-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LF6+uGmyf3pv0jXu0VFLvwvxHUi1kswyrvhG+XpRbb7x28i6aM4mo5iN2lal4MtW 9LmPdYrep2Wh6eIuRUKhwA== 0000950124-03-000954.txt : 20030328 0000950124-03-000954.hdr.sgml : 20030328 20030328152521 ACCESSION NUMBER: 0000950124-03-000954 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHERN MICHIGAN BANCORP INC CENTRAL INDEX KEY: 0000703699 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 382407501 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-49772 FILM NUMBER: 03624978 BUSINESS ADDRESS: STREET 1: 51 W PEARL ST CITY: COLDWATER STATE: MI ZIP: 49036 BUSINESS PHONE: 5172795500 MAIL ADDRESS: STREET 1: 51 W PEARL ST CITY: COLDWATER STATE: MI ZIP: 49036 10-K 1 k74384e10vk.txt ANNUAL REPORT FOR FISCAL YEAR ENDED 12/31/02 - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 2-78178 SOUTHERN MICHIGAN BANCORP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MICHIGAN 38-2407501 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 51 WEST PEARL STREET, COLDWATER, MICHIGAN 49036 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (517) 279-5500 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NAME ON EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- ------------------- NONE NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: COMMON STOCK, $2.50 PAR VALUE (TITLE OF CLASS) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES [ ] NO[X] The aggregate market value of the registrant's common stock, par value $2.50 per share (based on the last sale of the day) held by non-affiliates of the registrant as of June 28, 2002 was approximately $22,336,000. For purposes of this computation, all executive officers, directors and 5% shareholders of the registrant have been assumed to be affiliates. Certain of such persons may disclaim that they are affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's common stock as of March 14, 2003 was 1,849,349 shares. - -------------------------------------------------------------------------------- DOCUMENTS INCORPORATED BY REFERENCE Parts of Form 10-K Into Which Identity of Document Document is Incorporated - -------------------- ------------------------ Definitive Proxy Statement with Part III respect to the 2003 Annual Meeting of Shareholders of the Company. PART I INTRODUCTORY NOTE This Annual Report on Form 10-K may be deemed to contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. Accordingly, to the extent that this Annual Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company, please be advised that the Company's actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements. The differences may be caused by a variety of factors, including but not limited to adverse economic conditions, intense competition, including intensification of price competition and entry of new competitors and products, adverse federal, state and local 2 government regulation, inadequate capital, unexpected costs and operating deficits, increases in general and administrative costs, lower sales and revenue than forecast, loss of customers, inability to raise prices, failure to obtain new customers, litigation and administrative proceedings involving the Company, the possible acquisition of new businesses that result in operating losses or that do not perform as anticipated, resulting in unanticipated losses, the possible fluctuation and volatility of the Company's operating results, financial condition and stock price, losses incurred in litigation and settling cases, dilution in the Company's ownership of its business, adverse publicity and news coverage, inability to carry out marketing and sales plans, loss or retirement of key executives, changes in interest rates, inflationary factors, and other specific risks that may be alluded to in this Annual Report or in other reports issued by the Company. In addition, the business and operations of the Company are subject to substantial risks, which increase the uncertainty inherent in the forward-looking statements. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. ITEM 1. BUSINESS Overview The registrant, Southern Michigan Bancorp, Inc. (the "Company"), is a registered bank holding company incorporated under the laws of the State of Michigan, headquartered in Coldwater, Michigan. The Company was formed in 1982 for the purpose of acquiring all of the outstanding shares of Southern Michigan National Bank, which it did in November 1982. In December 1992, Southern Michigan National Bank converted its charter to that of a Michigan state banking corporation and changed its name to, Southern Michigan Bank & Trust (the "Bank"), with its main office located at 51 West Pearl Street, Coldwater, Michigan 49036. The Bank operates eleven (11) branch offices in the primarily rural areas of Branch, Hillsdale, and Calhoun counties in southwestern Michigan. In addition to the operations of the Bank described below, the Company owns and leases certain real estate to the Bank and third parties (see Item 2. Properties below); and SMB&T Financial Services, Inc., a subsidiary of the Bank, has been established to provide insurance and investment services, which services currently consist of the sale of certain insurance products to the Bank and limited sales of insurance products to the public. None of such activities are significant to the operations of the Company. In August 2000, SMB Mortgage Company was established as a subsidiary of the Bank. At that time all residential mortgage loans held by the Bank and all residential mortgage loan applications in the pipeline were transferred to SMB Mortgage Company. All of the residential mortgage activities previously conducted by the Bank were undertaken by SMB Mortgage Company. Banking Services The Bank offers a full range of banking services to individuals, businesses, governmental entities, and other institutions. These services include checking, savings, and NOW accounts, time deposits, safe deposit facilities, and money transfers. The Bank's lending operations provide secured and unsecured commercial and personal loans, real estate loans, consumer installment loans, lines of credit, and accounts receivable financing. 3 The Bank's Trust Department offers a wide variety of fiduciary services to individuals, businesses, not-for-profit organizations, and governmental entities, including services as trustee for personal, corporate, pension, profit sharing, and other employee benefit trusts. The Bank also provides security custodial services as an agent, acts as the personal representative for estates, and as a fiscal, paying and escrow agent for corporate customers and governmental entities. Residential mortgage loans are originated by SMB Mortgage Company. Some residential mortgage loans are retained by SMB Mortgage Company while others are sold to investors in the secondary market. When SMB Mortgage Company sells originated mortgage loans to investors, it makes a determination to either retain or sell the servicing rights to such loans. The Bank also offers securities brokerage services through an unaffiliated broker. The Bank maintains correspondent banking relationships with several larger banks, which correspondent relationships concern check clearing operations, transfer of funds, loan participations, the purchase and sale of federal funds, and other similar services. Competition The banking business in the Bank's market area is highly competitive. The Bank competes with other banks, savings and loan associations, credit unions, and finance companies. Banks and other financial institutions from surrounding areas maintain branches within the Bank's service area and offer additional competition. The Bank is also faced with increasing competition from non-depository financial intermediaries, such as large retailers, investment banks, and securities brokerage firms. Supervision and Regulation General Bank holding companies and banks are highly regulated by both state and federal agencies. As a bank holding company, the Company is subject to supervision and regulation by the Federal Reserve Board (the "FRB") pursuant to the Bank Holding Company Act of 1956, as amended (the "BHCA"). The BHCA restricts the product range of a bank holding company by circumscribing the types of businesses it may own or acquire. The BHCA limits a bank holding company to owning and managing banks or companies engaged in activities determined by the FRB to be closely related to banking as to be a proper incident thereto. The BHCA requires a bank holding company to obtain the prior approval of the FRB before acquiring a nonbanking company, or substantially all of the assets of a bank or a bank holding company, or direct or indirect ownership or control of more than five percent of the voting shares of a bank or a bank holding company. Under FRB regulations, the Company is required to serve as a source of financial and managerial strength to the Bank and must conduct its operations in a safe and sound manner. The Bank is subject to regulation, supervision, and regular bank examinations by the Federal Deposit Insurance Corporation ("FDIC") and the Michigan Office of Financial and Insurance Services ("OFIS"). OFIS is the Bank's chartering authority and primary regulator. 4 Under OFIS and FDIC regulations, the Bank is required to maintain reserves against its deposits and to maintain certain levels of capital and surplus. In addition, the Bank is subject to restrictions on the nature and amount of loans which may be made, the types and amounts of investments it may make, and certain limitations on the payment of dividends to its sole shareholder, the Company. Dividend Restrictions The Company's principal source of income consists of dividends paid by the Bank on its common stock (all of which is owned by the Company). Michigan law restricts the Bank's ability to pay dividends to its shareholder. Under the Michigan Banking Code of 1999, as amended, no dividend may be declared by the Bank in an amount greater than net income then on hand after deducting losses and bad debts. After payment of a dividend, the Bank must have a surplus amounting to not less than 20% of its capital. In addition, if the surplus of the Bank is less than the amount of its capital, before a dividend may be declared, the Bank must transfer to surplus not less than 10% of the net income of the Bank for the preceding 6 months in the case of quarterly or semiannual dividends or not less than 10% of its net profits for the preceding two consecutive 6 month periods in the case of annual dividends. Dividends cannot be paid from the Bank's capital or surplus. The payment of dividends by the Company and the Bank is also affected by various regulatory requirements and policies, such as the requirement to maintain adequate capital above regulatory guidelines. The "prompt corrective action" provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") impose further restrictions on the payment of dividends by insured banks which fail to meet specified capital levels and, in some cases, their parent bank holding companies. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized (see "Capital Requirements"). These regulations and restrictions may limit the Company's ability to obtain funds from the Bank for the Company's cash needs, including funds for acquisitions, payments of dividends and interest, and the payment of operating expenses. Based on the Bank's balance sheet as of December 31, 2002, the Bank could pay a dividend to the Company in the amount of $1,700,000 without prior regulatory approval. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, payment of dividends by a bank may be prevented by the applicable federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice. The FRB has issued a policy statement providing that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. Federal Regulation The following is a summary of certain statutes and regulations affecting the Company and the Bank. This summary is qualified in its entirety by such statutes and regulations, which are subject to change based on pending and future legislation and action by regulatory agencies. Proposals to change the laws and regulations governing the operation of banks and companies 5 which control banks and other financial institutions are frequently raised in Congress. The likelihood of any major legislation and the impact such legislation might have on the Company or the Bank are, however, impossible to predict. USA Patriot Act Enacted in 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") requires each financial institution to implement additional policies and procedures with respect to: money laundering; suspicious activities and currency transaction reporting; and currency crimes. The USA Patriot Act also contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. Gramm-Leach-Bliley Enacted late in 1999, the Gramm-Leach-Bliley Act ("Gramm-Leach-Bliley"), broadens the scope of financial services that banks may offer to consumers, essentially removing the barriers erected during the Depression that separated banks and securities firms, closes the loophole which permitted commercial enterprises to own and operate a thrift institution, and provides some new consumer protections with respect to privacy issues and ATM usage fees. Gramm-Leach-Bliley permits affiliations between banks, securities firms and insurance companies (which affiliations were previously prohibited under the Glass-Steagall Act). Under Gramm-Leach-Bliley, a bank holding company may qualify as a financial holding company and thereby offer expanded range of financial oriented products and services which products and services may not be offered by bank holding companies. To qualify as a financial holding company, a bank holding company's subsidiary depository institutions must be well-managed, well-capitalized and have received a "satisfactory" rating on its latest examination under the Community Reinvestment Act. Gramm-Leach-Bliley provides for some regulatory oversight by the Securities and Exchange Commission for bank holding companies engaged in certain activities, and reaffirms that insurance activities are to be regulated on the state level. States, however, may not prevent depository institutions and their affiliates from engaging in insurance activities. Commercial enterprises are no longer able to establish or acquire a thrift institution and thereby become a unitary thrift holding company. Thrift institutions may only be established or acquired by financial organizations. Gramm-Leach-Bliley provides new consumer protections with respect to the transfer and use of a consumer's nonpublic personal information and generally enables financial institution customers to "opt-out" of the dissemination of their personal financial information to unaffiliated third parties. ATM operators who charge a fee to non-customers for use of its ATM must disclose the fee on a sign placed on the ATM and before the transaction is made as a part of the on-screen display or by a paper notice issued by the machine. Riegle-Neal Prior to September 29, 1995, the BHCA prohibited a bank holding company from acquiring shares of any bank located outside the state in which the operations of the bank holding 6 company's banking subsidiaries were primarily conducted unless the acquisition was specifically authorized by statute of the state of the bank whose shares were to be acquired. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), the restriction on interstate bank acquisitions was repealed effective September 29, 1995. The FRB is now generally authorized to approve bank acquisitions by out-of-state bank holding companies that are adequately capitalized and managed irrespective of the permissibility of such acquisition under state law, but subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five (5) years. Each State is permitted to prohibit interstate branch acquisitions (i.e., acquisition of a branch without acquisition of the entire target bank or the establishment of de novo branches) and to examine acquired and de novo branches of out-of-state banks with respect to compliance with certain host State laws. FDICIA In December 1991, FDICIA was enacted, substantially revising the bank regulatory and funding provisions of the Federal Deposit Insurance Act and making revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" in respect of depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well-capitalized," "adequately capitalized," "undercapitalized," "significantly under capitalized" and "critically undercapitalized." A depository institution's capital tier will depend upon where its capital levels are in relation to various relevant capital measures, which will include a risk-based capital measure and a leverage ratio capital measure, and certain other factors. As of December 31, 2002, the Bank's capital ratios exceed the requirements to be considered a well-capitalized institution under FDIC regulation. FDICIA also contains a variety of other provisions that may affect the operations of depository institutions including reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch, and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well capitalized or are adequately capitalized and have not received a waiver from the FDIC. FIRREA Under the Financial Institutions Reform and Recovery and Enforcement Act of 1989 ("FIRREA"), a depository institution insured by the FDIC is liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. 7 Transactions with Affiliates and Insiders The Bank and the Company are affiliates of each other and, as such, are subject to certain federal restrictions with respect to loans and extensions of credit to the Company and other Company affiliates, investments in the Company's and its affiliates' securities, acceptance of such securities as collateral for loans to any borrowers, and leases, services and other agreements between the Bank and the Company. Additionally, regulations allow a bank to extend credit to the bank's and its affiliates' executive officers, directors, principal shareholders, and their related interests, only if the loan is made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with non-insiders, and if credit underwriting standards are followed that are no less stringent than those applicable to comparable transactions with non-insiders. Moreover, loans to insiders must not involve more than the normal risk of repayment or present other unfavorable features and must in certain circumstances be approved in advance by a majority of the entire board of directors of the Bank (and the interested party must abstain from participating directly or indirectly in the vote). The aggregate amount that can be lent to all insiders is limited to the Bank's unimpaired capital and surplus. Deposit Insurance Deposits held by the Bank are insured, to the extent permitted by law, by the Bank Insurance Fund ("BIF") administered by the FDIC. As required under FDICIA, the FDIC has established a system of risk-based deposit insurance premiums. Under this system each insured institution's assessment is based on the probability that the BIF will incur a loss related to that institution, the likely amount of the loss, and the revenue needs of the BIF. Each financial institution is assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The assessment rate applicable to the bank in the future will depend in part upon the risk assessment classification assigned to the Bank by the FDIC and in part on the BIF assessment schedule adopted by the FDIC. FDIC regulations currently provide that premiums related to deposits assessed by the BIF are to be assessed at a rate of between 0 cents and 27 cents per $100 of deposits. Under the Deposit Insurance Funds Act of 1996, effective January 1, 1997, the Bank is required to pay, in addition to the BIF deposit insurance assessment, if any, the Financing Corporation ("FICO") assessment to service the interest on FICO bond obligations. FICO assessment rates may be adjusted quarterly to reflect a change in assessment base for the BIF. The current FICO assessment rate for the first quarter of 2003 is 1.68 cents per $100 of deposits. Capital Requirements The FRB has imposed risk-based capital guidelines applicable to the Company. These guidelines require that bank holding companies maintain capital commensurate with both on and off balance sheet credit and other risks of their operations. Under the guidelines, a bank holding company must have a minimum ratio of total capital to risk-weighted assets ("Total Capital") of 8 8.0 percent. At least half of Total Capital must be composed of common shareholder's equity, qualifying perpetual preferred stock and minority interest in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets ("Tier I Capital"). At December 31, 2002, the Company's Total Capital to risk-weighted assets was 11.5 percent, which is above the regulatory minimum requirements. In addition to risk-based capital requirements, the FRB has also imposed leverage capital ratio requirements. The leverage ratio requirements establish a minimum required ratio of Tier I Capital to total assets less goodwill of 3 percent for the bank holding companies having the highest regulatory rating. All other bank holding companies are required to maintain a minimum Tier I capital yielding a leverage ratio of 4 percent. The Company's Tier I Capital leverage ratio at December 31, 2002 was 7.8 percent. The Bank is also subject to risk-weighted capital standards and leverage measures which are similar, but in some cases not identical, to the requirements applicable to bank holding companies. At December 31, 2002, the Bank met all applicable capital requirements. Community Reinvestment Act Under the Community Reinvestment Act of 1977, as amended (the "CRA"), a financial institution is required to help meet the credit needs of its entire community, including low-income and moderate-income areas. The Bank's CRA rating is determined by evaluation of the Bank's lending, service and investment performance. The Federal banking agencies may take CRA compliance into account in an agency's review of applications for mergers, acquisitions, and to establish branches or facilities. Monetary Policy and Economic Conditions The business of commercial banks, such as the Bank, is affected by monetary and fiscal policies of various regulatory agencies, including the FRB. Among the regulatory techniques available to the FRB are open market operations in United States Government securities, changing the discount rate for member bank borrowings, and imposing and changing the reserve requirement applicable to member bank deposits and to certain borrowings by member banks and their affiliates (including parent companies). These policies influence to a significant extent the overall growth and distribution of bank loans, investments and deposits and the interest rates charged on loans, as well as the interest rates paid on savings and time deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of constantly changing conditions in the national economy and the money market, as well as the effect of acts by the monetary and fiscal authorities, including the FRB, no definitive predictions can be made by the Company or the Bank as to future changes in interest rates, credit availability, deposit levels, or the effect of any such changes on the Company's or the Bank's operations and financial condition. 9 Employees As of December 31, 2002, 153 persons were employed by the Bank; 128 were full time employees and 25 were part time employees. Selected Statistical Information The following tables describe certain aspects of the Company's business in statistical form. 10 I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL The following are the average balance sheets for the years ending December 31: (Dollars in Thousands)
2 0 0 2 2 0 0 1 2 0 0 0 ------------------------------- ----------------------------- ----------------------------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ---- ------- -------- ---- ------- -------- ---- ASSETS Interest earning assets: Loans (A)(B)(C) $228,715 $16,456 7.2% $208,298 $18,490 8.9% $208,160 $20,131 9.7% Taxable investment securities (D) 29,169 1,365 4.7 36,203 2,360 6.5 33,966 2,212 6.5 Tax-exempt investment securities (A) 23,269 1,439 6.2 18,698 1,306 7.0 18,210 1,376 7.6 Federal funds sold 19 2 10.5 767 36 4.7 548 23 4.2 -------- ------- -------- ------- -------- ------- Total interest earning assets 281,172 19,262 6.8 263,965 22,192 8.4 260,884 23,742 9.1 Non-interest earning assets: Cash and due from banks 15,932 22,327 11,858 Other assets 20,997 20,784 19,370 Less allowance for loan loss (2,394) (1,854) (2,066) ------- -------- -------- Total assets $315,707 $305,223 $290,046 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing liabilities: Demand deposits $102,387 1,386 1.4% $ 89,282 $ 2,323 2.6% $ 83,326 $ 3,274 3.9% Savings deposits 46,079 916 2.0 43,054 1,297 3.0 43,793 1,467 3.3 Time deposits 68,377 2,230 3.3 80,387 4,275 5.3 73,450 4,171 5.7 Federal funds purchased 2,931 59 2.0 28 2 7.1 4,337 281 6.5 Other borrowings 25,071 1,856 7.4 23,367 1,749 7.5 20,915 1,504 7.2 -------- ------- -------- ------- -------- ------- Total interest bearing liabilities 244,845 6,447 2.6 236,118 9,646 4.1 225,821 10,697 4.7 Non-interest bearing liabilities: Demand deposits 40,022 38,676 36,334 Other 3,723 2,715 2,854 Common stock subject to repurchase obligation 1,571 1,501 2,734 Shareholders' equity 25,544 26,214 22,303 -------- -------- -------- Total liabilities and shareholders' equity $315,707 $305,223 $290,046 ======== ======== ======== Net interest earnings $12,815 $12,546 $13,045 ======== ======= ======= Interest rate spread 4.2% 4.3% 4.4% Net yield on interest earning assets 4.6% 4.8% 5.0% === === ===
(A) Includes tax equivalent adjustment of interest (assuming a 34% tax rate) for securities and loans of $489,000 and $19,000, respectively for 2002; $444,000 and $24,000, respectively for 2001; and $468,000 and $29,000, respectively for 2000. (B) Average balance includes average nonaccrual loan balances of $2,730,000 in 2002; $1,543,000 in 2001; and $745,000 in 2000. (C) Interest income includes loan fees of $933,000 in 2002; $815,000 in 2001; and $650,000 in 2000. (D) Average balance includes average unrealized gain (loss) of $883,000 in 2002; $907,000 in 2001; and $(515,000) in 2000 on available for sale securities. The yield was calculated without regard to this average unrealized gain (loss). 11 I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (CONTINUED) (Dollars in Thousands) The following table sets forth for the periods indicated a summary of changes in interest income and interest expense, based upon a tax equivalent basis, resulting from changes in volume and changes in rates: Volume Variance -- change in volume multiplied by the previous year's rate. Rate Variance -- change in rate multiplied by the previous year's volume. Rate/Volume Variance -- change in volume multiplied by the change in rate. This variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each. Interest on non-taxable securities has been adjusted to a fully tax equivalent basis using a statutory tax rate of 34% in 2002, 2001 and 2000.
