<PAGE> 1
SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
Filed by the registrant [X]
Filed by a party other than the registrant [ ]
Check the appropriate box:
[ ] Preliminary proxy statement
[ ] Confidential, for Use of the
Commission Only (as permitted by
Rule 14a-6(e)(2))
[X] Definitive proxy statement
[ ] Definitive additional materials
[ ] Soliciting material pursuant to Rule 14a-11(c) or Rule 14a-12
SOUTHERN MICHIGAN BANCORP. INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of filing fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and
0-11.
(1) Title of each class of securities to which transaction applies:
- --------------------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
- --------------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee
is calculated and state how it was determined):
- --------------------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
- --------------------------------------------------------------------------------
(5) Total fee paid:
- --------------------------------------------------------------------------------
[ ] Fee paid previously with preliminary materials.
- --------------------------------------------------------------------------------
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the form or schedule and the date of its filing.
(1) Amount previously paid:
- --------------------------------------------------------------------------------
(2) Form, schedule or registration statement no.:
- --------------------------------------------------------------------------------
(3) Filing party:
- --------------------------------------------------------------------------------
(4) Date filed:
- --------------------------------------------------------------------------------
<PAGE> 2
[Letterhead of Southern Michigan Bancorp, Inc.]
March 24, 2000
Dear Shareholder:
We invite you to attend our 2000 Annual Meeting of Shareholders. This
year's meeting will be held on Monday, April 17, 2000, at 4:00 p.m. at Southern
Michigan Bank & Trust, 51 West Pearl Street, Coldwater, Michigan.
Many of the traditional elements of our annual report, including our
audited financial statements, can be found in Appendix B to the Proxy Statement.
For your convenient reference, a table of contents is located on page B-1 of the
Proxy Statement.
It is important that your shares are represented at the Annual Meeting.
Please carefully read the Notice of Annual Meeting of Shareholders and Proxy
Statement. Whether or not you expect to attend the Annual Meeting, please sign,
date and return the enclosed Proxy using the envelope provided at your earliest
convenience.
Sincerely,
/s/ James T. Grohalski
- ----------------------------------
James T. Grohalski
President and
Chief Executive Officer
<PAGE> 3
SOUTHERN MICHIGAN BANCORP, INC.
51 West Pearl Street
Coldwater, Michigan 49036
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
The Annual Meeting of Shareholders of Southern Michigan Bancorp, Inc.
will be held on Monday, April 17, 2000 at Southern Michigan Bank & Trust, 51
West Pearl Street, Coldwater, Michigan at 4:00 p.m. for the purpose of
considering and voting on the following matters:
(1) Election of three (3) directors to serve for a three year period
ending with the annual meeting of shareholders following the year
ended December 31, 2002.
(2) Consider and act upon a proposal to adopt the Southern Michigan
Bancorp, Inc. 2000 Stock Option Plan.
(3) Ratification of the selection of Crowe, Chizek and Company LLP as
Independent Auditors for 2000.
(4) Transact such other business as may properly come before the meeting
or any adjournments thereof.
Shareholders of record at the close of business on March 1, 2000 are
entitled to notice of and to vote at the Annual Meeting.
It is important that your shares be represented at the meeting. We
urge you to sign and return the enclosed proxy as promptly as possible, whether
or not you plan to attend the meeting in person. If you do attend the meeting,
you may revoke your proxy and vote in person.
By Order of the Board of Directors
/s/ James T. Grohalski
------------------------------
James T. Grohalski
Secretary
Date: March 24, 2000
<PAGE> 4
SOUTHERN MICHIGAN BANCORP, INC.
51 West Pearl Street
Coldwater, Michigan 49036
PROXY STATEMENT
GENERAL INFORMATION
This Proxy Statement is furnished in connection with the solicitation
of proxies on behalf of the Board of Directors of Southern Michigan Bancorp,
Inc., a Michigan corporation (the "Company"), to be voted at the Annual Meeting
of Shareholders of the Company to be held Monday, April 17, 2000 at 4:00 p.m. at
Southern Michigan Bank & Trust, 51 West Pearl Street, Coldwater, Michigan (the
"Annual Meeting"), or any adjournment thereof, for the purposes set forth in the
accompanying Notice of Annual Meeting of Shareholders.
