-CLOSE> 2,132
<ALLOWANCE-DOMESTIC> 1,652
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 480
</TABLE>