2002 Compared to 2001 2001 Compared to 2000 Increase (Decrease) Due To Increase (Decrease) Due To --------------------------- --------------------------- Interest income on: Volume Rate Net Volume Rate Net ------ ---- --- ------ ---- --- Loans $ 1,695 $ (3,729) $ (2,034) $ 13 $ (1,654) $ (1,641) Taxable investment securities (406) (589) (995) 146 2 148 Tax-exempt investment securities 294 (161) 133 36 (106) (70) Federal funds sold (54) 20 (34) 10 3 13 ---------- --------- ---------- --------- --------- --------- Total interest earning assets $ 1,529 $ (4,459) $ (2,930) $ 205 $ (1,755) $ (1,550) ========= ========== ========== ========= ========== ========== Interest expense on: Demand deposits $ 303 $ (1,240) $ (937) $ 220 $ (1,171) $ (951) Savings deposits 86 (467) (381) (24) (146) (170) Time deposits (570) (1,475) (2,045) 379 (275) 104 Federal funds purchased 59 (2) 57 (305) 26 (279) Other borrowings 126 (19) 107 182 63 245 --------- ---------- --------- --------- --------- --------- Total interest bearing liabilities $ 4 $ (3,203) $ (3,199) $ 452 $ (1,503) $ (1,051) ========= ========== ========== ========= ========== ========== Net interest income $ 1,525 $ (1,256) $ 269 $ (247) $ (252) $ (499) ========= ========== ========= ========== ========== ==========
12 II. INVESTMENT PORTFOLIO (Dollars in Thousands) The following table sets forth the fair value and amortized cost of securities at December 31:
2 0 0 2 2 0 0 1 2 0 0 0 ------- ------- ------- Fair Amortized Fair Amortized Fair Amortized Value Cost Value Cost Value Cost ----- ---- ----- ---- ----- ---- U.S. Treasury and other U.S. Government agencies and corporations $ 16,103 $ 15,702 $ 21,476 $ 21,156 $ 19,163 $ 19,023 States and political subdivisions 27,505 26,788 30,322 30,098 22,737 22,575 Corporate securities 3,288 3,218 4,445 4,410 6,054 6,031 Other securities 1,915 1,902 5,288 5,262 3,521 3,566 --------- --------- --------- -------- -------- --------- Total investment securities $ 48,811 $ 47,610 $ 61,531 $ 60,926 $ 51,475 $ 51,195 ========= ========= ========= ======== ======== =========
The following table sets forth the market value of debt securities by maturity (or anticipated call date, if earlier) and weighted average yield for each range of maturities at December 31, 2002:
-----------------------------------Maturing--------------------------------- Within One Year 1 to 5 Years 5 to 10 Years After 10 Years --------------- ------------ ------------- -------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- U.S. Treasury and other U.S. Government agencies and corporations $ 1,524 6.2% $ 14,579 3.7% $ - -% $ - -% States and political subdivisions (1) 4,269 4.1 17,109 4.1 4,191 4.9 1,936 4.9 Corporate securities 1,788 3.8 1,500 5.1 - - - - Other securities 343 3.8 - - 189 5.8 - - --------- -------- --------- ----- --------- ---- Total (1) $ 7,924 4.3% $ 33,188 4.0% $ 4,380 4.9% $ 1,936 4.9% ========= ==== ======== ==== ========= ===== ========= ====
(1) Yields are not presented on a tax-equivalent basis. The weighted average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. Except as indicated and for U.S. Treasury and other U.S. Government agencies, total securities of any state (including all its political subdivisions) were less than 10% of shareholders' equity. At year-end 2002 and 2001, the market value of securities issued by the state of Michigan and all its political subdivisions totaled $10,358,000 and $10,563,000, respectively. 13 III. LOAN PORTFOLIO (Dollars in Thousands) TYPES OF LOANS The following table sets forth the classification of loans by major category at December 31:
2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Commercial, financial, and agricultural $ 152,500 $ 130,903 $ 112,748 $ 96,758 $ 82,533 Real estate mortgage 66,118 57,651 69,222 62,432 50,909 Installment 15,548 22,118 31,411 33,190 29,203 ----------- ----------- ----------- ----------- ----------- Total loans $ 234,166 $ 210,672 $ 213,381 $ 192,380 $ 162,645 =========== =========== =========== =========== ===========
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES The following table sets forth the maturities of the loan portfolio at December 31, 2002. Also provided are the amounts due after one year classified according to interest rate sensitivity.
Within 1 1 to 5 After 5 Year (A) Years Years Total -------- ----- ----- ----- Commercial, financial, and agricultural $ 60,035 $ 82,963 $ 9,502 $ 152,500 Real estate mortgages 9,003 15,168 41,947 66,118 Installment 8,089 7,355 104 15,548 ----------- ----------- ----------- ----------- Total $ 77,127 $ 105,486 $ 51,553 $ 234,166 =========== =========== =========== =========== Loans maturing after one year with: Fixed interest rates $ 49,990 $ 1,194 Variable interest rates 55,496 50,359 ----------- ----------- Total $ 105,486 $ 51,553 =========== ===========
(A) Amounts include demand loans, loans having no stated schedule of repayments, or no stated maturity and overdrafts. 14 \ NON-PERFORMING LOANS Non performing loans include nonaccrual and accruing loans past due 90 days or more. The following table sets forth the aggregate amount of non-performing loans in each of the following categories:
December 31 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Non accrual loans: Commercial, financial and agricultural $ 3,600 $ 1,853 $ 1,759 $ 306 $ 343 Real estate mortgage 198 84 - 23 - Installment - - - - - ----------- ----------- ----------- ----------- ----------- 3,798 1,937 1,759 329 343 Loans contractually past due 90 days or more and still accruing interest: Commercial, financial, and agricultural - 510 123 432 807 Real estate mortgage 162 223 277 134 161 Installment 9 36 55 34 120 ----------- ----------- ----------- ----------- ----------- 171 769 455 600 1,088 ----------- ----------- ----------- ----------- ----------- Total $ 3,969 $ 2,706 $ 2,214 $ 929 $ 1,431 =========== =========== =========== =========== =========== Percent of total loans outstanding 1.69% 1.28% 1.04% .48% .88% =========== ========== =========== =========== ==========
The accrual of interest income generally is discontinued when a loan becomes over 90 days past due as to principal or interest. When interest accruals are discontinued, interest credited to income in the current year and accrued interest from the prior year is reversed. Management may elect to continue the accrual of interest when: (1) the fair value of collateral is sufficient to cover the principal balance and accrued interest; and (2) the loan is in the process of collection. Interest of $43,000 and $31,000 was realized on nonaccrual loans during 2002 and 2001, respectively. Under original terms for these loans, interest income which would have been recorded approximates $296,000 and $205,000 in 2002 and 2001, respectively. There are no loan commitments outstanding to extend credits to these customers. POTENTIAL PROBLEM LOANS At December 31, 2002, the Company had approximately $5,666,000 in commercial, financial, agricultural loans for which payments are presently current, but the borrowers are experiencing certain financial and/or operational difficulties. These loans are subject to frequent management review and their special mention classification is reviewed on a monthly basis. At December 31, 2002, the Company also had loans of $6,118,000 that were considered impaired but are not included in the non performing table above. This includes $3,008,000 that is currently not past due, and $2,578,000 that was rewritten and is performing as per the new agreements. All loans 15 classified for regulatory purposes as loss, doubtful, substandard, or special mention have been included in the above disclosures. IV. SUMMARY OF LOAN LOSS EXPERIENCE (Dollars in Thousands) The following table sets forth changes in the allowance for loan losses:
Year Ended December 31 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Balance at beginning of year $ 2,065 $ 2,096 $ 2,132 $ 2,026 $ 1,863 Charge offs: Commercial, financial and agricultural (1,302) (1,225) (512) (505) (227) Installment (354) (520) (406) (492) (352) Real estate (48) (20) (24) (53) - ---------- ---------- --------- --------- --------- (1,704) (1,765) (942) (1,050) (579) Recoveries: Commercial, financial and agricultural 262 307 96 171 41 Installment 215 176 109 132 101 Real estate 3 1 1 1 - --------- --------- -------- -------- --------- 480 484 206 304 142 --------- --------- -------- -------- --------- Net charge offs (1,224) (1,281) (736) (746) (437) Provision for loan losses 2,671 1,250 700 852 600 --------- --------- -------- -------- --------- Balance at end of year $ 3,512 $ 2,065 $ 2,096 $ 2,132 $ 2,026 ========= ========= ======== ======== ========= Average loans outstanding $ 228,715 $ 208,298 $208,160 $178,906 $ 160,666 ========= ========= ======== ======== ========= Ratio of net charge offs to average loans outstanding .54% .61% .35% .42% .27% ========= ========= ======== ======== =========
16 IV. SUMMARY OF LOAN LOSS EXPERIENCE (CONTINUED) Allocation of the Allowance for Loan Losses The Securities and Exchange Commission's guide to the presentation of statistical information provides for a break down of the allowance for loan losses into major loan categories. The Company allocates the allowance among the various categories through an analysis of the loan portfolio composition, prior loan loss experience, evaluation of those loans identified as being probable problems in collection, results of examination by regulatory agencies and current economic conditions. The entire allowance is available to absorb any losses without regard to the category or categories in which the charged off loans are classified. Even though such an allocation has inherent limitations, the Company has compiled the results of its various reviews and has made estimates of the risk which might be allocated to the respective loan categories. The following table sets forth the allocation of the allowance for loan losses at December 31:
-----2 0 0 2----- -------2 0 0 1------- -------2 0 0 0------- ------1 9 9 9----- -----1 9 9 8------ ------- ------- ------- ------- ------- Percent Percent Percent Percent Percent of of of of of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category Of Total Of Total Of Total Of Total Of Total Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- Commercial, financial and agricultural $2,140 65.1% $1,296 62.1% $1,236 52.9% $ 924 50.3% $ 777 50.7% Real estate mortgage 33 28.3 30 27.4 35 32.4 127 32.5 103 31.3 Installment 163 6.6 231 10.5 325 14.7 601 17.2 521 18.0 Unallocated 1,176 - 508 - 500 - 480 - 625 - ------ ----- ------ ----- ------ ------ ------ ------- ------ ------ $3,512 100.0% $2,065 100.0% $2,096 100.0% $2,132 100.0% $2,026 100.0% ====== ===== ====== ===== ====== ====== ====== ======= ====== ======
The allowance for loan losses is maintained at a level which, in management's opinion, is adequate to absorb loan losses in the portfolio. In assessing the adequacy of the allowance, management reviews the characteristics of the loan portfolio in order to determine overall quality and risk profiles. Some factors considered by management in determining the level at which the allowance is maintained include a continuing evaluation of those loans identified as being subject to possible problems in collection, results of examination by regulatory agencies, current economic conditions, and historical loan loss experience. The increase in the 2002 allowance and provision for loan losses include higher charge offs and higher non performing and impaired loans. The increase in the 2001 provision for loan losses occurred to provide for increased charge offs and increased impaired loans and higher delinquency rates. The 2000 provision was set at a level considered necessary to cover expected loan losses. The 1999 and 1998 provisions increased to provide for loan growth and increased charge-offs, primarily as a result of increased customer bankruptcies. 17 V. DEPOSITS (Dollars in Thousands) The following table sets forth the average amount of deposits and rates paid for deposits for the years ended December 31:
2 0 0 2 2 0 0 1 2 0 0 0 ------- ------- ------- Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- Non interest bearing demand deposits $ 40,022 $ 38,676 $ 36,334 Interest bearing demand deposits 102,387 1.4% 89,282 2.6% 83,326 3.9% Savings deposits 46,079 2.0 43,054 3.0 43,793 3.3 Time deposits 68,377 3.3 80,387 5.3 73,450 5.7 --------- --------- --------- $ 256,865 $ 251,399 $ 236,903 ========= ========= =========
The following table sets forth as of December 31, 2002, the aggregate amount of outstanding time deposits of $100,000 or more by maturity (in thousands of dollars): Three months or less $ 6,580 Over three months through six months 5,773 Over six months through twelve months 4,155 Over twelve months 16,166 ---------- $ 32,674 ==========
VI. RETURN ON EQUITY AND ASSETS The following table sets forth consolidated operating and capital ratios for the years ended December 31:
2 0 0 2 2 0 0 1 2 0 0 0 ------- ------- ------- Return on average assets .33% .90% 1.16% Return on average equity (1) 4.04 10.47 15.13 Dividend payout ratio (2) 115.68 43.00 40.30 Average equity to average assets (1) 8.09 8.59 7.69
(1) Average equity used in the above table excludes common stock subject to repurchase obligation but includes average accumulated other comprehensive income. (2) Dividends declared divided by net income. ITEM 2. PROPERTIES The Bank's main office is located at 51 West Pearl Street, Coldwater, Michigan and is owned by the Bank. This facility, which opened in 1955 and expanded in 1976, consists of a one story structure comprising 27,945 square feet. Parking is available for approximately 125 cars and 6 teller windows are available to serve the Bank's customers. The Bank owns ten branch offices, two of which are in Coldwater, two in Union City, Michigan, one in Tekonsha, Michigan, one in Hillsdale, Michigan, one in Camden, Michigan, one in Athens, Michigan, one in North Adams, Michigan and one in Pennfield Township (Battle Creek), Michigan. In addition, 18 the Company owns a 15,000 square foot building in Battle Creek, Michigan and a 14,000 square foot building in Coldwater, Michigan. 6,000 square feet of the Battle Creek building is leased to the Bank for use by one of its Battle Creek branches. 3,500 square feet is leased to a local college, 2,300 square feet is leased as office space to local businesses and the remaining space is presently unoccupied. 7,446 square feet of the Coldwater building is leased to the Bank for use as a Consumer Loan center, 3,420 square feet is leased to a local title office, 394 square feet is leased to community nonprofit organizations and the remaining space is presently unoccupied. The Bank's branch offices range in size from 465 square feet to 6,000 square feet, with nine of the branch offices having drive-in facilities and seven of the branches having automated teller machines. All of the Company's and the Bank's facilities are maintained in good condition and are adequately insured. Management of Company believes the present facilities are adequate to meet both current and future needs. ITEM 3. LEGAL PROCEEDINGS The Bank is frequently engaged in litigation, both as plaintiff and defendant, which is incident to its business. In certain proceedings, claims or counterclaims may be asserted against the Bank. Based on the facts known to it to date, management of the Company does not currently anticipate that the ultimate liability, if any, arising out of any such litigation will have a material effect on the consolidated financial statements of the Company, except as disclosed in Note A of the Notes to Consolidated Financial Statements described in Item 15(a)(1) below. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is regularly quoted on the OTC Bulletin Board (OTCBB). The bid prices described below are quotations reflecting inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions. There were 546 shareholders of record at February 14, 2003. 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:
2002 2001 ------------------------------------------ ------------------------------------------- BID PRICE CASH BID PRICE CASH ------------------------- DIVIDENDS -------------------------- DIVIDENDS HIGH BID LOW BID DECLARED HIGH BID LOW BID DECLARED Quarter Ended - -------------------------------------------------------------------------------------------------------------------------- March 31 $ 16.25 $ 15.80 $ .16 $ 16.75 $ 14.50 $ .15 June 30 16.39 16.00 .16 17.00 15.51 .15 September 30 16.20 15.70 .16 17.30 15.16 .15 December 31 15.89 15.20 .16 16.40 15.45 .16
19 There are restrictions that currently limit the Company's ability to pay cash dividends. Information regarding dividend payment restrictions is described in Note N to the consolidated financial statements for the year ended December 31, 2002. Equity Compensation Plan Information The Following table summarizes certain information about equity compensation plans of the Company as of December 31, 2002:
- -------------------------------- ----------------------------- ----------------------------- ------------------------------ NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO BE ISSUANCE UNDER EQUITY ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (A)) PLAN CATEGORY (A) (B) (C) ------------- --- --- --- Equity Compensation Plans Approved by Security Holders 5,092 $15.32 104,908 Equity Compensation Plans Not Approved by Security Holders 0 0 0 - --------------------------------------------------------------------------------------------------------------------------- Total 5,092 $15.32 104,908 - ---------------------------------------------------------------------------------------------------------------------------
ITEM 6. SELECTED FINANCIAL DATA The following is a summary of certain financial information of the Company (Dollars are in thousands except for per share data).