The costs of soliciting proxies will be paid by the Company. Proxies
may be solicited by mail, in person or by telephone by directors, officers and
regular employees of the Company. These persons will not be specially
compensated for soliciting proxies. The Company will request brokerage houses
and other custodians, nominees and fiduciaries to forward materials to
beneficial owners of shares of the Company held of record by such persons and
will reimburse them for their reasonable charges and out-of-pocket expenses in
connection therewith.
As of March 1, 2000, the record date for the Annual Meeting, there were
1,958,498 shares of common stock of the Company, par value $2.50 per share (the
"Common Stock"), issued and outstanding. Each outstanding share is entitled to
one (1) vote on each matter submitted to a vote at the Annual Meeting. The
transaction of business at the Annual Meeting requires the presence of a quorum,
which will be established by the presence or representation at the Annual
Meeting of shares of the Company entitled to cast a majority of the votes at the
meeting. Directors will be elected by a plurality of the votes cast, whether in
person or by proxy, by holders of the Common Stock entitled to vote at the
Annual Meeting (see "Proposal (1) - Election of Directors"). The affirmative
vote of a majority of the outstanding shares entitled to vote at the Annual
Meeting is necessary to approve Proposals (2) and (3). Shares as to which
authority is withheld in the election of directors, abstentions and broker
non-votes will be counted for purposes of determining the presence of a quorum.
Since they are not votes cast, shares as to which authority is withheld will
have no effect on the election of directors. Abstentions and broker non-votes
will have the same effect as votes against Proposals (2) and (3).
Proxies are revocable by the delivery of written notice of revocation
to the Secretary of the Company at any time before the proxy is exercised. The
signing of a proxy does not preclude a shareholder from attending the Annual
Meeting and voting in person. All proxies returned before the Annual Meeting
will be voted in accordance with the instructions contained therein. If the
proxy is not marked with the shareholder's instructions as to voting, the shares
to which the proxy relates will be voted for the nominees for director named in
this Proxy Statement, for Proposals (2) and (3) and in the discretion of the
proxies on any other business as may properly come before the Annual Meeting.
All shareholders are encouraged to mark, date and sign the enclosed proxy card
and return it to Registrar and Transfer Company, the transfer agent for the
Company's stock. This Proxy Statement and accompanying proxy card were first
sent or given to shareholders on approximately March 24, 2000.
<PAGE> 5
Principal Shareholders
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 OF
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP(1) 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.
PROPOSAL (1) - ELECTION OF DIRECTORS
The Company's Board of Directors is currently composed of eleven
directors who are divided into three classes. One class is elected each year for
a three year term. Three directors are proposed to be elected at the Annual
Meeting to serve for a three year term ending with the annual meeting of
shareholders following the year ended December 31, 2002. All of the nominees are
currently serving as directors. If any of the nominees are unable or unwilling
to serve as a director, it is intended that the proxies will be voted for the
election of the person nominated by the Board of Directors in substitution. The
Company has no reason to believe that any nominee of the Board of Directors will
be unable to serve as a director if elected.
The following table lists the names of the nominees and the other
current directors and their ages as of February 29, 2000, their principal
occupations and the year in which each became a director.
2
<PAGE> 6
<TABLE>
<CAPTION>
YEAR FIRST BECAME A
PRINCIPAL OCCUPATION(S) FOR DIRECTOR OF THE
NAME OF DIRECTOR AGE PAST 5 YEARS(1) COMPANY
-------------------------------------------------------------------------------------------------------------
Nominees of the Board of Directors for Election at the Annual Meeting:
<S> <C> <C> <C>
Gregory J. Hull 51 Farmer 1995
Freeman E. Riddle 67 Owner - Spoor & Parlin, Inc. (farm 1982
equipment)
Thomas E. Kolassa 52 Owner - The Planning Group (insurance) 1995
Directors Whose Terms Continue until the 2001 Annual Meeting:
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 of 1982
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.
James J. Morrison 52 Owner - Morrison & Associates (insurance) 1991
Directors Whose Terms Continue until the 2002 Annual Meeting:
James P. Briskey 66 Owner - Pittsford Grain Incorporated 1982
(grain elevator operator)
Nolan E. Hooker 48 Owner - Hooker Oil Co. (distributor of 1991
heating oil)
Jane L. Randall 78 Owner - Dally Tire Co. (tire distributor) 1982
Director Not Standing for Re-Election:
Jerry L. Towns 65 President and Chief Executive officer of 1982
the Company and Chairman and Chief
Executive Officer of the Bank until
retirement on December 31, 1998
</TABLE>
3
<PAGE> 7
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 NUMBER OF AMOUNT AND NATURE OF TOTAL PERCENT 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)
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 officers as a 71,895 71,895 3.67%
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.
4
<PAGE> 8
Meetings, Committees and Compensation of the Board of Directors
The Board of Directors of the Company held twelve (12) meetings during
1999. All directors attended at least 75 percent (75%) of the aggregate of the
total number of meetings of the Board of Directors and the total number of
meetings held by all standing committees of the Board on which they serve.
The Company's Board of Directors has an Audit Committee which held four
(4) meetings during 1999. The Committee is comprised of Messrs. Galliers, Hull,
Hooker and Towns. The Audit Committee determines whether adequate internal
controls are being maintained. It meets with the Company's independent auditors
to review internal controls, procedures of the Company and the Bank, the scope
of internal audits, the financial position of the Company and external audits of
the Company.
The Bank's Board of Directors has a Compensation Committee which held
two (2) meetings during 1999. The Committee is comprised of Messrs. Morrison,
Cole and Briskey. The Compensation Committee is responsible for setting and
administering the policies which govern annual compensation and incentive
programs. In addition, from time to time, it reviews all executive compensation
and benefit programs available to executive officers of the Company and to all
officers and staff of the Bank. In this respect, the Committee makes
recommendations to the Board of Directors with respect to the Compensation of
the President and Chief Executive Officer, as well as reviewing and approving
the President and Chief Executive Officer's recommendations for other officers
of the Company.
The Company's Board of Directors has an Executive Committee which held
two (2) meetings during 1999. The Committee is comprised of Messrs. Towns,
Grohalski, Hull, Riddle, Kolassa and Mrs. Randall. The Executive Committee
reviews major policy changes, evaluates the performance of the President and
Chief Executive Officer and reviews any merger or expansion plans. The Executive
Committee also reviews any executive officer promotions and acts as the
nominating committee for future members of the Board of Directors.
The Executive Committee, acting as the nominating committee, will
consider nominees recommended by shareholders of the Company. The Company's
Bylaws establish a procedure with regard to nominations, other than by or at the
direction of the Board of Directors of the Company, of candidates for election
as directors (the "Notice Procedure"). The Notice Procedure provides that only
such persons who are nominated by the Board of Directors or by a shareholder who
has given timely written notice to the Secretary of the Company prior to the
meeting at which directors are to be elected will be eligible for election, as
the case may be, at the Annual Meeting. To timely nominate an individual under
the Notice Procedure, a shareholder must deliver notice to the Secretary of the
Company not less than thirty (30) days, but no more than ninety (90) days, prior
to the anniversary date of the record date for determination of shareholders
entitled to vote in the immediately preceding annual meeting of shareholders. To
be timely for consideration at the Annual Meeting, notice of shareholder
proposals and/or shareholder nominations must have been received by January 30,
2000. The Secretary has not received any such notice. Nominees proposed by a
shareholder for which written proxy solicitation by the Board of Directors is
sought shall be made in writing and shall be delivered to the Chairman or the
Secretary of the Company by December 31 of the year preceding the year in which
the nomination is proposed. Under the Notice Procedure, notice to the Company
from a shareholder who proposes to nominate a person at an annual meeting for
election as a director must contain such nominee's name, occupation, age,
business and residential address and beneficial ownership interest in the
Company, together with evidence of such person's willingness to serve as a
director if elected. Such notice must also be accompanied by a completed
Director Qualification,
5
<PAGE> 9
Eligibility and Disclosure Questionnaire and evidence that the proposed nominee
is eligible to serve as a director, all as required by, and in accordance with
the Company's Bylaws.
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
$150 for each committee meeting attended and participate in a bonus program
based upon the achievement of growth and profitability goals. No bonus was paid
to outside directors for 1999. Subject to approval by the shareholders as
described below, the directors will be eligible to receive stock options under
the Southern Michigan Bancorp, Inc. 2000 Stock Option Plan.