Year Ended December 31 2002 2001 2000 1999 1998 ---------------------------------------------------------------------------- Total interest income $ 18,754 $ 21,724 $ 23,245 $ 20,051 $ 19,446 Net interest income 12,307 12,079 12,548 11,616 11,414 Provision for loan losses 2,671 1,250 700 852 600 Net income 1,033 2,744 3,375 3,300 3,549 Per share data (1): Basic and diluted earnings per share .55 1.43 1.75 1.64 1.70 Cash dividends .64 .61 .70 .68 .60 Balance sheet data: Loans 234,166 210,672 213,381 192,380 162,645 Deposits 262,389 261,083 245,430 233,303 233,361 Other borrowings 22,606 24,588 25,588 15,588 5,588 Common stock subject to repurchase 1,618 1,523 1,478 3,990 6,029 Equity 24,873 25,547 24,211 19,990 19,345 Total assets 320,683 317,096 303,639 275,825 266,851 Return on average assets .33% .90% 1.16% 1.23% 1.42% Return on average equity 4.04% 10.47% 15.13% 16.37% 17.48%
(1) All per share amounts have been adjusted for a 10% stock dividend declared in 1999. 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the Company's financial condition which supplements the Consolidated Financial Statements. The analysis should be read in conjunction with such financial statements. CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Below are critical accounting policies the Company has identified. For a detailed discussion on the application of these and other accounting policies, see Note A - Nature of Operation and Significant Accounting Policies to the audited consolidated financial statements. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using historical loan loss experience, continued evaluation of those loans identified as being subject to possible problems in collection, results of examinations by regulatory agencies, current economic conditions, delinquency and charge off trends, loan volume, portfolio mix, concentrations of credit and lending policies, procedures and personnel. 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. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Loan Impairment: A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage and consumer loans and on an individual loan basis for other loans. 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. 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 interest rate or at the fair value of collateral if repayment is expected solely from the collateral. Accrued Pension Costs: The Bank has a defined benefit pension plan that 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 21 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. An actuary is engaged to estimate what the obligation of the Bank is as of year end. Assumptions used include the long term expected rate of return on the plan assets, the discount rate on benefit obligation and the rate of increase for employee compensation. Changes in the assumptions used could have a significant effect on the computed benefit obligation and expense. 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 11.2% in 2002 and decreased by 1.3% in 2001. The 2002 increase came in the commercial and real estate mortgage loan categories. In August of 2001, the Bank hired a commercial lender who was well known and respected in his market area. During 2002 loan growth in his market increased $11,611,000, or 83.3%. Real estate mortgage loans increased in 2002 as customers chose variable rate loan products to finance their homes. These variable rate loans were retained in the Bank's portfolio. Consumer installment loans continued to decline as the Bank has placed a very low emphasis on this type of loan product. The 1.3% decline in 2001 loans occurred in the real estate mortgage and installment loan categories. However, commercial loans increased 16.1% during that period, as the Bank focused attention on this area of lending and actively called on current and potential customers. Consumer installment loans decreased 29.6% as the Bank chose not to compete with manufacturers offering 0% new car loans and the Bank placed less emphasis on indirect lending. Real estate mortgage loans decreased 16.7% as the Bank increased sales of loans in the secondary market. With interest rates declining, a number of real estate mortgage loans were refinanced and sold in the secondary market. This reduced the number and amount of loans that the Bank retained. Gains recognized on the sale of real estate mortgage loans to the secondary market increased in 2002 to $1,442,000 from $1,161,000 in 2001. The secondary market loan activity increased in 2002 as mortgage rates remained low. Fixed rate loans, which represent all of the loans sold on the secondary market, continued to be very attractive. Loans held for sale at December 31, 2002 were $1,083,000. The real estate portfolio largely consists of residential mortgages within the local area with a low risk of loss. 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 $38,473,000 and $47,450,000 at December 31, 2002 and 2001, 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. Substantially all loans are granted to customers located in the Bank's service area, which is primarily southern Michigan. 22 Another significant component of cash flow is the securities portfolio. Total securities decreased by 20.7% in 2002 and increased by 19.5% in 2001. In 2002, the funds received from maturing securities were used to partially fund loan growth. In 2001, the funds were reinvested back into the portfolio. Excess deposits were also invested in the portfolio. The securities available for sale portfolio had net unrealized gains of $1,201,000 and $605,000 at December 31, 2002 and 2001, respectively. There are no concentrations of securities in the portfolio which would constitute an unusual risk except at year-end 2002 and 2001, securities issued by the State of Michigan and all of its political subdivisions totaled $10,358,000 and $10,563,000, respectively. Deposits traditionally represent the Company's principal source of funds. Total deposits increased .5% in 2002 and 6.4% in 2001. In 2001, the Bank experienced a substantial increase in deposits, however this was not unexpected. Because of the erratic financial markets the Bank did see a higher increase in our money market accounts than was expected. This was due to customers leaving the financial markets and placing their funds in accounts that paid slightly more interest than savings accounts, but that were not restricted as to withdrawals. Attracting and keeping traditional deposit relationships will continue to be a challenge to the Bank, particularly with the increased competition from non-deposit products. As alternate funding sources, the Bank obtains putable advances from the Federal Home Loan Bank (FHLB) and secures brokered certificate of deposits. 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 mortgage and SBA loans. FHLB advances may be a less expensive way to obtain longer term funds than paying a premium for long term deposits. The Bank has added $10,206,000 in brokered certificates of deposit from September through December of 2002. The Bank has found that these brokered funds are less expensive and more readily available than other long term deposits. Premises and equipment decreased by 9.3% and increased by 3.3% in 2002 and 2001, respectively. During 2001, the Bank upgraded its hardware and software to better serve its customers in the ever changing technological area. During 2002, the Bank was able to maintain its infrastructure without large expenditures causing depreciation expense to exceed new purchases for the year. 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 23 perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries less goodwill, core deposit intangibles and 10% of mortgage servicing rights assets. 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 ensure 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 Q to the financial statements. The ratios include the common stock subject to repurchase obligation in the Company's employee stock ownership plan (ESOP). As seen in Note Q, the Company exceeds the well capitalized requirements at December 31, 2002. At December 31, 2002 the Bank had a tier 1 capital to average asset ratio of 7.5%. On February 17, 2003, the Bank entered into an agreement with its banking regulators that requires the Bank to maintain this ratio at a level at or above 7%. 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 2002 and 2001, total average assets grew 3.4% and 5.2%. At the same time, average equity (including common stock held by the ESOP) decreased 2.2% in 2002 and increased 10.7% in 2001. Equity declined in 2002 because of the repurchase and retirement of 56,605 common stock shares. Future growth opportunities will focus on maintaining the existing customer base and growing within selected other markets identified as providing significant growth potential. LIQUIDITY AND INTEREST RATE SENSITIVITY The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest-earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and enhance consistent growth of net interest income through periods of changing interest rates. Maturing loans and investment securities are the principal sources of asset liquidity. Securities maturing or callable within 1 year were $16,692,000 at December 31, 2002 representing 34.1% of the market value of the investment securities portfolio, a slight decrease from the 36.0% level of 2001. Loans maturing within 1 year were $78,210,000 December 31, 2002 representing 33.4% of the gross loan portfolio, an increase from the 23.8% level of 2001. Financial institutions are subject to prepayment risk in falling rate environments. Prepayments 24 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 it 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, 2002, there was a net decrease in cash and cash equivalents of $4,145,000. The major sources of cash in 2002 were maturing securities, loan sales and purchased fed funds. The major uses of cash in 2002 were security purchases, loan growth and loans originated for sale. During the year ended December 31, 2001, there was a net increase in cash and cash equivalents of $4,943,000. The major sources of cash in 2001 were increases in deposits, maturing securities, loan sales and sales of securities. The major uses of cash in 2001 were security purchases and loans originated for sale. During the year ended December 31, 2000, there was a net increase in cash and cash equivalents of $6,443,000. The major sources of cash in 2000 were increase in deposits, maturing securities, loan sales and additional borrowings from the Federal Home Loan Bank. The major uses of cash in 2000 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 N 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 Bank also analyzes projected changes in market interest rates and the resulting effect on net interest income. 25 The following table shows the interest sensitivity gaps for five different time intervals as of December 31, 2002:
0-30 31-90 91-365 1-5 Over 5 Days Days Days Years Years ---- ---- ---- ----- ----- Interest-earning assets $101,168 $12,576 $56,306 $109,612 $2,439 Interest-bearing liabilities $69,053 $90,535 $32,347 $52,377 $1,615 ----------------------------------------------------------- Interest sensitivity gap $32,115 $(77,959) $23,959 $57,235 $824
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 management 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 1.9% in 2002, decreased by 3.7% in 2001 and increased by 8.0% in 2000. The 2002 increase is due to a combination of factors. Lowered rates continued to push interest income down, but higher loan balances partially offset this decrease. Offsetting the decrease in interest income was decreased interest expense on deposit accounts. Lower deposit interest was caused by the lowering of deposit rates and the run off of higher priced time deposits throughout the year. The 2001 decrease is largely due to the eleven decreases in the prime rate throughout the year. The 2000 increase is due to the increase in the commercial and real estate mortgage loan portfolio and the increases to prime rate throughout the year. These increases were partially offset by the increased interest paid for money market and CD deposits and increased interest paid for Federal Home Loan Bank borrowings. The uncertain economic environment and potential fluctuations in interest rates are expected to continue to impact the Company and the industry in 2003. 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 competitors' 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 probable losses in the loan portfolio. Some factors considered by management in determining the level at which the allowance is maintained include specific 26 credit reviews, historical 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 $2,671,000 in 2002, $1,250,000 in 2001 and $700,000 in 2000. The provision increased in 2002 primarily to account for loan growth, charge-offs, increased levels of non-performing and impaired loans and to provide for increases in allowance allocations for specific loan credits. The increase in the 2001 provision occurred to provide for increased charge offs, which included one loan totaling $673,000 during the first quarter. Also contributing to the increase were higher levels of impaired loans and delinquency rates. In 2002, net loan charge offs totaled $1,224,000. In the third quarter, $560,000 was charged off related to a $1,000,000 accounts receivable factoring facility for a single customer. In 2001, net loan charge offs totaled $1,281,000. As mentioned above, $673,000 was related to one borrower. Net loan charge offs totaled $736,000 in 2000. This was primarily attributable to three commercial customers. Two of these customers had been provided for in 1999 The provision will be adjusted quarterly, if necessary, to reflect actual charge-off experience and any known losses. For further information, see "Allowance for Loan Losses" below. Non-interest income, excluding security gains and losses, increased 13.0% in 2002, 16.3% in 2001 and remained constant in 2000. Service charges on deposit accounts increased $374,000 from 2001. In May of 2002, the Bank introduced a new overdraft product. The Bank began paying checks for qualifying customers, up to a specified dollar limit, rather than return the checks. A significant increase in overdraft volume has occurred since this product was introduced. 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. In 2002, gains recognized on the sale of real estate mortgage loans to the secondary market increased $281,000 or 24.2% from 2001. This increase was due to continued low mortgage rates making refinancing and new home purchases very attractive. Offsetting the increases was the $283,000 second quarter 2002 loss on viatical insurance contracts. In 2001, gains recognized on the sale of real estate mortgage loans to the secondary market increased $628,000 or 117.8% from 2000. In addition, security gains increased $532,000 during 2001. In 2000, trust fees, service charges on loans and earnings on life insurance assets increased but were offset by a decrease in the gains recognized on the sale of real estate mortgage loans to the secondary market. The Bank increased its deposit base by 5.2% and generated additional service charges as a result of the growth. Trust fees increased due to a new fee schedule put in place January 1, 2000. Security gains of $4,000 and $529,000 were recognized in 2002 and 2001, respectively. Security losses of $3,000 were recognized on sales of securities in 2000. Non-interest expense increased by 10.7% in 2002, 9.0% in 2001 and 8.8% in 2000. In 2002, the largest increase came in the salaries and employee benefit category. Over $260,000 more in commissions was paid to mortgage loan originators based on loan volumes generated for the year. In addition, health insurance increased $194,000 or 49.8% as insurance premiums increased and the Bank had more participants in the plan during 2002. The other large increase 27 in non-interest expense came in the professional and outside services which increased $374,000. During the fourth quarter of 2002, the Bank hired an outside consulting firm to review selected areas of the Bank looking for potential cost savings, revenue enhancements and efficiency measures. The Bank has implemented a number of recommendations made by the consulting firm and expects to see benefits to both efficiency and net income in 2003. In 2001, salaries and benefit expenditures increased as additional employees were added in Battle Creek to assist with the commercial and mortgage volumes projected in this region. In addition, over $100,000 more in commissions were paid to mortgage loan originators based on loan volumes generated for the year. Other non interest expenses increased $562,000. $190,000 was charged to earnings to write down impaired assets from cost to market value. In addition, $220,000 was charged to earnings relating to a potential liability arising out of litigation. In February of 2002, the Company resolved the litigation resulting in $60,000 of additional losses to the Company. In February 2003, the Company received an insurance settlement related to this loss of approximately $150,000, net of legal fees. In 2000, the largest increase came in the professional and outside services category. The Company spent $456,000 in legal and accounting fees in an attempt to merge with Sturgis Bank & Trust. The merger was called off in October of 2000 after Sturgis Bank and Trust did not obtain a fairness opinion from their investment advisors. In 2000, salaries and benefit expenditures increased as a cost of living increase of 2.6% was given to all employees at the beginning of the year. In addition, the loan department employees hired during 1999 were employees for the entire year of 2000 adding to the increase. Income tax expense was $118,000 in 2002, $875,000 in 2001 and $1,179,000 in 2000. Tax-exempt income continues to have a major impact on the Company's tax expense. The benefit offsetting lower coupon rates on municipal instruments is the nontaxable feature of the income earned on such instruments. This resulted in a lower effective tax rate and reduced federal income tax expense by approximately $305,000 in 2002, $267,000 in 2001 and $288,000 in 2000. Results of operations can be measured by various ratio analyses. Two widely recognized performance indicators are the return on equity and the return on assets. The Company's return on equity was 4.04% in 2002, 10.47% in 2001 and 15.13% in 2000. The return on average assets was .33% in 2002, .90% in 2001 and 1.16% in 2000. IMPACT OF INFLATION AND CHANGING PRICES 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 28 to protect against wide interest rate fluctuations. NONPERFORMING ASSETS Nonperforming assets include nonaccrual loans, accruing loans past due 90 days or more, and other real estate which includes foreclosures, deeds in lieu of foreclosure and real estate in redemption. 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 assets in each of the following categories:
December 31 2002 2001 2000 ---- ---- ---- (Dollars in thousands) Nonaccrual loans: Commercial, financial and agricultural $ 3,600 $ 1,853 $ 1,759 Real estate mortgage 198 84 - Installment - - - --------- --------- ---------- 3,798 1,937 1,759 Loans contractually past due 90 days or more: Commercial, financial and agricultural - 510 123 Real estate mortgage 162 223 277 Installment 9 36 55 --------- --------- ---------- 171 769 455 --------- --------- ---------- Total nonperforming loans 3,969 2,706 2,214 Other real estate owned 1,016 1,406 1,415 --------- --------- ---------- Total nonperforming assets $ 4,985 $ 4,112 $ 3,629 ========= ========= ========== Nonperforming loans to year-end loans 1.69% 1.28% 1.03% ======== ======== ========= Nonperforming assets to total assets 1.55% 1.30% 1.20% ======== ======== =========
Nonperforming loans increased in 2002 with the increase coming in nonaccrual commercial, financial and agricultural loans. A number of loans were added to nonaccrual status in 2002 as the economy softened and borrowers experienced financial difficulty. Nonperforming loans increased in 2001 with the largest increase coming in commercial, financial and agricultural loans contractually past due 90 days or more. In 2001, nonaccrual loans were made up of several commercial and agricultural loans where the borrower experienced severe financial difficulties and therefore became delinquent. 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, 2002, 2001 and 2000, the Company had loans of $9,473,000, $4,507,000 and $2,733,000, which were considered impaired. 29 Of these amounts, $3,008,000, $2,097,000 and $2,733,000 are not past due as of December 31, 2002, 2001 and 2000. At December 31, 2002, the Company had approximately $5,666,000 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. PROVISION FOR LOAN LOSSES In 2002, $2,671,000 was recorded as provision for loan losses compared to $1,250,000 in 2001 and $700,000 in 2000. The provision is charged to income to bring the allowance for loan losses to a level deemed appropriate by management based on the factors discussed under "Allowance for Loan Losses" below. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is based on regular, quarterly assessments of the probable estimated losses inherent in the loan portfolio. The allowance is based on two principles of accounting, Statement of Financial Accountings Standards (SFAS) No. 5 "Accounting for Contingencies", and SFAS No. 114, "Accounting by Creditors for Impairment of a Loan". The methodology used relies on several key features, including historical loss experience, specific allowances for identified problem loans and an unallocated allowance. The historical loss component of the allowance is based on the three and five year historical loss experience for each loan category. The component may be adjusted for significant factors that, in management's opinion, will affect the collectibility of the portfolio. The resulting loss estimate could differ from the losses actually incurred in the future. Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific loan credit. These allowances are calculated in accordance with SFAS No. 114. The unallocated portion of the allowance is based on management's evaluation of conditions that are not directly measured in the historical loss component or specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty. The conditions evaluated in connection with the unallocated allowance include current economic conditions, delinquency and charge off trends, loan volume, portfolio mix, concentrations of credit and lending policies, procedures and personnel. The allowance is maintained at a level, which in management's opinion, is adequate to absorb probable incurred loan losses in the loan portfolio. While management uses the best information 30 available to make these estimates, future adjustments to allowances may be necessary due to economic, operating or regulatory conditions beyond the Company's control. The allowance for loan losses was $3,512,000 or 1.50% of loans at December 31, 2002 compared to $2,065,000 or .98% of loans at December 31, 2001. The December 31, 2002 allowance consists of $2,336,000 in the historical loss experience component and specifically allocated reserves, leaving $1,176,000 unallocated. This compares to $1,557,000 and $508,000 at December 31, 2001, respectively. The increase in the historical and specific allocations is attributable to an increase in the historical loss experience as a result of higher charge offs in the last few years and higher non performing loans resulting in higher specific allocations. The increase in the unallocated allowance is the result of a number of factors including the slowing of the economy, increased layoffs and unemployment, a change in the mix of our loan portfolio which shows increasing commercial loans and fewer consumer loans and a higher charge off trend in the last year than the three to five year historical loss experience component would utilize and higher levels of nonperforming and impaired loans. COMMITMENTS AND OFF-BALANCE SHEET RISK The Bank maintains off balance sheet financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, letters of credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer at any time, as the customer's needs vary, as long as there is no violation of any condition established in the contract. Letters of credit are used to facilitate customers' trade transactions. Under standby letters of credit agreements, the Bank agrees to honor certain commitments in the event that its customers are unable to do so. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. 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. These financial instruments are recorded when they are funded. 31 The following tables represent the Company's contractual obligations and commitments at December 31, 2002:
Contractual Obligations: Payments Due By Period ---------------------- Less than 1 - 3 4 - 5 after 5 1 year years years years Total ------ ----- ----- ----- ----- FHLB advances $ 78 $ 20,178 $ 191 $ 553 $ 21,000 Other borrowing 1,606 - - - 1,606 Federal funds purchased 5,000 - - - 5,000 Operating leases 103 103 103 - 309 --------- --------- --------- --------- -------- Totals $ 6,787 $ 20,281 $ 294 $ 553 $ 27,915 Commitments: Payments Due By Period ---------------------- Less than 1 - 3 4 - 5 after 5 1 year years years years Total ------ ----- ----- ----- ----- Lines of credit $ 33,843 $ 194 $ 831 $ 3,605 $ 38,473 Letters of credit - - - - - Standby letters of credit 288 - - - 288 --------- --------- --------- --------- -------- Totals $ 34,131 $ 194 $ 831 $ 3,605 $ 38,761
REGULATORY MATTERS Representatives of the Office of Financial and Insurance Services (OFIS) completed an examination at the Company's subsidiary bank using financial information as of June 30, 2002. 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. As a result of such examination, the Bank has agreed to implement various actions and procedures primarily in the areas of: loan underwriting, problem loan administration, strategic planning and maintenance of Tier I Capital. The Bank was in the process of implementing substantially all of these actions and procedures prior to the examination. The loan related issues and actions are summarized in this annual report on Form 10-K in "Item 14 Controls and Procedures." In addition, the Bank has agreed to maintain Tier 1 Capital of not less than 7% and to develop a profit plan and update its strategic plan. Management of the Bank has complied and will continue to comply with the requirements of its regulatory agencies. Management of the Bank does not anticipate that any additional regulatory actions will be implemented. 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. NEW ACCOUNTING PRONOUNCEMENTS New accounting standards for asset retirement obligations, restructuring activities and exit costs, operating leases, and early extinguishments of debt were issued in 2002. Management has determined that when the new accounting standards are adopted in 2003 they will not have a material impact on the Company's financial condition or results of operations. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure is interest rate risk and liquidity risk. See 32 Liquidity and Interest Rate Sensitivity above. Business is transacted in U.S. dollars with no foreign exchange rate risk or any exposure to changes in commodity prices. The following tables provide information about the Company's financial instruments that are sensitive to changes in interest rates as of December 31, 2002 and 2001. 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.