Executive Compensation
The following table sets forth compensation paid by the Company and the
Bank with respect to the fiscal year ended December 31, 1999 to the Company's
Chief Executive Officer. Mr. Grohalski is the only executive officer of the
Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($)(1) COMPENSATION ($)(2)
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
James T. Grohalski
President and Chief Executive 1999 $140,570 $7,344
Officer of the Company and the 1998 $133,813 $7,400
Bank 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 annual benefits payable on a
straight-life annuity basis upon retirement at age 65 and are not subject to
deduction for social security benefits:
6
<PAGE> 10
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.
7
<PAGE> 11
Compensation Committee Report on Executive Compensation
Executive Compensation Policies.
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.
8
<PAGE> 12
Transactions with Directors and Officers
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.
PROPOSAL (2) - ADOPTION OF THE SOUTHERN MICHIGAN
BANCORP, INC. 2000 STOCK OPTION PLAN
On March 20, 2000, the Board of Directors adopted, subject to
shareholder approval, the Southern Michigan Bancorp, Inc. 2000 Stock Option Plan
(the "2000 Plan"). The text of the 2000 Plan is set forth in Appendix A to this
Proxy Statement. The following summary is subject to, and qualified in its
entirety by reference to Appendix A.
If approved by the shareholders, the 2000 Plan will permit the Company
to grant stock option awards to employees and directors. Management believes
that the 2000 Plan will be helpful in attracting and retaining skilled
personnel. The Board of Directors has recommended that the shareholders
authorize the stock option program by adopting the 2000 Plan.
The 2000 Plan provides for the grant of options covering up to 110,000
shares of Common Stock, which may be authorized but unissued shares or shares
acquired by the Company. If any option granted under the 2000 Plan is canceled
or expires for any reason prior to being exercised in full, the unpurchased
shares may again be subjected to an option under the 2000 Plan. The 2000 Plan
contains an anti-dilution provision, which provides for adjustment in the number
of shares in the event of stock splits, stock dividends and the like.
Options may be granted under the 2000 Plan to any employee or director
of the Company and its subsidiaries. As of December 31, 1999, there were
approximately 141 employees and 11 directors of the Company and its
subsidiaries, all of whom would be eligible to receive options under the 2000
Plan if approved by the shareholders of the Company. The persons to whom options
will be granted and the terms thereof will be determined by the Board of
Directors.
The Board of Directors is authorized to prescribe the times at which an
option may be exercised and the number of shares as to which an option may be
exercised at such times. However, no option may be exercised before the
expiration of one year from the date of grant, except in the case of the merger,
consolidation, sale of assets or dissolution of the Company, or more than ten
years after the date of grant, and no option may be granted after March 19,
2010. Under the 2000 Plan, the option price cannot be less than 100% of the fair
market value of the Common Stock on the date the option is granted. The option
price may be paid in cash, shares of Common Stock of the Company valued at the
fair market value thereof on the date of exercise or any combination of cash and
Common Stock. The average of the bid and ask prices of the Company's Common
Stock on February 29, 2000 was $22.9375 per share.
Options under the 2000 Plan are exercisable during the optionee's
lifetime only by the optionee and may not be transferred except by will or the
laws of descent and distribution. The options terminate one month after the
optionee ceases to be an employee or director, except that in the case of
9
<PAGE> 13
termination of employment or service as a director because of death or
disability, the options terminate one year thereafter and in the case of
termination of employment or service as a director because of retirement, the
option terminates three months thereafter. In the case of termination because of
death, disability, retirement or otherwise, an option may be exercised during
the applicable period following termination 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.
The Board of Directors may terminate or amend the 2000 Plan, but the
Board may not, without shareholder approval, increase the number of shares
covered by the 2000 Plan, reduce the minimum purchase price or extend the term
of the 2000 Plan or the maximum term of any option granted thereunder.
The following paragraphs contain a summary under current federal income
tax law of federal income tax consequences that generally will arise with
respect to options granted under the 2000 Plan and with respect to the sale of
stock acquired pursuant to the 2000 Plan.
Options granted under the 2000 Plan will be designated to be either
"nonstatutory stock options" or "incentive stock options" under Section 422 of
the Internal Revenue Code of 1986, as amended. The grant of an option will have
no immediate tax consequences to the optionee or the Company.
The exercise of a nonstatutory stock option will generally require an
optionee to include in income, as compensation, the amount by which the fair
market value of the acquired shares on the exercise date exceeds the option
price. The Company will be entitled to a deduction at the same time and in the
same amount as the optionee is taxed on income in connection with the exercise
of a nonstatutory stock option. Upon a subsequent sale or taxable exchange of
shares acquired upon exercise of a nonstatutory stock option, an optionee will
recognize long or short-term capital gain or loss equal to the difference
between the amount realized on the sale and the tax basis of such shares.
If the optionee exercises an incentive stock option and does not
dispose of the acquired shares within two years after the date of grant of the
option nor within one year after the date of the transfer of such shares to him
(a "disqualifying disposition"), the optionee will realize no compensation
income and any gain or loss that the optionee realizes on a subsequent
disposition of such shares will be treated as long-term capital gain or loss.
For purposes of computing the alternative minimum tax, however, the option
generally will be treated as if it were a nonstatutory stock option. If an
optionee makes a disqualifying disposition, the optionee will be required to
include in income, as compensation, the lesser of (i) the difference between the
option price and the fair market value of the acquired shares on the exercise
date or (ii) the amount of gain realized on such disposition. In addition,
depending on the amount received as a result of such disposition, the optionee
may realize long or short-term capital gain or loss. The Company will be
entitled to a deduction at the same time and in the same amount as the optionee
is taxed on compensation income as a result of a disqualifying disposition. If
there is no disqualifying disposition, no deduction will be available to the
Company.
Approval of the 2000 Plan requires the affirmative vote of a majority
of the votes cast by the holders of shares at the Annual Meeting. THE BOARD OF
DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE FOR ADOPTION OF THE 2000 PLAN.
10
<PAGE> 14
PROPOSAL (3) - RATIFICATION OF INDEPENDENT AUDITORS
The firm of Crowe, Chizek and Company LLP examined and certified the
financial statements of the Company for the year ended December 31, 1999. Upon
the recommendation of the Audit Committee, the Board of Directors has selected
Crowe, Chizek and Company LLP to act as the Company's independent auditors for
2000.
This selection is being submitted to shareholders for ratification.
While such ratification is not required, the Company believes it is an important
corporate decision in which shareholders should participate. If the selection is
not ratified, the Board of Directors may, nevertheless, choose to retain Crowe,
Chizek and Company LLP as auditors for 2000.
A representative of Crowe, Chizek and Company LLP is expected to be
present at the Annual Meeting to respond to appropriate questions from
shareholders and to make any comments deemed appropriate. THE BOARD OF DIRECTORS
RECOMMENDS THAT SHAREHOLDERS VOTE FOR RATIFICATION OF THE SELECTION OF CROWE,
CHIZEK AND COMPANY LLP AS INDEPENDENT AUDITORS FOR 2000.
OTHER MATTERS
The Board of Directors had not received notice by January 30, 2000 and
does not know, of any other matters which may come before the meeting. However,
if any other matters are properly presented to the meeting, it is the intention
of the holders of the proxies to vote, or otherwise to act, in accordance with
their judgment on such matters.
2001 SHAREHOLDER PROPOSALS
In order for shareholder proposals for the 2001 Annual Meeting of
Shareholders to be eligible for inclusion in the Company's proxy statement, they
must be received by the Company at its principal office, 51 West Pearl Street,
Coldwater, Michigan 49036, on or before November 24, 2000. To be considered for
presentation at the 2001 Annual Meeting of Shareholders, a shareholder proposal
not included in the Company's proxy statement must be received by the Company on
or before January 29, 2001 and not earlier than December 1, 2000. Any such
notice shall set forth a description of the business the shareholder proposes to
be brought before the annual meeting and shall comply with the requirements of
the Company's Bylaws.
CONSOLIDATION AGREEMENT
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 Southern Michigan Bank
& Trust will continue to operate as stand-alone banks. A condition to the
consummation of the transaction is the adoption of the 2000 Plan described in
Proposal (2) above.
The financial statements of the Company, supplementary financial
information and management's discussion and analysis of operations for the
fiscal year ended December 31, 1999 are included in Appendix B to this Proxy
Statement.