December 31, 2002: Principal Amount Maturing in: Fair Value 2003 2004 2005 2006 2007 Thereafter Total 12/31/02 ---- ---- ---- ---- ---- ---------- ---- -------- Rate sensitive assets: Fixed interest rate loan $21,101 $8,522 $8,323 $12,787 $20,358 $1,194 $72,285 $75,201 Average interest rate 7.95% 8.52% 8.45% 7.98% 7.75% 6.72% 7.90% Variable interest rate loans 57,109 12,704 11,133 19,479 12,180 50,359 162,964 162,964 Average interest rate 5.40 5.62 5.69 5.63 5.73 6.25 5.84 Fixed interest rate securities 16,692 18,788 6,727 2,535 1,703 2,366 48,811 48,811 Average interest rate 4.59 4.29 4.30 4.33 4.52 5.46 4.46 Other interest bearing assets 507 507 507 Average interest rate 1.06 1.06 Rate sensitive liabilities: Interest bearing checking 101,182 101,182 101,182 Average interest rate 1.26 1.26 Savings 34,978 34,978 34,978 Average interest rate 1.77 1.77 Time deposits 51,741 14,099 13,803 2,214 1,910 83,767 85,419 Average interest rate 2.83 3.15 3.19 3.57 2.95 3.57 Fixed interest rate borrowings 21,684 88 90 94 97 553 22,606 23,728 Average interest rate 6.37 4.57 4.57 4.57 4.57 4.57 6.29
33
December 31, 2001: Principal Amount Maturing in: Fair Value 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 ---- ---- ---- ---- ---- --------- ---- -------- Rate sensitive assets: Fixed interest rate loans $11,330 $4,212 $14,555 $7,677 $16,520 $16,747 $71,041 $73,350 Average interest rate 7.44% 9.01% 8.90% 9.25% 8.39% 8.82% 8.46% Variable interest rate loans 40,421 3,103 5,945 8,167 21,191 62,667 141,494 141,494 Average interest rate 5.66 5.71 5.75 5.84 5.92 7.31 6.65 Fixed interest rate securities 13,152 7,686 16,531 6,298 3,513 10,318 57,498 57,498 Average interest rate 4.66 4.88 4.13 4.32 4.02 4.41 4.43 Variable interest rate securities 4,033 4,033 4,033 Average interest rate Other interest bearing assets 8,115 8,115 8,115 Average interest rate 1.80 1.80 Rate sensitive liabilities: Interest bearing checking 104,261 104,261 104,261 Average interest rate .89 .89 Savings 33,129 33,129 33,129 Average interest rate 2.27 2.27 Time deposits 63,633 12,663 4.772 2,104 6 83,178 84,806 Average interest rate 3.99 4.15 4.20 4.21 4.21 3.57 Fixed interest rate borrowings 23,588 78 88 90 94 650 24,588 25,927 Average interest rate 6.47 4.57 4.57 4.57 4.57 4.57 6.39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is set forth in the Section entitled "Quantitative and Qualitative Disclosures about Market Risk" included under Item 7 of this annual report on Form 10-K and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See consolidated financial statements of the Company which are included in Item "15(a)(1) Exhibits, Financial Statement Schedules and Reports on Form 8-K," and begin on page FS-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information regarding the directors and officers of the Company is included in the Company's Proxy Statement relating to its 2003 Annual Meeting of Shareholders under the heading "Proposal (1) -- Election of Directors" and the information included therein is incorporated herein by reference. Information regarding beneficial ownership compliance is 34 included in the Company's Proxy Statement relating to its 2003 Annual Meeting of Shareholders under the heading "Disclosure of Delinquent Filers" and the information include therein is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation is included in the Company's Proxy Statement relating to its 2003 Annual Meeting of Shareholders under the headings "Executive Compensation," "Retirement Benefits," "Meetings, Committees and Compensation of the Board of Directors," "Compensation Committee Report on Executive Compensation," "Compensation Committee Interlocks and Insider Participation," and "Stock Performance Graph" and the information included therein is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding equity compensation plan information is included in this annual report on Form 10-K in "Item 5. Market For Registrant's Common Equity and Related Stockholder Matters." Information regarding security ownership of certain beneficial owners and management is included in the Company's Proxy Statement relating to its 2003 Annual Meeting of Shareholders under the headings "Principal Shareholders," "Proposal (1) -- Election of Directors," and "Change in Control of Registrant" and the information therein is included herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions is included in the Company's Proxy Statement relating to its 2003 Annual Meeting of Shareholders under the heading "Transactions with Directors and Officers" and the information therein is included herein by reference. ITEM 14. CONTROLS AND PROCEDURES (a) Within the 90 days prior to the date of filing of this report, we carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chairman and Chief Executive Officer along with the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14). Based upon that evaluation, the Company's Chairman and Chief Executive Officer along with the Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings. Prior to and during this evaluation, certain significant deficiencies or material weaknesses in internal controls existed, namely: - Commercial loan documentation review and disbursement controls have been inadequate to provide for appropriate segregation of duties at origination of loans. - Less than satisfactory commercial loan workout and collection efforts. 35 The following actions have been taken to correct these deficiencies in internal controls: - Creation of a Credit Administration Department reporting to the President of the Bank, independent of the loan officers. This department is now responsible for the underwriting, documentation and funding of new loans. - The Bank has hired a reputable outside consulting firm to assist with the collection of non-performing commercial loans. In addition, as part of the Credit Administration Department, the Bank has created a Managed Assets Division to work in conjunction with the outside consultant to ensure an acceptable reduction in non-performing loans. (b) There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of the Company are filed as a part of this report and are included herewith beginning on page FS-1: - Report of independent auditors - Consolidated Balance Sheets - December 31, 2002 and 2001 - Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 2002, 2001 and 2000 - Consolidated Statements of Income and Comprehensive Income - Years ended December 31, 2002, 2001 and 2000 - Consolidated Statements of Cash Flows - Years ended December 31, 2002, 2001 and 2000 - Notes to Consolidated Financial Statements (a)(2) Not applicable. (a)(3) Exhibits (Numbered in accordance with Item 601 of Regulation S-K). Exhibit No. Description of Exhibit ----------- ---------------------- Exhibit 2 Not applicable. Exhibit 3.1 Articles of Incorporation incorporated by reference to 36 Exhibit No. Description of Exhibit ----------- ---------------------- Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 and Exhibit 3 to Form S-3D filed April 30, 1998, File No. 2-78178. Exhibit 3.2 Amended and Restated By-Laws are incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, File No. 2-78178. Exhibit 4 Instruments Defining the Rights of Security Holders of the Company are the Articles of Incorporation and By-Laws (see Exhibits 3.1 and 3.2 above). Exhibit 9 Not applicable. Exhibit 10.1 Material Contracts -- Executive Compensation Plans and Arrangements: (1) Master Agreements for Directors' Deferred Income Plan; (2) Composite form of Executive Employee Salary Continuation Agreement, as amended; and (3) Master Agreements for Executives' Deferred Compensation Plan, as amended, are incorporated by reference to Exhibit 10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, File No. 2-78178. Exhibit 10.2 Southern Michigan Bancorp, Inc. 2000 Stock Option Plan is incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 2-78178. Exhibit 10.3 Employment Agreement dated January 1, 2002 by and between the Bank and the Company and James T. Grohalski is incorporated by reference to Exhibit 10(C) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, File No. 2-78178. Exhibit 10.4 Employment Agreement dated June 7, 2002 by and between the Bank and the Company and John H. Castle. Exhibit 10.5 Standard Form of Executive's Deferred Compensation Agreement. Exhibit 11 Not applicable. Exhibit 12 Not applicable. Exhibit 13 Not applicable. Exhibit 16 Not applicable. Exhibit 18 Not applicable. Exhibit 21 Subsidiaries of the Company. 37 Exhibit 22 Not applicable. Exhibit 23 Consent of Independent Auditors. Exhibit 24 Not applicable. Exhibit 27 Not applicable. Exhibit 99.1 Certification of the Company's Chief Executive Officer, John H. Castle, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2 Certification of the Company's Chief Financial Officer, Danice Chartrand, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 2002. (c) Exhibits - See Item 15(a)(3) above. (d) Financial Statement Schedules - Omitted due to inapplicability or because required information is shown in the Financial Statements and Notes thereto. 38 SOUTHERN MICHIGAN BANCORP, INC. 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, 2002 and 2001 and the related consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted in the United States of America. 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, 2002 and 2001 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. As disclosed in Note A, during 2002 the Company adopted new accounting guidance for goodwill and intangible assets. South Bend, Indiana February 5, 2003, except for Note N and Q, as to which the date is February 17, 2003 FS-1 SOUTHERN MICHIGAN BANCORP, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except number of shares)
December 31, 2002 2001 --------------------------- ASSETS Cash $ 3,642 $ 3,448 Due from banks 15,645 19,984 --------------------------- Cash and cash equivalents 19,287 23,432 Securities available for sale 48,811 61,531 Loans held for sale, net of valuation of --0- in 2002 & 2001 1,083 1,863 Loans, net of allowance for loan losses $3,512 - 2002 ($2,065 -- 2001) 230,654 208,607 Premises and equipment, net 7,137 7,868 Accrued interest receivable 2,118 2,310 Net cash surrender value of life insurance 6,472 6,015 Goodwill 620 620 Other intangible assets 150 189 Other assets 4,351 4,661 --------------------------- TOTAL ASSETS $ 320,683 $ 317,096 =========================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Non-interest bearing $ 42,462 $ 40,515 Interest bearing 219,927 220,568 --------------------------- Total deposits 262,389 261,083 Accrued expenses and other liabilities 4,197 4,355 Federal funds purchased 5,000 - Other borrowings 22,606 24,588 Common stock subject to repurchase obligation in Employee Stock Ownership Plan, shares outstanding -- 104,841 in 2002 (98,549 in 2001) 1,618 1,523 Shareholders' equity Preferred stock, 100,000 shares authorized; none issued or outstanding Common stock, $2.50 par value: Authorized - 4,000,000 shares Issued -- 1,864,046 shares in 2002 (1,920,651 in 2001) Outstanding -- 1,759,205 shares in 2002 (1,822,102 in 2001) 4,398 4,555 Additional paid-in capital 8,752 9,652 Retained earnings 11,366 11,528 Accumulated other comprehensive income, net 793 400 Unearned Employee Stock Ownership Plan shares (436) (588) --------------------------- TOTAL SHAREHOLDERS' EQUITY 24,873 25,547 --------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 320,683 $ 317,096 ===========================
See accompanying notes to consolidated financial statements. FS-2 SOUTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands, except number of shares and per share data)
Accumulated Other Additional Comprehensive Unearned Common Paid-In Retained Income ESOP Stock Capital Earnings (Loss), Net Shares TOTAL ------------------------------------------------------------------------------- BALANCE AT JANUARY 1, 2000 $ 4,597 $ 8,421 $ 7,949 $ (389) $ (588) $ 19,990 Net income for 2000 3,375 3,375 Cash dividends declared - $.70 per share (1,360) (1,360) Common stock repurchased and retired (28,757 shares) (72) (808) (880) Change in common stock subject to repurchase 53 2,459 2,512 Net change in unrealized gain (loss) on available for sale securities, net of tax 574 574 ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 4,578 10,072 9,964 185 (588) 24,211 Net income for 2001 2,744 2,744 Cash dividends declared - $.61 per share (1,180) (1,180) Common stock repurchased and retired (19,851 shares) (50) (348) (398) Change in common stock subject to repurchase 27 (72) (45) Net change in unrealized gain (loss) on available for sale securities, net of tax 215 215 ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 4,555 9,652 11,528 400 (588) 25,547 Net income for 2002 1,033 1,033 Cash dividends declared - $.64 per share (1,195) (1,195) Common stock repurchased and retired (56,605 shares) (142) (763) (905) Change in common stock subject to repurchase (15) (80) (95) Tax effect of benefit plan 30 30 Reduction of ESOP obligation (87) 152 65 Net change in unrealized gain (loss) on available for sale securities, net of tax 393 393 ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2002 $ 4,398 $ 8,752 $ 11,366 $ 793 $ (436) $ 24,873 =============================================================================
See accompanying notes to consolidated financial statements. FS-3 SOUTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (In thousands, except per share data)
Year ended December 31, 2002 2001 2000 ------------------------------------------ Interest income: Loans, including fees $ 16,437 $ 18,466 $ 20,102 Securities: Taxable 1,365 2,360 2,212 Tax-exempt 950 862 908 ------------------------------------------ 2,315 3,222 3,120 Other 2 36 23 ------------------------------------------ Total interest income 18,754 21,724 23,245 Interest expense: Deposits 4,532 7,895 8,912 Other 1,915 1,750 1,785 ------------------------------------------ Total interest expense 6,447 9,645 10,697 ------------------------------------------ NET INTEREST INCOME 12,307 12,079 12,548 Provision for loan losses 2,671 1,250 700 ------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,636 10,829 11,848 Non-interest income: Service charges on deposit accounts 1,436 1,062 1,102 Trust fees 593 565 535 Net securities gains (losses) 4 529 (3) Net gains on loan sales 1,442 1,161 533 Earnings on life insurance assets 270 253 247 Loss on viatical settlement contracts (283) - - Other 393 367 514 ------------------------------------------ 3,855 3,937 2,928 Non-interest expense: Salaries and employee benefits 6,255 5,275 4,803 Occupancy, net 846 749 720 Equipment 1,261 1,195 1,040 Printing, postage and supplies 391 413 409 Advertising and marketing 208 316 271 Professional and outside services 1,064 690 1,032 Amortization of goodwill - 63 63 Amortization of other intangibles 39 131 56 Other 2,276 2,315 1,828 ------------------------------------------ 12,340 11,147 10,222 ------------------------------------------ Income before income taxes 1,151 3,619 4,554 Federal income taxes 118 875 1,179 ------------------------------------------ NET INCOME 1,033 2,744 3,375 Other comprehensive income: Unrealized gains on securities arising during the year 600 854 866 Reclassification adjustment for accumulated (gains) losses included in net income (4) (529) 3 Tax effect (203) (110) (295) ------------------------------------------ Other comprehensive income 393 215 574 ------------------------------------------ COMPREHENSIVE INCOME $ 1,426 $ 2,959 $ 3,949 ========================================== BASIC AND DILUTED EARNINGS PER COMMON SHARE $ .55 $ 1.43 $ 1.75 ==========================================
See accompanying notes to consolidated financial statements. FS-4 SOUTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Year ended December 31, 2002 2001 2000 ------------------------------------------ OPERATING ACTIVITIES Net income $ 1,033 $ 2,744 $ 3,375 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 2,671 1,250 700 Depreciation 918 900 741 Net amortization of investment securities 350 121 45 Net securities (gains) losses (4) (529) 3 Loans originated for sale (68,285) (55,835) (18,805) Proceeds on loans sold 70,507 56,157 19,305 Net gains on loan sales (1,442) (1,161) (533) Net realized (gain) loss on disposal of fixed assets 24 8 (25) Earnings on life insurance assets (270) (253) (247) Loss on viatical settlement contracts 283 - - Amortization of goodwill - 63 63 Amortization of other intangible assets 39 131 56 Reduction of obligation under ESOP 65 - - Net change in: Accrued interest receivable 192 752 (620) Other assets 137 (879) (1,679) Accrued expenses and other liabilities (150) 1,447 (13) ------------------------------------------ Net cash from operating activities 6,068 4,916 2,366 INVESTING ACTIVITIES Activity in available-for-sale securities: Proceeds from sales 254 12,559 997 Proceeds from maturities and calls 26,110 22,570 12,731 Purchases (13,394) (44,452) (10,153) Purchase of life insurance (470) 28 (9) Loan originations and payments, net (24,718) 1,428 (21,737) Proceeds from sale of premises and equipment 59 15 206 Additions to premises and equipment (270) (1,172) (1,836) ------------------------------------------ Net cash from investing activities (12,429) (9,024) (19,801) FINANCING ACTIVITIES Net change in deposits 1,306 15,653 12,127 Net change in federal funds purchased 5,000 (4,000) 4,000 Proceeds from other borrowings 1,170 1,000 10,000 Repayments of other borrowings (3,152) (2,000) - Cash dividends paid (1,203) (1,204) (1,369) Repurchase of common stock (905) (398) (880) ------------------------------------------ Net cash from financing activities 2,216 9,051 23,878 ------------------------------------------ NET CHANGE IN CASH AND CASH EQUIVALENTS (4,145) 4,943 6,443 Beginning cash and cash equivalents 23,432 18,489 12,046 ------------------------------------------ ENDING CASH AND CASH EQUIVALENTS $ 19,287 $ 23,432 $ 18,489 ========================================== Cash paid for interest 6,504 $ 9,825 $ 10,687 Cash paid for income taxes 925 1,102 965
See accompanying notes to consolidated financial statements. FS-5 SOUTHERN MICHIGAN BANCORP, INC. 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 and consumer loans to customers. The majority of loans are secured by business assets, commercial real estate, and consumer assets. There are no foreign loans. SMB Mortgage Company was established in August 2000 as a wholly-owned subsidiary of the Bank. All residential real estate loans are transacted through this subsidiary. The majority of loans are secured by residential real estate. 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) and its wholly-owned subsidiary, SMB Mortgage Company, after elimination of significant intercompany balances and transactions. USE OF ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 securities and other financial instruments and the actuarial present value of pension benefit obligations, net periodic pension expense and accrued 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 or loss 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, 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 HELD FOR SALE: Loans held for sale are reported at the lower of cost or market value in the aggregate. Net unrealized losses are recorded in a valuation allowance by charges to income. 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. All interest accrued but not received for these loans is reversed against interest income. Payments received on such loans are reported as principal reductions until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest contractually due are brought current and future payments are reasonably assured. FS-6 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE A -- NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation allowance for probable incurred 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 loan is necessarily subjective. Accordingly, management estimates the allowance balance based on past loan loss experience, nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, information in regulatory examination reports, 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. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. 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 interest 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. Land is carried at cost. MORTGAGE SERVICING RIGHTS: Mortgage servicing rights represent both purchased rights and the allocated value of mortgage servicing rights retained on loans sold. Mortgage 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 OTHER INTANGIBLE ASSETS: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable assets. Upon adopting new accounting guidance on January 1, 2002, the Company ceased amortizing goodwill. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. The effect on net income of ceasing goodwill amortization in 2002 was an increase of $42,000. Other intangible assets consist of core deposit intangible assets arising from branch acquisitions. They are initially measured at fair value and then are amortized on the straight line method over their estimated useful lives, which is 10 years. OTHER REAL ESTATE: Other real estate was $1,016,000 and $1,406,000 at December 31, 2002 and 2001 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 the lower of the loan balance or fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and real estate is carried at fair value less estimated cost of disposal. Expenses, gains and losses on disposition, and changes in any valuation allowance are reported in other expense. FS-7 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE A -- NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK COMPENSATION: Employee compensation expense under stock option plans is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock Based Compensation. Stock options were not granted until 2001 and as such, disclosures are excluded for prior periods.
2002 2001 ---- ---- Net income as reported $ 1,033 $ 2,744 Deduct: stock based compensation expense determined under fair value based method (1) (9) ------------ ------------ Pro forma net income $ 1,032 $ 2,735 Basic earnings per share as reported .55 1.43 Pro forma basic earnings per share .55 1.42 Diluted earnings per share as reported .55 1.43 Pro forma diluted earnings per share .55 1.42
The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date.
2002 2001 ---- ---- Risk-free interest rate N/A 5.00% Expected option life N/A 6.00 years Expected stock price volatility N/A 19.04% Dividend yield N/A 3.95%
COMPANY OWNED LIFE INSURANCE: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at its net cash surrender value, or the amount that can be realized. 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 and short term borrowings with a maturity of 90 days or less. COMPREHENSIVE INCOME: Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income includes the net change in unrealized gains and losses on securities available for sale, net of tax, which is also recognized as a separate component of shareholders' equity. FS-8 SOUTHERN MICHIGAN BANCORP, INC. 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. The fair value estimates of existing on-and off- balance-sheet financial instruments does not include the value of anticipated future business or values of assets and liabilities not considered financial instruments. 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 65% 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 28% of the loan portfolio and are collateralized by mortgages on residential real estate. Consumer loans make up approximately 7% of the loan portfolio and are primarily collateralized by consumer assets. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and standby letters of credit issued to meet customer needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS: New accounting standards for asset retirement obligations, restructuring activities and exit costs, operating leases, and early extinguishments of debt were issued in 2002. Management has determined that when the new accounting standards are adopted in 2003 they will not have a material impact on the Company's financial condition or results of operations. 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. While management does not believe there are such matters that will have a material effect on the consolidated financial statements as of December 31, 2002, the Bank is defending legal counterclaims in excess of $5,000,000. RECLASSIFICATIONS: Some items in the prior year consolidated financial statements have been reclassified to conform with the current year presentation. FS-9 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE B -- BASIC AND DILUTED EARNINGS PER COMMON SHARE A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the years ended December 31, 2002, 2001 and 2000 is presented below:
2002 2001 2000 ---- ---- ---- BASIC EARNINGS PER COMMON SHARE Net income (in thousands) $ 1,033 $ 2,744 $ 3,375 ========================================== Weighted average common shares outstanding 1,877,990 1,937,844 1,947,384 Less: Unallocated ESOP shares (11,430) (15,400) (15,400) ------------------------------------------ Weighted average common shares outstanding for basic earnings per common share 1,866,560 1,922,444 1,931,984 ========================================== Basic earnings per common share $ .55 $ 1.43 $ 1.75 ========================================== DILUTED EARNINGS PER COMMON SHARE Net income (in thousands) $ 1,033 $ 2,744 $ 3,375 ========================================== Weighted average common shares outstanding for basic earnings per common share 1,866,560 1,922,444 1,931,984 Add: Dilutive effects of assumed exercises of stock options 264 121 - ------------------------------------------ Average shares and dilutive potential of common shares outstanding 1,866,824 1,922,565 1,931,984 ========================================== Diluted earnings per common share $ .55 $ 1.43 $ 1.75 ==========================================
FS-10 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE C -- SECURITIES Year end investment securities were as follows (in thousands):
GROSS GROSS FAIR UNREALIZED UNREALIZED AVAILABLE FOR SALE, 2002 VALUE GAINS LOSSES ------------------------------------------ U.S. Treasury and Government agencies $ 16,103 $ 401 $ - States and political subdivisions 27,505 722 (5) Corporate securities 3,288 70 - Mortgage-backed securities 532 13 - ------------------------------------------ Total debt securities 47,428 1,206 (5) Equity securities 1,383 - - ------------------------------------------ TOTAL $ 48,811 $ 1,206 $ (5) =========================================== GROSS GROSS FAIR UNREALIZED UNREALIZED AVAILABLE FOR SALE, 2001 VALUE GAINS LOSSES --------------------------------------- U.S. Treasury and Government agencies $ 21,476 $ 324 $ (4) States and political subdivisions 30,322 293 (69) Corporate securities 4,445 35 - Mortgage-backed securities 1,495 22 - ------------------------------------------ Total debt securities 57,738 674 (73) Equity securities 3,793 4 - ------------------------------------------ Total $ 61,531 $ 678 $ (73) ===========================================
Included above for 2001, are $4,033,000 in floating rate securities that are putable on a weekly basis. Sales of available for sale securities were (in thousands):
2002 2001 2000 ------------------------------------------ Proceeds $ 254 $ 12,559 $ 997 Gross gains 4 573 1 Gross losses - (44) (4)
Contractual maturities of debt securities at year-end 2002 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.
FAIR VALUE ----------- Due in one year or less $ 7,581 Due from one to five years 33,188 Due from five to ten years 4,191 Due after ten years 1,936 Mortgage-backed securities 532 ----------- $ 47,428 ===========
Securities with a carrying value of $8,072,000 and $13,047,000 were pledged as collateral for public deposits and for other purposes in 2002 and 2001. FS-11 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE C -- SECURITIES (CONTINUED) Except as indicated, total securities of any state (including all its political subdivisions) were less than 10% of shareholders' equity. At year-end 2002 and 2001, the market value of securities issued by the state of Michigan and all its political subdivisions totaled $10,358,000 and $10,563,000, respectively. NOTE D -- LOANS Loans at year-end were as follows (in thousands):
2002 2001 --------------------------- Commercial $ 152,500 $ 130,903 Consumer 15,548 22,118 Real estate mortgage 66,118 57,651 --------------------------- 234,166 210,672 Less allowance for loan losses (3,512) (2,065) --------------------------- LOANS, NET $ 230,654 $ 208,607 ===========================
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. Other changes include adjustments for loans applicable to one reporting period that are excludable from the other reporting period.
2002 2001 --------------------------- Balance at January 1 $ 3,812 $ 4,113 New loans, including renewals 6,736 6,294 Repayments (6,401) (6,341) Other changes, net 326 (254) --------------------------- BALANCE AT DECEMBER 31 $ 4,473 $ 3,812 ===========================
The unpaid principal balance of mortgage loans serviced for others, which are not included on the consolidated balance sheet, was $24,928,000 and $46,690,000 at December 31, 2002 and 2001, respectively. Activity for capitalized mortgage servicing rights was as follows (in thousands):
2002 2001 2000 ------------------------------------------ Balance at January 1 $ 424 $ 780 $ 796 Additions - - 184 Amortized to expense (255) (356) (200) ------------------------------------------ BALANCE AT DECEMBER 31 $ 169 $ 424 $ 780 ==========================================
No valuation allowance for capitalized mortgage servicing rights was necessary at December 31, 2002, 2001 or 2000. FS-12 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE E -- ALLOWANCES FOR LOAN LOSSES Changes in the allowance for loan losses for the years ended December 31 were as follows (in thousands):
2002 2001 2000 ------------------------------------------ Balance at January 1 $ 2,065 $ 2,096 $ 2,132 Provision for loan losses 2,671 1,250 700 Loans charged off (1,704) (1,765) (942) Recoveries 480 484 206 ------------------------------------------ Net charge-offs (1,224) (1,281) (736) ------------------------------------------ BALANCE AT DECEMBER 31 $ 3,512 $ 2,065 $ 2,096 ==========================================
2002 2001 --------------------------- Information regarding impaired loans follows (in thousands): Year end loans with allowance for loan losses allocated $ 5,381 $ 3,405 Year end loans with no allowance for loan losses allocated 4,092 1,102 --------------------------- Total impaired loans $ 9,473 $ 4,507 =========================== Amount of allowance allocated to these loans $ 1,404 $ 845 =========================== 2002 2001 2000 ------------------------------------------ Average balance of impaired loans during the year $ 11,059 $ 5,950 $ 3,121 Cash basis interest income recognized during the year $ 319 $ 267 $ 275 Interest income recognized during the year $ 319 $ 233 $ 257
Nonperforming loans were as follows (in thousands):
2002 2001 --------------------------- Loans past due over 90 days still on accrual $ 171 $ 769 Nonaccrual loans 3,798 1,937
Nonperforming loans and impaired loans are defined differently. Some loans may be included in both categories, whereas other loans may only be included in one category. NOTE F -- PREMISES AND EQUIPMENT, NET Premises and equipment, net consist of (in thousands):
2002 2001 --------------------------- Land $ 793 $ 786 Buildings and improvements 8,900 8,897 Equipment 5,007 4,907 --------------------------- 14,700 14,590 Less accumulated depreciation (7,563) (6,722) --------------------------- TOTALS $ 7,137 $ 7,868 ===========================
Depreciation and amortization expense charged to operations was approximately $918,000, $900,000 and $741,000 in 2002, 2001 and 2000, respectively. FS-13 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE F -- PREMISES AND EQUIPMENT, NET (CONTINUED) Equipment rental expense was $293,000, $322,000 and $310,000 for 2002, 2001 and 2000. Lease commitments under noncancelable operating equipment leases were as follows (in thousands): 2003 $ 103 2004 103 2005 103 2006 & after - ---------- TOTAL $ 309 ========== NOTE G -- GOODWILL AND INTANGIBLE ASSETS GOODWILL The change in the carrying amount of goodwill for the year is as follows (in thousands): Beginning of year $ 620 Goodwill from acquisition during year - ----------- END OF YEAR $ 620 =========== Goodwill is no longer amortized starting in 2002. The effect of not amortizing goodwill is summarized as follows (in thousands):
2002 2001 2000 ------------------------------------------ Reported net income $ 1,033 $ 2,744 $ 3,375 Add back: goodwill amortization, net of tax - 42 42 ------------------------------------------ ADJUSTED NET INCOME $ 1,033 $ 2,786 $ 3,417 ========================================== Basic earnings per share: Reported net income $ .55 $ 1.43 $ 1.75 Add back: goodwill amortization, net of tax - .02 .02 ----------------------------------------- Adjusted net income $ .55 $ 1.45 $ 1.77 ========================================= Diluted earnings per share: Reported net income $ .55 $ 1.43 $ 1.75 Add back: goodwill amortization, net of tax - .02 .02 ----------------------------------------- Adjusted net income $ .55 $ 1.45 $ 1.77 =========================================
ACQUIRED INTANGIBLE ASSETS Acquired intangible assets were as follows as of year end (in thousands):
DECEMBER 31, 2002 December 31, 2001 GROSS NET Gross Net CARRYING ACCUMULATED CARRYING Carrying Accumulated Carrying AMOUNT AMORTIZATION AMOUNT Amount Amortization Amount ---------------------------------------------------------------------------------- Amortized intangible assets: Core deposit intangibles $ 559 $ 409 $ 150 $ 559 $ 370 $ 189 ================================== =====================================
Aggregate amortization expense was $39,000, $131,000 and $56,000 for 2002, 2001 and 2000, respectively. Estimated amortization expense for each of the next five years (in thousands): 2003 $ 39 2004 39 2005 39 2006 33 2007 - --------- TOTAL $ 150 ========= FS-14 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE H -- DEPOSITS The carrying amount of domestic deposits at year-end follows (in thousands):
2002 2001 --------------------------- Non-interest bearing checking $ 42,462 $ 40,515 Interest bearing checking 46,276 40,640 Savings 34,978 33,129 Money market accounts 54,906 63,621 Time deposits 83,767 83,178 --------------------------- TOTALS $ 262,389 $ 261,083 ===========================
The carrying amount of time deposits over $100,000 was $32,674,000 and $26,027,000 at December 31, 2002 and 2001, respectively. Interest expense on time deposits over $100,000 was $776,000, $1,737,000 and $1,482,000 for the years ended December 31, 2002, 2001 and 2000, respectively. At year-end 2002, scheduled maturities of time deposits were as follows for the years ending December 31 (in thousands): 2003 $ 51,741 2004 14,099 2005 13,803 2006 2,214 2007 1,910 ----------- TOTALS $ 83,767 ===========
Related party deposits were $2,021,000 and $2,047,000 at December 31, 2002 and 2001, respectively. NOTE I -- OTHER BORROWINGS Other borrowings primarily represent advances obtained by the Bank from the Federal Home Loan Bank (FHLB) of Indianapolis and advances by the Company on a line of credit. $20,000,000 of the FHLB advances have interest rates ranging from 6.28% to 6.89% and have quarterly stated interest adjustment dates. On the stated interest adjustment dates, the FHLB will have the option to adjust the interest 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 adjust the interest rate. The remaining $1,000,000 FHLB advance is at a fixed rate of 4.57% with principal payments beginning in December of 2003 and continuing through December of 2013. 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 and SBA loans. Eligible FHLB mortgage and SBA loan collateral at December 31, 2002 and 2001 was approximately $52,018,000 and $43,436,000. At year-end 2002, scheduled principal reductions on these FHLB advances were as follows for the years ending December 31 (in thousands): 2003 $ 78 2004 10,088 2005 10,090 2006 94 2007 97 Thereafter 553 ----------- TOTAL FHLB ADVANCES $ 21,000 ===========
Other borrowings also includes a loan with Fifth Third Bank for the ESOP with a balance at December 31, 2002 and 2001 of $436,000 and $588,000. The loan does not have a formal repayment schedule, matures on April 30, 2003 and is unsecured. On February 22, 2002, the Company renewed a $4,000,000 revolving line of credit with LaSalle Bank, which matures on February 22, 2003 and is secured by the Bank's stock. At year end 2002, the balance was $1,170,000. The line allows the Company to choose its interest rate for each draw, based on the LaSalle Bank National Association prime rate or adjusted LIBOR. All advances outstanding on this line are based on adjusted LIBOR and have variable rates ranging from 3.525% to 3.570%. FS-15 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE J -- INCOME TAXES Income tax expense consists of (in thousands):
2002 2001 2000 ------------------------------------------ Current $ 731 $ 1,096 $ 1,100 Deferred (613) (221) 79 ------------------------------------------ TOTALS $ 118 $ 875 $ 1,179 ==========================================
Income tax expense calculated at the statutory federal income tax rate of 34% differs from actual income tax expense as follows (in thousands):
2002 2001 2000 ------------------------------------------ Income tax at statutory rates $ 391 $ 1,230 $ 1,548 Tax-exempt interest income, net (305) (267) (288) Increase in net cash surrender value of life insurance policies (97) (89) (87) Loss on viatical investment 28 - - Valuation allowance against capital loss 54 - - Low income housing partnership tax credit (25) - - Other items, net 72 1 6 ------------------------------------------ TOTALS $ 118 $ 875 $ 1,179 ==========================================
Year-end deferred tax assets and liabilities consist of (in thousands):
2002 2001 --------------------------- Deferred tax assets: Allowance for loan losses $ 914 $ 476 Deferred compensation and supplemental retirement liability 647 605 Intangible asset amortization 62 96 Pension liability 47 70 Write off of viatical investment 68 - Write down of other real estate 41 - Deferred loan fees 27 - Other 6 25 --------------------------- Subtotals 1,812 1,272 Valuation allowance against capital loss (54) - --------------------------- Totals 1,758 1,272 Deferred tax liabilities: Net unrealized appreciation on available for sale securities (408) (205) Mortgage servicing rights (57) (144) Other (29) (15) --------------------------- Totals (494) (364) --------------------------- NET DEFERRED TAX ASSET $ 1,264 $ 908 ===========================
An allowance against the net deferred tax asset was considered necessary at December 31, 2002 as the likelihood of receiving a tax benefit on a portion of the capital loss on the viatical investment is considered doubtful. FS-16 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE K -- BENEFIT 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. Assets held by the plan primarily include corporate and foreign bonds and common equity securities. Information about the pension plan was as follows (in thousands):
2002 2001 ---------------------------- Change in benefit obligation: Beginning benefit obligation $ (1,645) $ (1,510) Service cost (118) (120) Interest cost (105) (107) Actuarial (gain) loss from change in actuarial assumptions 263 3 Benefits paid 96 89 --------------------------- Ending benefit obligation $ (1,509) $ (1,645) =========================== Change in plan assets, at fair value: Beginning plan assets $ 1,479 $ 1,527 Actual return (115) (103) Employer contribution 186 144 Benefits paid (96) (89) --------------------------- Ending plan assets $ 1,454 $ 1,479 =========================== Net amount recognized: Funded status $ (55) $ (166) Unrecognized net actuarial gain (72) (30) Unrecognized transition obligation 5 6 Unrecognized prior service cost 12 12 --------------------------- Accrued pension cost $ (110) $ (178) ===========================
The components of pension expense and related actuarial assumptions were as follows (in thousands except ratio information):
2002 2001 2000 ------------------------------------------ Components of net periodic benefit cost: Service cost $ 118 $ 120 $ 113 Interest cost 105 107 99 Expected return on plan assets (104) (128) (137) Net amortization and deferral 16 - (6) ------------------------------------------ Net periodic benefit cost $ 135 $ 99 $ 69 ========================================== Discount rate on benefit obligation 7.0% 7.0% 7.0% Long-term expected rate of return on plan assets 7.5% 8.0% 8.0% Rate of compensation increase 3.0% 3.0% 3.0%
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 participants. Expense charged to operations for contributions to the plan totaled $86,000, $91,000 and $73,000 in 2002, 2001 and 2000. An additional contribution of $87,000 was made to the plan in 2002 to allow the plan to pay down the ESOP loan. During 2000, the Company amended its ESOP plan to adopt 401(k) provisions allowing for employee salary deferrals to purchase mutual funds. Company matching is provided in Company stock. Substantially all employees have converted their ESOP accounts to the amended plan. FS-17 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE K -- BENEFIT PLANS (CONTINUED) Shares held by the ESOP at year-end are as follows:
2002 2001 --------------------------- Allocated shares 104,841 98,549 Unallocated shares 10,115 15,400 --------------------------- TOTAL ESOP SHARES 114,956 113,949 ===========================
The fair value of the allocated shares held by the ESOP is approximately $1,618,000 and $1,523,000 at December 31, 2002 and 2001, respectively. The ESOP obtained a loan for $588,000 to purchase 15,400 shares. The balance of the loan at December 31, 2002 and 2001 is $436,000 and $588,000. 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. Current rates paid on deferred compensation balances range from 6.82% - 12.98%. Deferred compensation expense was $248,000, $204,000 and $216,000 in 2002, 2001 and 2000. The liability for vested benefits was $1,658,000 and $1,548,000 at December 31, 2002 and 2001, respectively. The Bank also maintains a supplemental retirement plan to provide annual payments to particular executives subsequent to their retirement. The plan covers two individuals, both of whom are retired. Liabilities associated with this plan totaled $244,000 and $232,000 at December 31, 2002 and 2001. Expense associated with this plan totaled $29,000, $27,000 and $26,000 in 2002, 2001 and 2000. NOTE L -- STOCK OPTIONS On April 17, 2000, the Company approved a Stock Option Plan to advance the interests of the Company and its shareholders by affording to directors, officers and other employees of the Company an opportunity to acquire or increase their proprietary interest in the Company using stock options. Option shares authorized under the plan total 110,000. Options are to be granted with an exercise period of 10 years or less, an exercise price of not less than the fair market value of the stock on the date the options are granted and a vesting period as determined by the Board of Directors. The plan will terminate on the earliest of: (i) March 20, 2010; (ii) when all shares have been issued through exercise of options granted under this Plan; or (iii) at any earlier time that the Board of Directors may determine. A total of 10,191 options were granted in 2001. FS-18 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE L -- STOCK OPTIONS (CONTINUED) A summary of the activity in the plan is as follows for the years ended December 31, 2002 and 2001.