11
<PAGE> 15
The Company files an Annual Report on Form 10-K with the Securities and
Exchange Commission. The 1999 Form 10-K will be available upon written request
after March 31, 2000. To request a copy of the Form 10-K, address the request to
Southern Michigan Bancorp, Inc., 51 West Pearl Street, Coldwater, Michigan
49036, Attention: James T.
Grohalski, Secretary.
By Order of the Board of Directors
/s/ James T. Grohalski
----------------------------------
James T. Grohalski
Secretary
12
<PAGE> 16
APPENDIX A
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.
A-1
<PAGE> 17
(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:
(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.
A-2
<PAGE> 18
(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 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.
A-3
<PAGE> 19
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 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
A-4
<PAGE> 20
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.
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.
A-5
<PAGE> 21
(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
A-6
KZLIB:333991.4\110861-00001
<PAGE> 22
APPENDIX B
Southern Michigan Bancorp, Inc. is a one bank holding company. The Company's
subsidiary bank (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.
CONTENTS
Management's Discussion and Analysis------------------------------------- B-1
Management's Responsibility for Financial Information-------------------- B-9
Independent Auditor's Report--------------------------------------------- B-10
Consolidated Financial Statements---------------------------------------- B-11
Notes to Consolidated Financial Statements------------------------------- B-15
Selected Financial Data/Common Stock Market Prices and Dividends--------- B-29
Shareholder Information-------------------------------------------------- B-30
Board of Directors and Strategic Management Team------------------------- B-31
<PAGE> 23
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 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.
B-1
<PAGE> 24
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 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.
B-2
<PAGE> 25
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.
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>
B-3
<PAGE> 26
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 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.
B-4
<PAGE> 27
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 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.
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.
B-5
<PAGE> 28
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.
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.
B-6
<PAGE> 29
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.
<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>
B-7
<PAGE> 30
<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 0 0 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>
B-8
<PAGE> 31
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL INFORMATION
Management of Southern Michigan Bancorp, Inc. has prepared and is responsible
for the accompanying financial statements and for their integrity and
objectivity. In the opinion of management, the financial statements, which
necessarily include amounts based on management's estimates and judgements, have
been prepared in conformity with generally accepted accounting principles on a
consistent basis. Management also prepared the other information in the Annual
Report and is responsible for its accuracy and consistency with the financial
statements.
The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that transactions
are executed in accordance with the Company's authorizations and policies.
Further, such a system provides reasonable assurances as to the integrity and
reliability of the financial statements which fairly present financial position
and results of operations in conformity with generally accepted accounting
principles. Internal accounting controls are augmented by written policies
covering standards of personal and business conduct and an organizational
structure providing for division of responsibility and authority.
Management monitors the effectiveness of and compliance with established control
systems through a continuous program of internal audit and credit examinations
and recommends possible improvements thereto. In addition, as part of their
audit of the Company's financial statements, Crowe, Chizek and Company LLP,
independent auditors, completed an evaluation of selected internal accounting
controls to establish a basis for reliance thereon in determining the nature,
timing, and extent of audit tests to be applied. Management has considered the
recommendations from the examination of controls concerning the Company's system
of internal controls and has taken actions that we believe are cost-effective in
the circumstances to respond appropriately to these recommendations. Management
believes that, as of December 31, 1999, the Company's system of internal
controls is adequate to accomplish the objectives discussed herein. Further,
management believes the system of controls has prevented or detected on a timely
basis any occurrences that could be material to the financial statements and
that timely corrective actions have been initiated when appropriate.
The Board of Directors exercises its responsibility for the financial statements
and related information through the Audit Committee, which is composed entirely
of outside directors. The Audit Committee meets regularly with management and
Crowe, Chizek and Company LLP, to assess the scope of the annual audit plan and
to review the status of results of audits, including major changes in accounting
policies and reporting practices. Crowe, Chizek and Company LLP has direct and
confidential access to the Audit Committee at all times to discuss the results
of their audits.
/s/ James T. Grohalski
------------------------------
James T. Grohalski
President & C.E.O.
B-9
<PAGE> 32
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
B-10
<PAGE> 33
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.
B-11
<PAGE> 34
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.
B-12
<PAGE> 35
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.
B-13
<PAGE> 36
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.
B-14
<PAGE> 37
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.
B-15
<PAGE> 38
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.