2002 2001 ---- ---- WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE EXERCISE SHARES PRICE SHARES PRICE -------------------------------------------------------------- Outstanding at beginning of year 9,880 $ 15.32 - $ - Granted - - 10,191 15.32 Exercised - - - - Forfeited (4,788) 15.32 (311) 15.32 -------- -------- Outstanding at end of year 5,092 $ 15.32 9,880 $ 15.32 ========= ========= ========= ========= Options exercisable at year-end - - - - Weighted-average fair value of options granted during year $ - $ 2.55
Options outstanding at year-end 2002 were as follows:
OUTSTANDING EXERCISABLE ----------- ----------- WEIGHTED AVERAGE WEIGHTED REMAINING AVERAGE CONTRACTUAL EXERCISE RANGE OF EXERCISE PRICES NUMBER LIFE NUMBER PRICE ----------------------------------------------------------------------------------------------------- $15 - $16 5,092 8.33 YEARS - -
NOTE M -- 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. Accounting principles generally accepted in the United States of America 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, 2002 and 2001, respectively, the Bank had no commitments under commercial letters of credit, used to facilitate customers' trade transactions. 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, 2002 and 2001, respectively, commitments under outstanding standby letters of credit were $288,000 and $183,000. FS-19 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE M -- COMMITMENTS (CONTINUED) Loan commitments outstanding to extend credit are detailed below (in thousands):
2002 2001 --------------------------- Fixed rate $ 2,231 3,359 Variable rate 36,242 44,091 ---------------------------- TOTALS $ 38,473 $ 47,450 ============================
The fixed rate commitments have stated interest rates ranging from 4.75% to 9.875%. 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, 2002, the Company had line of credit agreements with LaSalle Bank and Fifth Third Bank totaling $4,000,000 and $6,250,000, respectively. The balances on these lines were $1,170,000 and $436,000 respectively, at December 31, 2002. The line of credit at LaSalle Bank is secured by the Bank's stock and matures on February 22, 2003. The line of credits at Fifth Third Bank is unsecured and matures on April 30, 2003. In addition, at December 31, 2002, the Bank had line of credit arrangements to be able to purchase federal funds totaling $17,000,000, subject to quarterly and annual reviews. The balance on these lines at December 31, 2002 was $5,000,000. Certain executives of the Bank have employment contracts which have change of control clauses. The employment contracts provide for the payment of three years worth of the officers' salaries upon a change of control. NOTE N -- RESTRICTIONS ON TRANSFERS FROM SUBSIDIARY Banking laws, regulations and regulatory agreements restrict the amount the Bank may transfer to the Company in the form of cash dividends, loans and advances. Approximately $1,700,000 of the Bank's retained earnings is available for transfer to the Company in 2003 in the form of dividends without prior regulatory approval. NOTE O -- SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION Condensed financial statements of Southern Michigan Bancorp, Inc. follow (in thousands):
Balance Sheets December 31, 2002 2001 --------------------------- ASSETS Cash $ 1 $ 2 Securities available for sale 1,675 1,708 Investment in subsidiary 25,591 24,594 Premises and equipment, net 1,122 1,078 Other 4 601 --------------------------- TOTAL ASSETS $ 28,393 27,983 =========================== LIABILITIES AND SHAREHOLDERS' EQUITY Dividends payable $ 299 $ 307 Other liabilities (3) 18 Other borrowings 1,606 588 Common stock subject to repurchase obligation in ESOP 1,618 1,523 Shareholders' equity 24,873 25,547 --------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 28,393 $ 27,983 ===========================
FS-20 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE O -- SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION (CONTINUED)
Statements of Income Year ended December 31, 2002 2001 2000 ------------------------------------------ Dividends from Bank $ 620 $ 457 $ 1,415 Interest income 67 105 151 Other income 231 240 249 Loss on viatical settlement contracts (283) - - Other expenses (195) (177) (500) ------------------------------------------- 440 625 1,315 Federal income tax (expense) benefit (15) (31) 71 ------------------------------------------ 425 594 1,386 Equity in undistributed net income of Subsidiary Bank 608 2,150 1,989 ------------------------------------------ NET INCOME 1,033 2,744 3,375 Net change in unrealized gains on securities available for sale, net of tax 393 215 574 ------------------------------------------ Other comprehensive income 393 215 574 ------------------------------------------ COMPREHENSIVE INCOME $ 1,426 $ 2,959 $ 3,949 ========================================== Statements of Cash Flows Year ended December 31, 2002 2001 2000 ------------------------------------------ OPERATING ACTIVITIES Net income $ 1,033 $ 2,744 $ 3,375 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of Subsidiary Bank (608) (2,150) (1,989) Depreciation 34 31 34 Net amortization of investment securities 5 10 22 Net realized gain on disposal of fixed assets - - (150) Reduction of obligation under ESOP 65 - - Net securities gains (4) - - Loss on viatical settlement contracts 283 - - Other 321 (279) 329 ------------------------------------------ Net cash from operating activities 1,129 356 1,621 INVESTING ACTIVITIES Activity in available-for-sale securities: Proceeds from sales 254 - 799 Proceeds from maturities and calls 251 1,757 516 Purchases (467) (510) (986) Proceeds from sale of premises and equipment - - 204 Additions to premises and equipment (78) - (1) ------------------------------------------- Net cash from investing activities (40) 1,247 532 FINANCING ACTIVITIES Proceeds from other borrowings 1,170 - - Repayments of other borrowings (152) - - Cash dividends paid (1,203) (1,204) (1,369) Repurchase of common stock (905) (398) (880) ------------------------------------------- Net cash from financing activities (1,090) (1,602) (2,249) ------------------------------------------- NET CHANGE IN CASH AND CASH EQUIVALENTS (1) 1 (96) Beginning cash and cash equivalents 2 1 97 ------------------------------------------ ENDING CASH AND CASH EQUIVALENTS $ 1 $ 2 $ 1 ==========================================
FS-21 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE P -- 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 amount reported in the balance sheet approximates fair value. SECURITIES AVAILABLE FOR SALE: Fair values for securities available for sale 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 AND LOANS HELD FOR SALE: 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. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. ACCRUED INTEREST RECEIVABLE: The carrying amount reported in the balance sheet approximates fair value. NET CASH SURRENDER VALUE OF LIFE INSURANCE: The carrying amount reported in the balance sheet approximates fair value. MORTGAGE SERVICING RIGHTS: The carrying amount reported in the balance sheet approximates fair value. OFF-BALANCE-SHEET INSTRUMENTS: The estimated fair value of off-balance sheet instruments is based on current fees or costs that would be charged to enter or terminate the arrangements. The estimated fair value is not considered to be significant for this presentation. 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. FEDERAL FUNDS PURCHASED: The carrying amount reported in the balance sheet approximates fair value. 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. ACCRUED INTEREST PAYABLE: The carrying amount reported in the balance sheet approximates fair value. 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, 2002 and 2001, 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, 2002 and 2001 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. FS-22 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE P -- FAIR VALUE INFORMATION (CONTINUED) The estimated fair values of the Company's financial instruments at year end are as follows (in thousands):
2002 2001 --------------------------- --------------------------- CARRYING FAIR Carrying Fair AMOUNT VALUE Amount Value --------------------------- --------------------------- Financial assets: Cash and cash equivalents $ 19,287 $ 19,287 $ 23,432 $ 23,432 Securities available for sale 48,811 48,811 61,531 61,531 Loans held for sale 1,083 1,083 1,863 1,863 Loans, net of allowance for loan losses 230,654 233,570 208,607 210,916 Accrued interest receivable 2,118 2,118 2,310 2,310 Net cash surrender value of life insurance 6,472 6,472 5,732 5,732 Mortgage servicing rights 169 169 424 424 Financial liabilities: Deposits $ (262,389) $ (264,041) $ (261,083) $ (262,711) Federal funds purchased (5,000) (5,000) - - Other borrowings (22,606) (23,728) (24,588) (25,927) Accrued interest payable (166) (166) (223) (223)
NOTE Q -- 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. 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 only 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:
MINIMUM REQUIRED TO BE MINIMUM REQUIRED WELL CAPITALIZED FOR CAPITAL UNDER PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS ----------------------- ------------------------- ------------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ----------------------- ------------------------- ------------------------ 2002 TOTAL CAPITAL (TO RISK WEIGHTED ASSETS) CONSOLIDATED $27,952 11.5% $19,419 8.0% $24,273 10.0% BANK 27,067 11.2 19,296 8.0 24,120 10.0 TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS) CONSOLIDATED 24,912 10.3 9,710 4.0 14,564 6.0 BANK 24,042 10.0 9,648 4.0 14,472 6.0 TIER 1 CAPITAL (TO AVERAGE ASSETS) CONSOLIDATED 24,912 7.8 12,799 4.0 15,999 5.0 BANK 24,042 7.5 12,754 4.0 15,943 5.0
FS-23 SOUTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE Q -- REGULATORY MATTERS (CONTINUED)
Minimum Required To Be Minimum Required Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Regulations ----------------------- ------------------------- ------------------------ Amount Ratio Amount Ratio Amount Ratio ----------------------- ------------------------- ------------------------ 2001 Total capital (to risk weighted assets) Consolidated $27,884 12.0% $18,556 8.0% $23,195 10.0% Bank 25,435 11.1 18,420 8.0 23,024 10.0 Tier 1 capital (to risk weighted assets) Consolidated 25,819 11.1 9,278 4.0 13,917 6.0 Bank 23,370 10.2 9,210 4.0 13,815 6.0 Tier 1 capital (to average assets) Consolidated 25,819 8.3 12,520 4.0 15,651 5.0 Bank 23,370 7.6 12,380 4.0 15,475 5.0
Both the Company and the Bank, at year-end 2002 and 2001, were categorized as well capitalized. At December 31, 2002 the Bank had a tier 1 capital to average asset ratio of 7.5%. On February 17, 2003, the Bank entered into an agreement with its banking regulators that requires the Bank to maintain this ratio at a level at or above 7%. In addition, under this agreement, the Bank will establish and monitor certain lending and operational policies and procedures. NOTE R -- QUARTERLY FINANCIAL DATA (UNAUDITED)
EARNINGS (LOSS) PER SHARE INTEREST NET INTEREST NET ------------------------- INCOME INCOME INCOME (LOSS) BASIC FULLY DILUTED ------------------------------------------------------------------------ 2002 FIRST QUARTER $ 4,734 $ 3,081 $ 563 $ .30 $ .30 SECOND QUARTER 4,767 3,176 342 .18 .18 THIRD QUARTER 4,599 3,049 (118) (.06) (.06) FOURTH QUARTER 4,654 3,001 246 .13 .13 2001 First Quarter $ 5,738 $ 2,974 $ 674 $ .35 $ .35 Second Quarter 5,508 2,904 656 .34 .34 Third Quarter 5,449 3,109 722 .37 .37 Fourth Quarter 5,029 3,092 692 .37 .37
The net income for the second quarter of 2002 was negatively affected by provisions for loan losses in excess of the prior year by $150,000 and a $283,000 loss on viatical settlement contracts, as a result of new information learned about the ability of the company servicing the policies to have sufficient funds to pay continuing premiums necessary to keep the policies in force. The net income for the third quarter of 2002 was negatively affected by provisions for loan losses in excess of the prior year by $1,175,000. The net income for the fourth quarter of 2002 was negatively affected by provisions for loan losses in excess of the prior year by $196,000 and by adjustments to certain accruals. FS-24 SELECTED FINANCIAL DATA
Year Ended December 31 2002 2001 2000 1999 1998 ---------------------------------------------------------------------------- Total interest income $ 18,754 $ 21,724 $ 23,245 $ 20,051 $ 19,446 Net interest income 12,307 12,079 12,548 11,616 11,414 Provision for loan losses 2,671 1,250 700 852 600 Net income 1,033 2,744 3,375 3,300 3,549 Per share data: Basic and diluted earnings per share .55 1.43 1.75 1.64 1.70 Cash dividends .64 .61 .70 .68 .60 Balance sheet data: Gross loans 234,166 210,672 213,381 192,380 162,645 Deposits 262,389 261,083 245,430 233,303 233,361 Other borrowings 22,606 24,588 25,588 15,588 5,588 Common stock subject to repurchase 1,618 1,523 1,478 3,990 6,029 Equity 24,873 25,547 24,211 19,990 19,345 Total assets 320,683 317,096 303,639 275,825 266,851 Return on average assets .33% .90% 1.16% 1.23% 1.42% Return on average equity (1) 4.04 10.47 15.13 16.37 17.48 Dividend payout ratio (2) 115.68 43.00 40.30 41.61 35.56 Average equity to average assets (1) 8.09 8.59 7.69 7.52 8.11
All per share amounts have been adjusted for a 10% stock dividend declared in 1999. (1) Average equity used in the above table excludes common stock subject to repurchase obligation but includes average unrealized appreciation or depreciation on securities available for sale. (2) Dividends declared divided by net income. 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 546 shareholders of record at February 14, 2003. 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:
2002 2001 ------------------------------------------ ------------------------------------------ BID PRICE CASH Bid Price Cash ------------------------- DIVIDENDS ------------------------ Dividends HIGH BID LOW BID DECLARED High Bid Low Bid Declared Quarter Ended - ------------------------------------------------------------------------------------------------------------------------ March 31 $ 16.25 $ 15.80 $ .16 $ 16.75 $ 14.50 $ .15 June 30 16.39 16.00 .16 17.00 15.51 .15 September 30 16.20 15.70 .16 17.30 15.16 .15 December 31 15.89 15.20 .16 16.40 15.45 .16
There are restrictions that currently limit the Company's ability to pay cash dividends. Information regarding dividend payment restrictions is described in Note N to the consolidated financial statements for the year ended December 31, 2002. FS-25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTHERN MICHIGAN BANCORP, INC. Dated: March 26, 2003 By: /s/ John H. Castle ------------------------------- John H. Castle Its: Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Marcia S. Albright /s/ Nolan E. Hooker - --------------------------------- -------------------------------------- Marcia S. Albright, Director Nolan E. Hooker, Director /s/ James P. Briskey /s/ Gregory J. Hull - --------------------------------- -------------------------------------- James P. Briskey, Director Gregory J. Hull, Director /s/ John H. Castle /s/ Thomas E. Kolassa - --------------------------------- -------------------------------------- John H. Castle, Director Thomas E. Kolassa, Director /s/ H. Kenneth Cole /s/ Kurt G. Miller - --------------------------------- -------------------------------------- H. Kenneth Cole, Director Kurt G. Miller, Director /s/ William E. Galliers /s/ Freeman E. Riddle - --------------------------------- -------------------------------------- William E. Galliers, Director Freeman E. Riddle, Director Dated: March 26, 2003 S-1 CERTIFICATIONS I, John H. Castle, certify that: 1. I have reviewed this annual report on Form 10-K of Southern Michigan Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and S-2 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 26, 2003 /s/ John H. Castle -------------------------------------------- John H. Castle, Chief Executive Officer and Director (Principal Executive Officer) I, Danice Chartrand, certify that: 1. I have reviewed this annual report on Form 10-K of Southern Michigan Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and S-3 report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 26, 2003 /s/ Danice Chartrand ---------------------------------------------- Danice Chartrand, Chief Financial Officer (Principal Financial Officer) S-4 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 INDEX TO EXHIBITS EXHIBITS SOUTHERN MICHIGAN BANCORP, INC. (A MICHIGAN CORPORATION) 51 WEST PEARL STREET COLDWATER, MICHIGAN 49036 INDEX TO EXHIBITS
Exhibit No. Description of Exhibit ----------- ---------------------- Exhibit 2 Not applicable. Exhibit 3.1 Articles of Incorporation incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 and Exhibit 3 to Form S-3D filed April 30, 1998, File No. 2-78178. Exhibit 3.2 Amended and Restated By-Laws are incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, File No. 2-78178. Exhibit 4 Instruments Defining the Rights of Security Holders of the Company are the Articles of Incorporation and By-Laws (see Exhibits 3.1 and 3.2 above). Exhibit 9 Not applicable. Exhibit 10.1 Material Contracts -- Executive Compensation Plans and Arrangements: (1) Master Agreements for Directors' Deferred Income Plan; (2) Composite form of Executive Employee Salary Continuation Agreement, as amended; and (3) Master Agreements for Executives' Deferred Compensation Plan, as amended, are incorporated by reference to Exhibit 10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, File No. 2-78178. Exhibit 10.2 Southern Michigan Bancorp, Inc. 2000 Stock Option Plan is incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 2-78178. Exhibit 10.3 Employment Agreement dated January 1, 2002 by and between the Bank and the Company and James T. Grohalski is incorporated by reference to Exhibit 10(C) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, File No. 2-78178. Exhibit 10.4 Employment Agreement dated June 7, 2002 by and between the Bank and the Company and John H. Castle. Exhibit 10.5 Standard Form of Executive's Deferred Compensation Agreement. Exhibit 11 Not applicable.
E-1
Exhibit No. Description of Exhibit ----------- ---------------------- Exhibit 12 Not applicable. Exhibit 13 Not applicable. Exhibit 16 Not applicable. Exhibit 18 Not applicable. Exhibit 21 Subsidiaries of the Company. Exhibit 22 Not applicable. Exhibit 23 Consent of Independent Auditors. Exhibit 24 Not applicable. Exhibit 27 Not applicable. Exhibit 99.1 Certification of the Company's Chief Executive Officer, John H. Castle, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2 Certification of the Company's Chief Financial Officer, Danice Chartrand, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
E-2 EX-10.4 3 k74384exv10w4.txt EMPLOYMENT AGREEMENT EXHIBIT 10.4 EMPLOYMENT AGREEMENT This Agreement is made this 7th day of June, 2002, by and between Southern Michigan Bancorp, Inc., a Michigan corporation, (the "Corporation") and, John H. Castle (the "Employee"). WHEREAS, the Board of Directors of the Corporation believes that the future services of the Employee in the capacity of President and Chief Executive Officer will be of great value to the Corporation; WHEREAS, the Corporation operates a wholly owned commercial banking subsidiary known as Southern Michigan Bank & Trust which is engaged in the general business of banking, hereinafter the "Bank"; and WHEREAS, the Employee is willing to serve in the employ of the Corporation and the Bank on a full-time basis for the term of this Agreement. NOW, THEREFORE, in consideration of the premises and the mutual covenants herein set forth, the parties hereto have agreed and do hereby mutually agree as follows: 1. Term -- Agreement to Serve The Corporation hereby employs for itself, the Bank and or any additional subsidiaries (hereinafter sometimes collectively referred to as the "Corporation"), the services of Employee for a period commencing as of the date first written above and terminating December 31, 2004 (the "Termination Date"), subject to the rights of earlier termination hereinafter set forth, to perform the duties of President and Chief Executive Officer for the Corporation and the Bank. The Employee hereby accepts such employment in consideration of the compensation and the other terms and conditions herein provided, and agrees to serve the Corporation well and faithfully and to devote his best efforts to such employment as long as it shall continue hereunder. During the period of such employment, the Employee will devote all of his time and attention -- reasonable vacations, periods of illness and the like excepted -- to the affairs of the Corporation. 2. Base Salary and Fringe Benefits Except as otherwise provided herein, as compensation for these services hereunder, the Corporation will pay to Employee, in installments and on dates in accordance with its normal payroll, during the period of his employment hereunder, a base salary at the aggregate rate of one hundred fifty thousand dollars ($150,000) per year, subject to the right of the parties, by mutual agreement, to adjust such rate upward in respect of any future calendar year or years after the date hereof, (hereinafter referred to as "Base Pay"). In addition the Corporation shall: E-3 (a) Provide four (4) weeks paid vacation annually. (b) Reimburse fees and expenses incurred in connection with business of the Corporation or the Bank including fees for attendance at banking related conventions and similar items approved by the Board of Directors. (c) Provide an executive automobile and pay for the insurance, maintenance and gasoline utilized by Employee. (d) Provide a membership to Coldwater Country Club, and such other clubs as agreed to by the parties from time to time, and pay for all dues, fees and assessments. 3. Bonus and Options (a) Subject to the rules and regulations applicable thereto, the Corporation shall provide for Employee's participation in any option, incentive employee benefit plans or compensation programs administered by the Corporation or the Bank or under its direction, including any employee bonus plans as may presently exist or are to be placed into effect after the date hereof. (b) Corporation shall negotiate in good faith an Incentive Bonus Plan applicable to Employee and other key officers of the Corporation, effective as of calendar year 2002. 4. Termination of Employment The employment of the Employee under the terms of this Agreement shall cease and terminate as follows: (a) Expiration of Term On the Termination Date; or, (b) Death On the date of his death; or, (c) Termination by the Corporation with Cause For Cause at any time by action of the Board. For purposes hereof, the term "Cause" shall mean removal by order of a regulatory agency having jurisdiction over the Corporation or the Bank, or the Employee's willful and repeated failure to perform his duties under this Employment Agreement, which failure has not been cured within thirty (30) days after the Corporation gives notice thereof to the Employee; it being expressly understood that negligence or bad judgment shall not constitute "Cause" so long as such act or omission shall be without intent of E-4 personal profit and is reasonably believed by the Employee to be in or not adverse to the best interests of the Corporation; or, (d) Disability Upon receipt by the Employee of written notice from the Corporation that, in its opinion, based on reliable medical evidence, the Employee is unable by reason of permanent physical or mental disability to continue the proper performance of his duties hereunder. For purposes of this Employment Agreement, the Employee's "permanent disability" shall be deemed to have occurred after one hundred eighty (180) consecutive days, during which one hundred eighty (180) days the Employee, by reason of his physical or mental disability or illness, shall have been unable to discharge his duties under this Employment Agreement. The date of permanent disability shall be such one hundred eightieth (180th) day. In the event either the Corporation or the Employee, after receipt of notice of the Employee's permanent disability from the other, dispute that the Employee's permanent disability shall have occurred, the Employee shall promptly submit to physical examinations by three physicians in the Coldwater, Michigan, area and, unless two of such physicians shall issue their written statement to the effect that in their opinion, based on their diagnosis, the Employee is capable of resuming his employment and devoting his full time and energy to discharging his duties within sixty (60) days after the date of such statement, such permanent disability shall be deemed to have occurred; or, (e) Termination by the Corporation without Cause At the election of the Corporation, at any time during the term of this Agreement without cause. (f) Termination in Connection with a Change in Control. i) A "Change in Control" shall result if, and shall be deemed to have occurred on the date of, a transaction pursuant to which: (a) Any person or group (as such terms are used in connection with Sections 13(d) and 14(d) of the Exchange Act) becomes the "beneficial owner" (as defined in Rule 13(d)(3) and 13(d)(5) under the Exchange Act), directly or indirectly, of securities of the Corporation representing 50% or more of the combined voting power of the Corporation's then outstanding securities; (b) A merger, consolidation, sale of assets, reorganization, or proxy contest is consummated and, as a consequence of which, members of the Board in office immediately prior to such transaction or event constitute less than a majority of the Board thereafter; E-5 (c) During any period of 24 consecutive months, individuals who at the beginning of such period constitute the Board (including for this purpose any new director whose election or nomination for election by the Corporation's stockholders was approved by a vote of at least one-half of the directors then still in office who were directors at the beginning of such period) cease for any reason to constitute at least a majority of the Board; or (d) A merger, consolidation or reorganization is consummated with any other corporation pursuant to which the shareholders of the Corporation immediately prior to the merger, consolidation or reorganization do not immediately thereafter directly or indirectly own more than fifty percent (50%) of the combined voting power of the voting securities entitled to vote in the election of directors of the merged, consolidated or reorganized entity. Notwithstanding the foregoing, no trust department or designated fiduciary or other trustee of such trust department of the Corporation or a subsidiary of the Corporation, or other similar fiduciary capacity of the Corporation with direct voting control of the stock shall be treated as a person or group within the meaning of subsection (i)(a) hereof. Further, no profit-sharing, employee stock ownership, employee stock purchase and savings, employee pension, or other employee benefit plan of the Corporation or any of its subsidiaries, and no trustee of any such plan in its capacity as such trustee, shall be treated as a person or group within the meaning of subsection (i)(a) hereof. ii) If during the term of this Agreement and after the date of a Change in Control, Employee is discharged without Cause or Employee resigns because he has: (1) been demoted, (2) had his compensation reduced, (3) had his principal place of employment transferred away from Branch County, Michigan or a county contiguous thereto, or (4) had his job title, status or responsibility materially reduced, then the Corporation shall make the payments to Employee set forth in subsection (iv) of this Section (f). iii) If Employee is discharged by the Corporation other than for Cause and there is a Change in Control within twelve (12) months following the discharge, then the Corporation shall make the payments to Employee set forth in subsection (iv) of this Section (f). iv) In the event of the termination of Employee's employment as described in subSection (ii) or (iii) above, Employee shall be entitled to receive: (1) a cash payment equal to 2.99 times his Compensation (as defined below), or (2) upon Employee's election, 2.99 times his Compensation payable in equal monthly payments, in cash, without interest. The lump sum cash payment or the first monthly cash payment, as the case may be, shall be paid at the end of the first month commencing after the Employee's termination of employment in the case of a benefit entitlement under subsection (ii) or (iii) above, and in the event of the election by Employee to receive monthly payments, shall continue each consecutive month thereafter until 36 payments have been made; provided that more than 90 days before a Change in Control, Employee E-6 may elect to defer the commencement date of payments (whether lump sum or monthly) by a period of three years, in which case interest shall accrue on unpaid balances at 120% of the applicable federal rate through the date of the payment of such lump sum, or commencement of payments, as the case may be. In the event Employee dies before collecting all amounts and benefits due under this Section, any payments owing shall be paid to the person or persons as stated in the last designation of beneficiary concerning this Agreement signed by Employee and filed with the Corporation, and if not, then to the personal representative of the Employee. The payments and benefits provided for in this Section 4(f) are in lieu of compensation, benefits or amounts the Employee might otherwise be entitled to under the Corporation's severance policy or otherwise payable by the Corporation by reason of termination of employment. The term "Compensation," as used in this section, shall mean the average of the sum of Employee's base salary plus any cash bonuses for the last three complete calendar years preceding Employee's termination of employment. Compensation shall not include any amount, other than base salary and cash bonuses, included in Employee's taxable compensation for federal income tax purposes and reported to Employee and the Internal Revenue Service ("IRS"), such as the reporting of previously deferred compensation or gain realized upon exercise of any non qualified stock options. v) In the event the payments required under this Agreement, when added together with any other amounts required to be included by Employee under the provisions of the Internal Revenue Code of 1986, as amended, result in an "Excess Parachute Payment," as that term is defined in Section 280G of the Code, then the amount of the payments provided for in this agreement shall be reduced to that amount which causes no excise tax to be imposed under Section 4999 (or any successor thereto) of the Code. vi) Any subsequent employment by Employee shall not reduce the obligation of the Corporation to make the full payments and provide the full benefits specified herein and Employee shall have no obligation to seek other employment or otherwise mitigate the effect of his discharge from employment. (g) Payments Upon Termination other than Change in Control. Upon termination of employment of the Employee pursuant to Section 4(b),(c) or (d) above, the Employee shall be entitled to receive the amount of Base Pay and Benefits provided for in Paragraphs 2 and 3 hereof through the date of his termination of employment. In the event of the termination of employment of Employee pursuant to Sections 4(a) or (e) above, the Corporation shall pay to the Employee his Base Pay and other benefits listed in Paragraphs 2 and 3 until the later of December 31, 2004 or One (1) year after the Termination Date. E-7 5. Right to Other Benefits. Except as otherwise specified herein, nothing in this Agreement shall abridge, eliminate, or cause Employee to lose Employee's right or entitlement to any other Corporation benefit to which Employee may be entitled due to his status as an employee under any plan or policy of Corporation on such terms and conditions as are required of any employee under any plan or policy of Corporation. Further, nothing in this Agreement shall create in Employee any greater rights or entitlements, except as specified in this Agreement. The plans and policies referred to in this Paragraph 5 include, but are not limited to, life insurance plans, dental, disability or health insurance benefits, severance policies, club memberships, and accrued vacation pay. 6. Noncompetition and Nonsolicitation Agreement and Business Protection. Notwithstanding anything to the contrary contained elsewhere in this Agreement: (a) Noncompetition Agreement and Nonsolicitation Agreement (i) In view of Employee's importance to the success of the Corporation, Employee and Corporation agree that the Corporation would likely suffer significant harm from Employee's competing with Corporation during Employee's term of employment with Corporation and for some period of time thereafter. Accordingly, Employee agrees that Employee shall not engage in competitive activities while employed by Corporation and during the Restricted Period. Employee shall be deemed to engage in competitive activities if he shall, without the prior written consent of the Corporation, (i) in Branch County, Michigan, and counties contiguous thereto (including the municipalities therein), render services directly or indirectly, as an employee, officer, director, consultant, advisor, partner or otherwise, for any organization or enterprise which competes directly or indirectly with the business of Corporation or any of its affiliates in providing financial products or services (including, without limitation, banking, insurance, or securities products or services) to consumers and businesses, or (ii) directly or indirectly acquires any financial or beneficial interest in (except as provided in the next sentence) any organization which conducts or is otherwise engaged in a business or enterprise in Branch County, Michigan, and counties contiguous thereto (including all municipalities) which competes directly or indirectly with the business of Corporation or any of its affiliates in providing financial products or services (including, without limitation, banking, insurance or securities products or services) to consumers and businesses. Notwithstanding the preceding sentence, Employee shall not be prohibited from owning less that 1 percent of any publicly traded corporation, whether or not such corporation is in competition with Corporation. For purposes of this Paragraph 6 the term "Restricted Period" shall equal One (1) year, commencing as of the date of Employee's termination. E-8 (ii) While employed by Corporation and for a period of One (1) year following Employee's termination of employment with Corporation, Employee agrees that Employee shall not, in any manner directly (i) solicit by mail, by telephone, by personal meeting, or by any other means, any customer or prospective customer of Corporation to whom Employee provided services, or for whom Employee transacted business, or whose identity become known to Employee in connection with Employee's services to Corporation (including employment with or services to any predecessor or successor entities), to transact business with a person or an entity other than the Corporation or its affiliates or reduce or refrain from doing any business with the Corporation or its affiliates or (ii) interfere with or damage (or attempt to interfere with or damage) any relationship between Corporation or its affiliates and any such customer or prospective customer. The term "solicit" as used in this Agreement means any communication of any kind whatsoever, inviting, encouraging or requesting any person to take or refrain from taking any action with respect to the business of Corporation and its subsidiaries. (iii) While employed by Corporation and for a period of One (1) year following Employee's termination of employment with Corporation, Employee agrees that Employee shall not, in any manner directly solicit any person who is an employee of Corporation or any of its affiliates to apply for or accept employment or a business opportunity with any other person or entity. (iv) The parties agree that nothing herein shall be construed to limit or negate the common law of torts or trade secrets where it provides broader protection than that provided herein. (v) Notwithstanding the foregoing, this Section 6(a) shall not apply in the event of termination pursuant to Section 4(f). (b). Confidential Information Employee has obtained and may obtain confidential information concerning the businesses, operations, financial affairs, organizational and personnel matters, policies, procedures and other non-public matters of Corporation and its affiliates, and those of third-parties that is not generally disclosed to persons not employed by Corporation or its subsidiaries. Such information (referred to herein as the "Confidential Information") may have been or may be provided in written form or orally. Employee shall not disclose to any other person the Confidential Information at any time during his employment with Corporation or after the termination of his employment, provided that Employee may disclose such Confidential Information only to a person who is then a director, officer, employee, partner, attorney or agent of Corporation who, in Employee's reasonable good faith judgment, has a need to know the Confidential Information. E-9 (c) Remedies (i) Employee acknowledges that a violation on Employee's part of this Paragraph 6 would cause immeasurable and irreparable damage to Corporation. Accordingly, Employee agrees that notwithstanding Paragraph 13 hereof, Corporation shall be entitled to injunctive relief in any court of competent jurisdiction for any actual or threatened violation of any of the provisions of this Paragraph 6, in addition to any other remedies it may have. (ii) In addition to Corporation's right to seek injunctive relief as set forth in subsection (i) above of this Section 6(c) in the event that Employee shall violate the terms and conditions of this Paragraph 6, Corporation may: (i) make a general claim for damages and (ii) terminate any payments or benefits payable by Corporation, if applicable, to Employee. 7. Inventions, Discoveries and Improvements The Employee hereby agrees to assign and transfer to the Corporation, its successors and assigns, his entire right, title and interest in and to any and all inventions, discoveries, trade secrets and improvements thereto which he may discover or develop, either solely or jointly with others, during his employment hereunder and for a period of one year after termination of such employment, which would relate in any way to the business of the Corporation or any parent, subsidiary or affiliate of the Corporation, together with all rights to letters patent, copyrights or trademarks which may be granted with respect thereto. Immediately upon making or developing any invention, discovery, trade secret or improvement thereto, Employee shall notify the Corporation thereof and shall execute and deliver to the Corporation, without further compensation, such documents as may be necessary to assign and transfer to the Corporation his entire right, title and interest in and to such invention, discovery, trade secret or improvement thereto, and to prepare or prosecute applications for letters patent with respect to the same in the name of the Corporation. 8. Confidential Information Employee shall not at any time, in any manner, while employed by the Corporation or thereafter, either directly or indirectly, except in the course of carrying out the Corporation's business or as previously authorized in writing on behalf of the Corporation, disclose or communicate to any person, firm, or corporation, any information of any kind concerning any matters affecting or relating to the Corporation's business or any of its data, figures, projections, estimates, customer lists, tax records, personnel histories, and accounting procedures of the Corporation, without regard to whether any or all of such information would otherwise be deemed confidential or material. E-10 9 Non-Assignability (a) Neither party to this Agreement shall have the right to assign this Agreement or any rights or obligations hereunder provided that nothing herein shall prevent the Employee from designating one or more members of his family or a trust or trusts for the members of his family as a beneficiary or beneficiaries entitled to receive payments hereunder as heretofore specified. (b) Except as provided above, no title to any payments which shall become due and payable to the Employee, his personal representative or designated beneficiary under the provisions hereof, shall be vested in him or any of them until the actual payment thereof is made to such person by the Corporation in accordance with the provisions of this Agreement. Neither he nor any of them shall have the right or power to transfer, assign, anticipate or encumber any interest in any such payment, prior to the actual receipt thereof from the Corporation. Neither this Agreement, the Corporation nor any person's rights hereunder shall be liable for the debt, contract or engagement of any of them. None of them shall be permitted to appoint any agent or attorney-in-fact and except as provided herein, to collect or receive his share of such payments or any part thereof unless permission to do so shall be specifically granted by the Corporation in writing. The Corporation, in the absence of such written permission, shall not in any manner recognize such appointment, transfer, assignment or encumbrance. (c) If the Employee or any personal representative or any designated beneficiary attempts to transfer, assign or encumber his interest in such payments, or any part thereof, prior to the payment or distribution thereof to him or her; or, if any transfer or seizure thereof is attempted to be made or brought through the operation of any bankruptcy or insolvency law, the right of the person taking such action or concerned therein or affected thereby, and who would, but for this provision, be entitled to receive such payments, or any part thereof, shall forthwith and ipso facto terminate, all rights bestowed on any such person being hereby, on the happening of any such event, expressly revoked; and the Corporation shall thereafter, in its absolute discretion, at such time or times as it deems proper, cause such part of such person's theretofore existing share of such payments to be paid to such person or persons, including the Employee, of any parent, spouse or child of said person, as the Corporation, in its uncontrolled discretion, shall deem advisable; and the remainder of such payments, if any, may be distributed by the Corporation to the person or person who would have been entitled to receive the same if such person had died immediately prior to said attempted transfer, assignment or encumbrance, or attempted transfer or seizure by operation of law. 10. Binding Effect This Agreement shall be binding upon and inure to the benefit of any successor of the Corporation, and any such successor shall be deemed substituted for the Corporation E-11 under the terms of this Agreement. As used in this Agreement, the term "successor" shall include any person, firm, corporation, or other business entity which, at any time, whether by merger, purchase, or otherwise, acquires all or substantially all of the assets or business of the Corporation. 