B-16
<PAGE> 39
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
---- ---- ----
BASIC EARNINGS PER COMMON SHARE
<S> <C> <C> <C>
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>
B-17
<PAGE> 40
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
=========================================================
</TABLE>
There were no securities held to maturity as of December 31, 1999.
AVAILABLE FOR SALE, 1998
<TABLE>
<S> <C> <C> <C> <C>
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
=========================================================
<CAPTION>
HELD TO MATURITY, 1998
<S> <C> <C> <C> <C>
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>
B-18
<PAGE> 41
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.
B-19
<PAGE> 42
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
==========================================
<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>
B-20
<PAGE> 43
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>
<CAPTION>
<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>
<CAPTION>
<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>
B-21
<PAGE> 44
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>
B-22
<PAGE> 45
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.
B-23
<PAGE> 46
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.
B-24
<PAGE> 47
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
===========================
<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)
------------------------------------------
4,008 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
==========================================
<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>
B-25
<PAGE> 48
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 sale $ 250
</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.
B-26
<PAGE> 49
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.
B-27
<PAGE> 50
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.
B-28
<PAGE> 51
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.
COMMON STOCK MARKET PRICES AND DIVIDENDS
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.
B-29
<PAGE> 52
SHAREHOLDER INFORMATION
ANNUAL MEETING
The Annual Meeting of Southern Michigan Bancorp, Inc. will be held on April 17,
2000 at 4:00 p.m. at Southern Michigan Bank & Trust, 51 W. Pearl Street,
Coldwater, Michigan.
FORM 10-K
A copy of the annual report to the Securities and Exchange Commission Form 10-K
will be provided free to stockholders upon written request. Address requests to
Southern Michigan Bancorp, Inc., 51 West Pearl Street, Coldwater, Michigan,
49036, Attention: James T. Grohalski, Secretary.
TRANSFER AGENT
Registrar and Transfer Company acts as transfer agent for the Company's stock.
For information concerning the transfer of the Company's stock, call Registrar
and Transfer at (800) 456-0596.
DIVIDEND REINVESTMENT
Southern Michigan Bancorp, Inc. provides an automatic dividend reinvestment plan
that allows shareholders to increase their holdings without brokerage fees. For
more information, call Registrar and Transfer Company at (800) 456-0596.
MARKET MAKERS
The following brokerage firms make a market for Southern Michigan Bancorp, Inc.
stock:
Hilliard Lyons, Inc., Coldwater, Michigan
(517) 278-4333 or (800) 211-5257
Howe Barnes Investments, Inc., Chicago, Illinois
(312) 655-2954 or (800) 800-4693
Robert Baird & Co., Grand Rapids, Michigan
(616) 459-4491 or (800) 800-6200
B-30
<PAGE> 53
BOARD OF DIRECTORS AND STRATEGIC MANAGEMENT TEAM
<TABLE>
<CAPTION>
BOARD OF DIRECTORS (SOUTHERN MICHIGAN BANCORP, INC. STRATEGIC MANAGEMENT TEAM
AND SOUTHERN MICHIGAN BANK & TRUST) (SOUTHERN MICHIGAN BANK & TRUST)
<S> <C>
James P. Briskey - Owner, Pittsford Grain, Incorporated James T. Grohalski - President & Chief Executive Officer
(grain elevator operator) Christopher Hugar - Sr. Vice-President/Head of Lending
H. Kenneth Cole - Treasurer, Hillsdale College Jaylen Johnson - Sr. Vice-President/Cashier
William E. (Buzz) Galliers - Co-owner and Chief Executive Officer, Stanley E. Tipton - Sr. Vice-President/Loan Administration
G&W Display Fixtures, Inc. (manufacturer of display fixtures) Danice Chartrand - Vice-President/Controller
James T. Grohalski - President and Chief Executive Officer, Andrew Karr - Vice-President/Human Resources
Southern Michigan Bank & Trust(1) Michael Lammers - Vice-President/Sr. Trust Officer
Nolan E. (Rick) Hooker - Owner, Hooker Oil Co. (distributor of Patrick J. Peruchietti - Vice-President/Retail Sales
heating oil) Julie Waterbury - Vice-President/Accounting
Gregory J. Hull - Farmer Patty Parker - Assistant Vice-President/Marketing
Thomas E. Kolassa - Owner, The Planning Group (insurance)
James J. Morrison - Owner, Morrison & Associates (insurance)
Jane L. Randall - Owner, Dally Tire Co. (tire distributor)
Freeman E. Riddle - Owner, Spoor and Parlin, Inc. (farm
equipment)
Jerry L. Towns - Chairman, Southern Michigan Bancorp, Inc.