11. Entire Agreement This Agreement contains the entire agreement of the parties hereto concerning the subject matter hereof, and cancels any and all other oral or written agreements or understandings between the parties with respect to the subject matter hereof, provided, however, that the provisions of the Second Addendum, other than paragraph 4 thereof, shall remain in full force and effect. The Agreement may not be changed orally, but only by agreement in writing signed by both parties. 12. Authorization for Acts of Corporation Any act, request, approval, consent or opinion of the Corporation hereunder shall be authorized, given or expressed by resolution of its Board of Directors. 13. Arbitration. Subject to the Corporation's right to seek injunctive relief under subsection 6(c)(i) of this Agreement, the parties hereto agree to arbitrate any issue, misunderstanding, disagreement or dispute in connection with the terms in effect in this Agreement in accordance with the Rules of the American Arbitration Association, before one arbitrator mutually agreeable to the parties. If either party determines that the parties have been unable to agree upon one arbitrator, then such party may appoint one arbitrator and require the other party to appoint a second arbitrator. Whereupon, the two appointed arbitrators shall appoint a third neutral arbitrator. If the arbitrators selected by the parties are unable or fail to agree upon the third arbitrator, the American Arbitration Association shall select the third arbitrator. Failure by a party to either (i) accept as mutually agreeable, or (ii) appoint an arbitrator, within 30 days of receipt of notice of the appointment of an arbitrator by the other party, shall be deemed as acceptance of arbitration by such single arbitrator. The arbitration shall occur in Coldwater, Michigan, or such other place as mutually agreed upon. The prevailing party shall be entitled to recover any and all costs associated with any arbitration proceeding (and any subsequent proceeding to enforce rights thereunder) including the recovery of reasonable attorneys fees. Judgement on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 14. Governing Law This Agreement is executed and delivered in the State of Michigan and is intended to be interpreted, construed and enforced in accordance with the laws of such State. E-12 IN WITNESS WHEREOF, the Corporation has caused this Agreement to be executed on its behalf by the Chairman of its Board of Directors, and the Employee has signed this Agreement, all as of the date and year first above written. Southern Michigan Bancorp, Inc. By: /s/James Morrison ----------------------------------- James Morrison, Chairman, Board of Directors /s/ John H. Castle ----------------------------------- John H. Castle, Employee E-13 EX-10.5 4 k74384exv10w5.txt EXECUTIVE DEFERRED COMPENSATION AGREEMENT EXHIBIT 10.5 SOUTHERN MICHIGAN BANK & TRUST DEFERRED COMPENSATION AGREEMENT THIS AGREEMENT is made this --- day of --------------- by and between SOUTHERN MICHIGAN BANK & TRUST (the "Company"), and ------------------------- (the "Executive"). INTRODUCTION To encourage its key employees to continue employment, the Company is willing to provide to the Executive's Deferred Compensation Plan (the "Plan"). The Executive is a Participant in the Plan. This Agreement between the Executive and the Company modifies the terms of the Executive's participation in the Plan, and replaces all benefits which otherwise were payable under the Plan. AGREEMENT The Executive and the Company agree as follows: ARTICLE 1 DEFINITIONS 1.1 Definitions. Whenever used in this Agreement, the following words and phrases shall have the meanings specified: 1.1.1 "Change of Control" means the transfer of 51% or more of the Company's outstanding voting common stock followed within twelve (12) months by the Executive's Termination of Employment for reasons other than death, disability or retirement. 1.1.2 "Code" means the Internal Revenue Code of 1986, as amended. References to a Code section shall be deemed to be to that section as it now exists and to any successor provision. 1.1.3 "Compensation" means the total amount base salary payable to the Executive. 1.1.4 "Disability" means, if the Executive is covered by a Company-sponsored disability insurance policy, total disability as defined in such policy without regard to any waiting period. If the Executive is not covered by such policy, Disability means the Executive suffering a sickness, accident or injury which, in the judgment of a physician satisfactory to the Company, prevents the Executive from performing substantially all of the Executive's normal duties for the Company. As a condition to any benefits, the Company may require the Executive to submit to such physical or mental evaluations and tests as the Company's Board of Directors deem appropriate. E-14 1.1.5 "Early Retirement Date" means the Executive attaining age 62 and completing 10 Years of Service. 1.1.6 "Election Form" means the Form attached as Exhibit 1. 1.1.7 "Normal Retirement Date" means the Executive attaining age 65. 1.1.8 "Termination of Employment" means the Executive's ceasing to be employed by the Company for any reason whatsoever, voluntary or involuntary, other than by reason of an approved leave of absence. 1.1.9 "Years of Service" means the total number of twelve-month periods during which the Executive is employed on a full-time basis by the Company, inclusive of any approved leaves of absence. ARTICLE 2 DEFERRAL ELECTION 2.1 Initial Election. The Executive shall make an initial deferral election under this Agreement by filing with the Company a signed Election form within 30 days after the date of this Agreement. The Election Form shall set forth the amount of Compensation to be deferred. The Election Form shall be effective to defer only Compensation earned after the date the Election Form is received by the Company. 2.2 Election Changes. 2.2.1 Generally. The Executive may modify the amount of Compensation to be deferred by filing a subsequent signed Election Form with the Company. The modified deferral shall not be effective until the calendar year following the year in which the subsequent Election Form is received by the Company. The Executive may not change the form of benefit payment initially elected under Section 2.1. 2.2.2 Hardship. If an unforeseeable financial emergency arising from the death of a family member, divorce, sickness, injury, catastrophe or similar event outside the control of the Executive occurs, the Executive, by written instructions to the Company may reduce or cease future deferrals under this Agreement. ARTICLE 3 DEFERRAL ACCOUNT 3.1 Establishing and Crediting. The Company shall establish a Deferral Account on its books for the Executive, and shall credit to the Deferral Account the following amounts: 3.1.1 Deferrals. The Compensation deferred by the Executive, as of the time such amounts would have otherwise been paid to the Executive. E-15 3.1.2 Interest. On the first day of each month and immediately prior to the payment of any benefits, interest on the account balance since the preceding credit under this Section 3.1.2, if any, at an annual rate, compounded monthly, equal to Merrill Lynch long term, high-grade corporation bond rate as published in the Wall Street Journal on the first business day following the preceding December 31. 3.2 Statement of Accounts. The Company shall provide to the Executive, within one hundred twenty (120) days after each anniversary of this Agreement, a statement setting forth the Deferral Account balance. 3.3 Accounting Device Only. The Deferral Account is solely for measuring amounts to be paid under this Agreement. The Deferral Account is not a trust fund of any kind. The Executive is a general unsecured creditor of the Company for the payment of benefits. The benefits represent the mere Company promise to pay such benefits. The Executive's rights are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by the Executive's creditors. ARTICLE 4 TERMINATION BENEFITS 4.1 Normal Termination Benefit. If the Executive's Termination of Employment occurs on or after the Early Retirement Date of Normal Retirement Date for reasons other than death, the Company shall pay to the Executive the benefit described in this Section 4.1. 4.1.1 Amount of Benefit. The benefit under this Section 4.1 is the Deferral Account balance at the Executive's Termination of Employment. 4.1.2 Payment of Benefit. The Company shall pay the benefit to the Executive in 180 equal monthly installments commencing on the first day of the month following the Executive's Termination of Employment. The Company shall continue to credit interest under Section 3.1.3 during the benefit payment period. The monthly installments shall be the amount required to amortize the remaining Deferral Account balance (with interest accruing at the interest rate determined under Section 3.1.2) over the number of months remaining of the original 180 months. 4.2 Disability Benefit. If the Executive's Termination of Employment for Disability occurs prior to the Early and Normal Retirement Dates, the Company shall pay to the Executive the benefit described in Section 4.1 as if the date of the Executive's termination of Employment were the Executive's Normal Retirement Date. 4.3 Termination Prior to Early Retirement Date. If the Executive's Termination of Employment occurs prior to both the Early Retirement Date and the Normal Retirement Date, and for reasons other than death or Disability, the Company shall pay the Executive the benefit described in this Section 4.3. E-16 4.3.1 Amount of Benefit. The benefit under this Section 4.3 is the Deferral Account balance at the date of the Executive's Termination of Employment. 4.3.2 Payment of Benefit. The Company shall pay the benefit to the Executive in a lump sum within 90 days after the Executive's Termination of Employment. 4.4 Hardship Distribution. Upon the Company's determination (following petition by the Executive) that the Executive has suffered an unforeseeable financial emergency as described in Section 2.2.2, the Company shall distribute to the Executive all or a portion of the Deferral Account balance as determined by the Company, but in no event shall the distribution be greater than is necessary to relieve the financial hardship. ARTICLE 5 DEATH BENEFITS 5.1 Death During Active Service. If the Executive dies while in the active service of the Company, the Company shall pay to the Executive's beneficiary the benefit described in this Section 5.1. 5.1.1 Amount of Benefit. The benefit under Section 5.1 is the greater of the Deferral Account balance at the date of the Executive's death, or the Supplemental Death Benefit set forth in Section 5.1.3. 5.1.2 Payment of Benefit. The Company shall pay the benefit to the beneficiary in the manner stated in the Form of Benefit selection in EXHIBIT 1 attached hereto, and beginning within 90 days following the Executive's death. 5.1.3 Supplemental Death Benefit. The Company shall pay to the designated beneficiary a supplemental death benefit equal to $__________ per month for 180 months beginning the first day of the first month after the Executive's death. 5.2 Death During Benefit Period. If the Executive dies after benefit payments have commenced under this Agreement but before receiving all such payments, the Company shall pay the remaining benefits to the Executive's beneficiary at the same time and in the same amounts they would have been paid to the Executive had the executive survived. ARTICLE 6 BENEFICIARIES 6.1 Beneficiary Designations. The Executive shall designate a beneficiary by filing a written designation with the Company. The Executive may revoke or modify the designation at any time by filing a new designation. However, designations will only be effective if signed by the Executive and accepted by the Company during the Executive's lifetime. The Executive's beneficiary designation shall be deemed automatically revoked if the beneficiary predeceases the Executive, or if the Executive names a spouse as beneficiary and the marriage is subsequently dissolved. If the Executive dies with out a valid beneficiary designation, all payments shall be E-17 made to the Executive's surviving spouse, if any, and if none, to the Executive's surviving children and the descendants of any deceased child by right of representation, and if no children or descendants survive to the Executive's estate. 6.2 Facility of Payment. If a payable is to a minor, to a person declared incompetent, or to a person incapable of handling the disposition of his or her property, the Company may pay such benefit to the guardian, legal representative or person having the care or custody of such minor, incompetent person or incapable person. The Company may require proof of incompetency, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit. ARTICLE 7 GENERAL LIMITATIONS Notwithstanding any provision of this Agreement to the contrary, the Company shall not pay any benefit under this Agreement that is attributable to the Company's matching contributions or the interest earned on such contributions: 7.1 Excess Parachute Payment. To the extent the benefit would be an excess parachute payment under Section 280G of the Code. 7.2 Termination for Cause. If the Company terminates the Executive's employment for: 7.2.1 Gross negligence or gross neglect of duties; 7.2.2 Commission of a felony or of a gross misdemeanor involving moral turpitude; or 7.2.3 Fraud, disloyalty, dishonesty or willful violation of any law or significant Company policy committed in connection with the Executive's employment and resulting in an adverse effect on the Company. 7.3 Suicide. If the Executive commits suicide within two years after the date of this Agreement, or if the Executive has made any material misstatement of fact on any application for life insurance purchased by the Company. ARTICLE 8 CLAIMS AND REVIEW PROCEDURES 8.1 Claims Procedure. The Company shall notify the Executive's beneficiary in writing, within ninety (90) days of his or her written application for benefits, of his or her eligibility or non eligibility for benefits under the Agreement. If the Company determines that the beneficiary is not eligible or benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of the Agreement on with the denial is based, (3) a description of any additional information or material necessary for the claimant to E-18 perfect his or her claim, and a description of why it is needed, and (4) an explanation of the Agreement's claims review procedure and other appropriate information as to the steps to be taken if the beneficiary wishes to have the claim reviewed. If the Company determines that there are special circumstances requiring additional tie to make a decision, the Company shall notify the beneficiary of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to additional ninety (90) day period. 8.2 Review Procedure. If the beneficiary is determined by the Company not to be eligible for benefits, or if the beneficiary believes that he or she is entitled to greater or different benefits, the beneficiary shall have the opportunity to have such claim reviewed by the Company by filing a petition for review with the Company within sixty (60) days after receipt of the notice issued by the Company. Said petition shall state the specific reasons which the beneficiary believes entitled him or her to benefits or to greater or different benefits. Within sixty (60) days after receipt by the Company of the petition, the Company shall afford the beneficiary (and counsel, if any) an opportunity to present his or her position to the Company orally or in writing, and the beneficiary (or counsel) shall have the right to review the pertinent documents. The Company shall notify the beneficiary of its decision in writing with in the sixty (60) day period, stating specifically the basis of its decision, written in a manner calculated to be understood by the beneficiary and the specific provisions of the Agreement on which the decision is based. If, because of the need for a hearing, the sixty (60) day period is not sufficient, the decision may be deferred for up to another sixty (60) day period at the election of the Company, but notice of this deferral shall be given to the beneficiary. ARTICLE 9 AMENDMENTS AND TERMINATION The Company may amend or terminate this Agreement at any time prior to the Executive's Termination of Employment by written notice to the Executive. In no event shall this Agreement be terminated without payment to the Executive of the Deferral Account balance attributable to the Executive's deferrals and interest credited on such amounts. ARTICLE 10 MISCELLANEOUS 10.1 Binding Effect. This Agreement shall bind the Executive and the Company, and their beneficiaries, survivors, executors, administrators and transferees. 10.2 No Guaranty of Employment. This Agreement is not an employment policy or contract. It does not give the Executive the right to remain an employee of the Company, nor does it interfere with the Company's right to discharge the Executive. It also does not require the Executive to remain an employee nor interfere with the Executive's right to terminate employment at any time. E-19 10.3 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached or encumbered in any manner. 10.4 Tax Withholding. The Company shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement. 10.5 Applicable Law. The Agreement and all rights hereunder shall be governed by the laws of Michigan, except to the extent preempted by the laws of the United States of America. 10.6 Unfunded Arrangement. The Executive and beneficiary are general unsecured creditors of the Company for the payment of benefits under this Agreement. The benefits represent the mere promise of the Company to pay such benefits. The rights to the benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Executive's life is a general asset of the Company to which the Executive and beneficiary have no preferred or secured claim. IN WITNESS WHEREOF, the Executive and a duly authorized Company officer have signed this Agreement. EXECUTIVE: COMPANY: SOUTHERN MICHIGAN BANK & TRUST - ----------------------------- ------------------------------ E-20 BENEFICIARY DESIGNATION SOUTHERN MICHIGAN BANK & TRUST DEFERRED COMPENSATION AGREEMENT (Name of Employee) I designate the following as beneficiary of any death benefits under the Southern Michigan Bank & Trust Deferred Compensation Agreement: Primary:________________________________________________________________________ ________________________________________________________________________________ Contingent: ________________________________________________________________________________ ________________________________________________________________________________ NOTE: TO NAME A TRUST AS BENEFICIARY, PLEASE PROVIDE THE NAME OF THE TRUSTEE(s) AND THE EXACT NAME AND DATE OF THE TRUST AGREEMENT. I understand that I may change these beneficiary designations by filing a new written designation with the Company. I further understand that the designations will be automatically revoked if the beneficiary predeceases me, or, if I have named my spouse as beneficiary and our marriage is subsequently dissolved. Signature: ____________________________ Date: ________________________________ Accepted by the Company this _____ day of _____________, 20____. By: __________________________________ Title: ________________________________ E-21 EX-21 5 k74384exv21.txt SUBSIDAIRES OF THE COMPANY . . . EXHIBIT 21 SUBSIDIARIES OF THE COMPANY
State or County Name of Subsidiary of Incorporation ------------------ ---------------- Southern Michigan Bank & Trust Michigan SMB&T Financial Services, Inc. Michigan SMB Mortgage Company Michigan
Southern Michigan Bancorp, Inc. is the immediate parent and owns 100% of the outstanding shares of Southern Michigan Bank & Trust. Southern Michigan Bank & Trust is the immediate parent and owns 100% of the outstanding shares of SMB&T Financial Services, Inc. and SMB Mortgage Company. E-22 EX-23 6 k74384exv23.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements of Southern Michigan Bancorp, Inc. on Form S-3 (Registration No. 33-24977 and Registration No. 333-51417), of our report dated February 5, 2003 except for Notes N and Q, as to which the date is February 17, 2003, on the consolidated financial statements of Southern Michigan Bancorp, Inc., which report is included in the 2002 Annual Report on Form 10-K of Southern Michigan Bancorp, Inc. /s/ Crowe, Chizek and Company LLP ----------------------------------- Crowe, Chizek and Company LLP South Bend, Indiana March 26, 2003 E-23 EX-99.1 7 k74384exv99w1.txt 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 99.1 CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, John H. Castle, the Chief Executive Officer of Southern Michigan Bancorp, Inc. (the "Company") hereby certifies that, to the best of his knowledge: 1. The Company's Annual Report on Form 10-K for the year ended December 31, 2002, and to which this Certification is attached as Exhibit 99.1 (the "Annual Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2003 /s/ John H. Castle ------------------------------------------- John H. Castle Chief Executive Officer This certification accompanies the Annual Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended. E-24 EX-99.2 8 k74384exv99w2.txt 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 99.2 CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Danice Chartrand, the Chief Financial Officer of Southern Michigan Bancorp, Inc. (the "Company") hereby certifies that, to the best of her knowledge: 1. The Company's Annual Report on Form 10-K for the year ended December 31, 2002, and to which this Certification is attached as Exhibit 99.2 (the "Annual Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2003 /s/ Danice Chartrand --------------------------------------- Danice Chartrand Chief Financial Officer This certification accompanies the Annual Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended. E-25 -----END PRIVACY-ENHANCED MESSAGE-----