</TABLE>
HONORARY DIRECTORS
John S. Furry
Gerald L. Hensley
James E. Koss
Harvey Randall
Raymond W. Smith
(1) Mr. Grohalski is the President and Chief Executive Officer and the only
executive officer of Southern Michigan Bancorp, Inc.
B-31
<PAGE> 54
PLEASE MARK VOTES REVOCABLE PROXY
/x/ AS IN THIS EXAMPLE SOUTHERN MICHIGAN BANCORP, INC.
PROXY FOR ANNUAL MEETING
SOUTHERN MICHIGAN BANCORP, INC.
The undersigned does hereby appoint Jaylen T. Johnson and Julie A.
Waterbury, or either one of them, proxy with full power of substitution, in the
name, place and stead of the undersigned, to vote all of the Common Shares of
Southern Michigan Bancorp, Inc., held by the undersigned on March 1, 2000 at the
Annual Meeting of Shareholders to be held at Southern Michigan Bank & Trust, 51
West Pearl Street, Coldwater, Michigan, on April 17, 2000 at 4:00 p.m., and at
any adjournment or adjournments thereof with all the powers the undersigned
would possess if personally present. The undersigned revokes all proxies
heretofore given to vote at such meeting and any adjournment or adjournments
thereof.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ALL NOMINEES AND FOR PROPOSALS 2
AND 3.
WITH- FOR ALL
FOR HOLD EXCEPT
1. Election as Directors of
all nominees listed below / / / / / /
(except as marked to the
contrary below):
GREGORY J. HULL FREEMAN E. RIDDLE THOMAS E. KOLASSA
INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, MARK "FOR
ALL EXCEPT" AND WRITE THAT NOMINEE'S NAME IN THE SPACE PROVIDED BELOW.
- --------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
2. Approval of adoption of the
Southern Michigan Bancorp, Inc. / / / / / /
2000 Stock Option Plan
FOR AGAINST ABSTAIN
3. Ratification of the selection
of Crowe, Chizek and Company LLP / / / / / /
as Independent Auditors for 2000
The Board of Directors recommends shareholders vote "FOR" the nominees
listed in Proposal (1) and "FOR" Proposals (2) and (3). IF NO SPECIFIC VOTE IS
GIVEN, THE PROXY WILL BE VOTED "FOR" ALL NOMINEES AND "FOR" PROPOSALS (2) AND
(3). IF ANY OTHER BUSINESS IS PROPERLY PRESENTED AT THE MEETING, THIS PROXY
SHALL BE VOTED IN THE DISCRETION OF THE PROXIES. All shares represented by
properly executed proxies will be voted as directed. THIS PROXY IS SOLICITED ON
BEHALF OF THE BOARD OF DIRECTORS and may be revoked before its exercise by
either written notice or notice in person at the meeting or by a subsequently
dated proxy. The undersigned hereby acknowledges receipt of a Notice of Annual
Meeting and Proxy Statement, each dated March 24, 2000, for the Annual Meeting
of Shareholders of the Company called for April 17, 2000.
NOTE: Please sign your name(s) exactly as printed on your stock certificates to
authorize the voting of your shares as indicated above. Persons signing as
Executors, Administrators, Trustees, etc. should so indicate. If shares are held
jointly, each holder should sign. If executed by a corporation, a duly
authorized officer should sign.
----------------------
Please be sure to sign and date this Date
Proxy in the boxes provided
- ------------------------------------------------------------------
- ------------------------------------------------------------------
Stockholder sign above Co-holder (if any) sign above
/\ DETACH ABOVE CARD, SIGN, DATE AND MAIL IN POSTAGE PAID ENVELOPE PROVIDED /\
SOUTHERN MICHIGAN BANCORP, INC.
- --------------------------------------------------------------------------------
PLEASE ACT PROMPTLY
SIGN, DATE & MAIL YOUR PROXY CARD TODAY
- --------------------------------------------------------------------------------
